COVID 19: Prop 13 and It’s Impact on Tenants With Erik Hernandez #699


Bruce Norris is joined this week by Erik HernandezErik is a commercial real estate agent and a senior vice president and principal with Lee and Associates in Ontario specializing in industrial real estate. Erik’s specialties include active tenant-buyer representation, landlord representation, land sales and development, build-to-suit assignments, and investment sales and analysis. Erik’s real estate career now expands over 20 years in the Inland Empire, and he’s achieved recognition for many notable transactions. He has been involved in over a billion dollars worth of commercial real estate transactions. See below for full video and resources.

Episode Highlights

  • How would he describe 2019 as a whole from an activity standpoint?
  • How has California become a destination market for brand new, state-of-the-art buildings?
  • How is the retail model holding up in terms of how they were affected by COVID?
  • Have there been any law changes that could impact the industrial real estate world?
  • What does SB 939 cover?
  • What does Prop 13 cover, and will it be on the November ballot?
  • Is this a proposition they want to see passed?

Episode Notes

Bruce Norris: Hi, thank you for joining us. My name is Bruce Norris, and today our special guest is Erik Hernandez. Erik is back with us probably for, I don’t know, fourth or fifth time. Erik’s a commercial real estate agent and a senior vice president and principal with Lee and Associates in Ontario specializing in industrial real estate. Erik’s specialties include active tenant-buyer representation, landlord representation, land sales and development, build-to-suit assignments, and investment sales and analysis. Erik’s real estate career now expands over 20 years in the Inland Empire, and he’s achieved recognition for many notable transactions. He has been involved in over a billion dollars worth of commercial real estate transactions. Erik, we welcome you back to our show.

Erik Hernandez: Bruce, it’s great to be back. I think it’s been too long. It’s always great to catch up with the smartest guy in real estate that I know, and that’s you.

Bruce Norris: You know what’s fun, though? You know, when you put stuff in writing, as I do, some of the stuff you look at after you put it in writing and go, “Boy, I sure hope that comes true.” So three years ago, we wrote a report that the title was Two Percent Mortgage Rates, $40 Trillion in Debt. There was a timeframe for a lot of that to happen, both the interest rate and the $40 trillion. So today this morning, I just got an e-mail from a guy that I’ve used as a lender occasionally, and I recommend him regularly, and he just told me he did his first funding of a sub-three percent, 30-year mortgage. That’s pretty incredible.

Give me a review of 2019 for the commercial real estate world that you’re connected to. It seems like an eon ago at this point, but wrap up 2019 as far as how it was.

Erik Hernandez: 2019 from an activity standpoint was one of the best years ever for industrial commercial real estate in the Inland Empire. Now we are fortunate to be at the crossroads of a lot of different things. Here in Southern California, the Inland Empire is really the only major market you can go to if you are looking for a brand new state of the art industrial facility. For example, Amazon has taken, I’ve lost track of how many buildings they’ve taken now, in the last 24 months and their huge expansion there. But even if Amazon wanted to go to, let’s say, Los Angeles or Orange County and lease a million square foot building, they really can’t because there’s really no land left to do that. If they want to do that, they’ve got to come to the Inland Empire. So they’ve taken, multiple locations all over the Inland Empire from out in the east, out to the west. It’s interesting how they do it because they build these buildings. You’ve probably seen this project right off the 15 freeway in Eastvale, and they build these million square foot building. What people don’t realize is inside some of these buildings, they put two additional stories of deck mezzanine. So when you drive by, you don’t realize that it’s really a three-story industrial building on the inside. It’s just incredible the amount of improvements they put into these buildings.

We’re a destination market for brand new state-of-the-art buildings, and from a technology standpoint, we’re at the crossroads of this next wave of E-commerce 2.0 where people obviously have been buying things online for a long time, but their willingness to buy other large ticket items has really taken off in the last five years. If you’re familiar with, like Wayfair, you know, the furniture company that sells a lot of things online. The technology has caught up in the willingness for people to buy those types of things online has really taken off. I may be a little bit more old school. I like to go touch it and feel it. Now, my sister is a really good example. She’s in her early 30s, got married, started a family, bought a place in Irvine, and she furnished probably 70 percent of it online. I asked her, I said, “Well, what? How do you do that? What if you don’t like the furniture? It doesn’t work.” And she said, “Well, I just call them up and return it. I’ve got 30 days to return it.” That didn’t really exist even maybe 10 years ago where you could buy that type of furniture online and have the confidence to be able to return it. Now the reverse logistics end of that business, all these companies are really still trying to get a handle on it because the returns are a whole other issue. But we’re really fortunate in Southern California and in the Inland Empire to be at the right place at the right time with many things happening that is good for growth and development and job creation in the Inland Empire.

