In the world where being grunge is often applauded and rewarded, I remain convinced that being tacky is a cultural statement about one’s point of reference.

Is it just me or have you also noticed some of the creeping influences of grunge within the world of CRE?

Of late, I’m becoming more acutely aware of the relationship between cracked stucco, peeling paint, potholed parking lots, leaking roofs and the level of an owner’s commitment to creating and maintain property value through capital improvements and dedication to property management.

I See Ugly Properties

My recent observations of properties in the metro Phoenix, Arizona commercial real estate market have led me to the conclusion that something grungy is happening. Once pristine properties are now left to the elements. The same grunge is becoming more and more apparent in the Prescott, Flagstaff and Sedona, Arizona commercial real estate markets.

There appears to be a deliberate draw-down on capital commitments and property management. It’s obvious, it’s annoying and it most certainly can impact a commercial property’s actual and perceived value. Capital is tight and owners are hesitant to spend.

In a market with negligible, if any, appreciation, some owners are choosing to tighten their financial belts by commiting the unpardonable sin of withholding capital and maintenance improvements necessary to the value equation. Some of this is being forced on owners under the principle of too much property, too little capital.

More than ever, those scant investors who are looking to buy or exchange are digging deeply into the maintenance history of a targeted property and insisting that value adjustments be made for improvements during the initial 36-month their ownership window.

Tenant Perceptions & the Grunge Factor

Retention is now as important as leasing itself. The most clostly and devestating loss a property experiences is vacancy recovery. In fact, I’m finding that in some cases retention is the only path owners can take to sustain their already threatened values.

Grunge shrinks values and contributes to poor leasing and negative tenant retention rates.

• Grunge = concerned, nervous and even angry tenant.
• Grunge = lower lease price per square foot.
• Grunge = a position of weakness in the renewal process.
• Grunge = refinancing problems reflected in appraisals.
• Grunge = diminished public percention of a property.
• Grunge = all sorts of ugliness…that’s why it’s called “grunge.”

The tenant issues stemming from CRE Grunge are myriad and they create value objections on the front end of the leasing process as well as retention problems. When a property enters a cycle toward physical decline the market responds with like-kind perceptions.

Quality maintenance = perceived and actual value.

Retail tenants are more keenly aware of the relationship between quality properties, price per s.f., NNN charges and more importantly, in their minds, consumer traffic.

We can cheat on maintenance, but not for long. Tenants are shopping the market, constantly looking for an edge on cost, a better location, a cleaner look and an owner committed to upkeep.

Grunge may be a prevailing desease we have to live with during the overbuilt, under-capitalized commercial real estate market. But, rest assured, grunge eventually extracts its toll.

There has been a lot of talk about pent-up demand, cash on the side lines and investors in the wings. So far we have not seen the long awaited collision of reduced prices and pent-up demand.

We travel down the road, wearied and parched, as months go by without our seeing a passing vehicle.

Small and