Bruce Norris: What you just said has ramifications for anybody that has a physical location for furniture.

Erik Hernandez: Very true. Yeah. So one of my clients -now, you wouldn’t think about this. Let’s use Costco as an example. If you go on costco.com and buy piece furniture there, very often that piece of furniture is not warehoused with Costco, it’s warehoused with a third party, like one of my clients, for example. So you buy it online, and the order gets routed from Costco to my client, and then they fulfill it and they do the last mile delivery. They do the white glove, bring it up to your doorstep, you pay an extra $50-$80, they bring it over the threshold into your home. They install it, take care of it, and then if you need it picked up because you want to return it, you pick up the phone and call them and they come back and they get it from you. It’s interesting. Costco obviously has a huge physical presence, but they’ve integrated their e-commerce aspect to their business. So during this COVID quarantine, stay-at-home that we all went through over the last few months, if a business did not have a large component of their business type e-commerce, they got hit pretty hard compared to those businesses that were able to thrive and still do a large percentage of their business online. It’s a really good example of that and how technology has changed, how we buy things, and how people do business.

Bruce Norris: Well, it’s also when you’re thinking about where the future is going to go, I don’t think it’s going to retreat from that a great distance because you have a business model that works regardless. So you really would be hesitant to say, “OK, well, let’s buy a bunch more square footage in a mall or something when you go, ‘well, wait a minute, let’s create a safer model than that.'”

Erik Hernandez: It’ll be interesting to see how the next few years develop. A lot of people are very concerned about retail real estate. That seems to be the market that has really just gotten impacted the most during all of this. I sent you an article. We had talked about this – the Irvine Company back in March was way ahead of most landlords in thinking about how they were going to deal with their retail, especially restaurant tenants. Back in March, there was an article in the Orange County Register on March twenty third, and the Irvine Company basically came out to their tenants at Fashion Island and the Irvine spectrum, and they gave them a 90-day rent break. They said that for April, May and June, it’s now rent-free. Pay it back next year, and we will amortize it over a period of twelve months in 2021 because they knew that it was going to be an issue. They’re the first company that I can really think of that got way out ahead of what was happening. Actually, at the time, it was pretty pioneering because I think the emergency order or the lockdown order stayed home maybe the week before.

Bruce Norris: That was a lot of foresight and probably made their customers breathe a big sigh of relief. Nobody said they had to find a way to close or get the heck out of here. So that was smart for retention.

Erik Hernandez: Well, having a tenant, it’s got a chance to make it and be in business as a landlord is better than putting your tenant out of business. Landlords have invested interest in working with tenants, especially if they’ve been severely impacted by all of this, to figure out how to make it work and lend a helping hand to keep their tenants in business.

Bruce Norris: I think that type of thing also is remembered. I got to be honest with you. You know, when you reach across the table and say, OK, I understand you’re going to be having a difficult time. I’m going to help you get through it. Not everybody did that, but the people that did it I think will be remembered for doing it. I would certainly feel that way.

There’s another segment. I know you’re not connected to this part, but we talked about retail getting hit. Hotels are another one. So that’s kind of connected to commercial real estate, and I know you’re not connected to it on a daily basis, but do you know people that are and the survivability of that model? Is that a big problem?

Erik Hernandez: You know, it would be a stretch for me to pretend to be an expert on the hotel side, so any information I have is just really anecdotal. I do know a couple of people that work out or manage some notable local hotel places and based on what I have seen them post on Facebook or interacted with them about how low their occupancy levels have gone locally. The occupancy levels locally dipped below 20 percent. Sometimes they were ten to fifteen percent. It’s a variety of different things. People not traveling has a huge impact because if you travel and go out of town, the first thing you do is you probably book a hotel room if you’re not staying with family. If you’re traveling for business or pleasure, you may not rent the car today, you might just uber everything, but you still need a place to stay. Hotels and Airbnb is very popular. All of those businesses were pretty severely impacted during all this. It would be a reach for me to speculate on how that’s all going to evolve over the next few years, but they’ve definitely been severely impacted. That’s for sure.

Bruce Norris: We were going to have somebody else join us, but they had a family member who passed away. My condolences to them.

Is there any law changes? So if you have an apartment and found out you couldn’t evict somebody and they were talking about a moratorium of rent – if you’re a hard money lender there was talk about a moratorium of payment – so is there any legislation that they’ve dreamed up that might impact the industrial real estate world?

Erik Hernandez: So there’s actually a bill that’s going through California right now in the legislature, the National Commercial Real Estate Development Organization, and many other groups, many chambers of commerce and other business-driven organizations that understand the business side of things, there’s something called SB 939 that is trying to get out of committee in the legislature. I believe it’s on the Senate side in California. It basically is going to give commercial tenants the ability to not pay rent for 12 months. I think I’ve got an e-mail here that would be better suited. Maybe if I read it, it would give a little more detail for that. Let me pull that up there. In fact, the angle that this is being pushed is to help commercial tenants in their leases, and the idea was that it would be for restaurants, right? But it’s not really written for restaurants. It could apply to any commercial real estate lease. So basically, the idea is that commercial tenants would not have to pay rent retroactive to March 2020 for an indeterminate amount of time tied to the state’s emergency order. And it doesn’t require payment of rent until twelve months after the order is lifted. So, for example, if the state’s emergency order is lifted at the end of the year, businesses could be operating and generating revenue for more than a year but not be required to pay rent until January 2022.

Bruce Norris: Wow.

Erik Hernandez: Now, if you’re a landlord, most landlords typically have a mortgage on their building. Are they going to go to their mortgage lender and say, “Hey, my tenant’s not paying me rent so I’m not going to pay you?” I don’t think that’s going to work. I think the mortgage lender is going to be standing there going, “Well, if you don’t pay me, it looks like you’re not going to have the property anymore. It’s going to be my property now.” So there’s a whole cascade of events that sets off. I understand where maybe the idea’s coming from. These restaurants, in particular, some probably won’t make it. I hope they all make it, but unfortunately, that’s probably not going to be the case. So I understand the idea of wanting to help, but it’s a good example of government getting in the way of something and having a good idea gone bad vs. savvy landlords, and then the Irvine Company is a really good example, getting way ahead of the problem. This was back in March, three months ago. They got ahead of it and started working with their tenants to actively make sure they could keep them in business so that when things started opening back up, like now, they still have tenants. When we were all working from home, most of the work that I did during that time, if there were existing deals that were in progress, I did several lease renegotiation between tenants and landlords where sometimes I was on the landlord side, sometimes I was on the tenant side where we all sat back down together, you know, virtually basically or on conference calls, saying, “How do we figure this out?”

One of my clients was tied to the furniture business. Another side, I was on the landlord side and the tenant came to us and they said, “Hey, we’re in the picture frame business,” and they bring in picture frames from all over the world and they sell them wholesale to retailers. Right. By the end of March, their revenue was zero. They didn’t expect they were gonna be able to sell anything for April. Hopefully business picked back up in May, and they have been a great tenant for several years. They always paid on time, so the landlord worked something out and did some rent relief. We worked it out so that we would make it up on the back end of the lease. Now, the landlord doesn’t want to lose a good tenant, and it was an extraordinary time to add certain businesses. Revenue just went to zero. There were many stories like that where people were impacted if their business wasn’t directly tied at eCommerce. Landlords want to work with tenants to keep them in business if they think they are good tenants. I’ve seen the vast majority of landlords have been more than willing to lend in open air and figure out how everybody works together to come up with something that’s mutually beneficial for all parties.

Bruce Norris: Yeah, that makes it makes a lot of sense. Will Prop 13 be on the ballot in November for commercial?

Erik Hernandez: Yes, so we’re talking about the split roll property tax initiative, right?

Bruce Norris: My gut sense is that it will pass. So I’m just curious, what do you feel? Do you think it will not pass or do you think it will pass?

Erik Hernandez: I hope it doesn’t pass.

Bruce Norris: I hope it doesn’t pass either. It would triple my building tax.

Erik Hernandez: So this is a good fundamental understanding that maybe most people don’t realize in how commercial real estate leases happen. So the general idea, whenever I see someone advocating for the split roll property taxes is it’s with the idea that we need to get those rich real estate owners to pay their fair share. That’s a whole other debate on what is the fair share. Do they not pay enough? Do they pay too much already? That’s a whole other topic. But in general, the premise of raising property taxes on commercial real estate to raise money and get someone to pay more is very misleading because the vast majority of commercial real estate leases in California, certainly at least 99 percent or more of all commercial real estate leases I’ve ever negotiated and the Standard AIR commercial real estate lease form says that if property taxes go up, the landlord has the right to pass that cost on to the tenant. So, for example, whenever a building sells from one party to another, if it’s a different party that requires the property because of Prop 13, the property taxes only get reassessed at the new market value when the property trades hands. So when that property trades hands, the real estate taxes go up, the assessed value goes up. With that increase in property taxes, the bill goes to the owner, but all the owner does is they give the bill to the tenant and they say, “OK, you now owe me this amount of additional property taxes because I’ve got the right to pass through that additional increasing cost to the tenant.” If property taxes go up on assessed values and then the property taxes for commercial real estate, the vast majority of the increases in those taxes will be paid by the existing businesses operating in those buildings. California already has a problem losing businesses to other states for a variety of different reasons: legislative, unfriendly business environment, regulations, whatever you want to take. I mean, even Elon Musk is tweeting that he was going to move the Tesla factory out of Fremont to another state because of all the wrangling he was going through with the local officials up there. I don’t know if that really happened or not or if that would just leverage negotiation. But it got a lot of attention. Toyota made a big splash a couple years ago when they moved their headquarters that was in the South Bay in Los Angeles to Texas. Texas very actively likes to poach high-profile companies from California because, I think in their mind, it’s pretty easy to do. The last thing I would like to see is Prop 13 be changed because, frankly, of all the legislation that people can poke fun at or say that, you know, California is a difficult place to do business, in my opinion, Prop 13 is a shining example of one of the great pieces of legislation that California passed that a lot of other states don’t have. Prop 13 especially protects our seniors and people that have owned homes for a long time from not getting priced out of the home that they lived in for maybe 20 or 30 years. It’s a great piece of legislation, and I don’t think we should touch it at all.

Bruce Norris: I brought that up to an economist one time who was very much in favor of changing Prop 13 for residences. And when I brought up that’s a protection for people to keep their homes. His comment was that’s why they have reverse mortgages.

Erik Hernandez: Put them in more debt? Great job paying off your home. Now we’re going to put you in more debt so you can stay in it.

Bruce Norris: Yeah, not very sensitive.

Erik Hernandez: I really do believe that Prop 13 is one of the great pieces of legislation that California passed. A client of mine that was in town a few months ago from Massachusetts, we have similarly sized homes valuation wise, but the property taxes for his home are five times what mine are. That’s incredible.

Bruce Norris: California doesn’t win all the tax battles, of course, when you mean you make income. We do a lot of stuff in Florida that has zero or has six percent sales tax, not seven and a half. You know, you start adding those pieces together, and it’s a big difference.

The reason I’m concerned about it passing is because the inventory they’re going after is owned by a very small percentage of people. It really depends on the voter understanding where that lands because it’s going to land, just like you said, not going to land in the negative side of the person that owns a building. It’s going to get passed to the person that rents from them who’s going to pass it on in product costs to the consumer if he can. Now, if he can’t and he just has to eat that change, you might have a vacancy. So there are some ramifications to it, that’s for sure. But I think because so few people own that type of real estate that’s impacted, it has a chance to pass better than what I would have liked. Even if it doesn’t pass, and this is a difficult thing; a couple of years ago, we voted against rent control, and now we have it. So it’s kind of an interesting journey how things can get changed that you voted against, and Prop 13 has always been my opinion or my understanding that it really does have to get changed by a vote of the people. I don’t know why that’s different.

Erik Hernandez: I hope that people that are going to go into battle to help people understand what it really means when you do this split roll property tax initiative, and this has been tried several times, right? You know, it’s often for different reasons. You know, sometimes the schools need more money or we need more money for this or whatever the purpose is, you’re really not getting the owners of the real estate to pay for it, right? Maybe that mentality is that we’re going to get Scrooge McDuck to pay more. But actually, they’re not going to pay any more at all. It’s going to be all of these tenants that are operating these buildings, many of which are small to medium-sized businesses. And, you know, some of those people, you know, that’s the difference between being able to pay rent this month or payroll or maybe letting an employee go or increasing your cost, if you can, to absorb that additional debt. You know in some cases, I would imagine if the building’s been owned for a long time, the property tax increase would be substantial. I hope it doesn’t pass. The purpose for the money, and do we need more money for other things? That’s a whole other discussion, but I think the idea that only a few people are going to pay for their tour is really misdirected because it’s really going to be all the businesses that operate: law firms, attorneys, hospitals, medical clinics, doctors groups, small manufacturers, value add people, distribution. Everybody that you see that’s in a business building will be directly impacted because they’re tenant operating in that building. I think it’s just really misdirected, in my opinion. I hope it doesn’t pass.

Bruce Norris: I hope it doesn’t either.

The Norris Group originates and services loans in California and Florida under California DRE License 01219911, Florida Mortgage Lender License 1577, and NMLS License 1623669.  For more information on hard money lending, go www.thenorrisgroup.com and click the Hard Money tab.

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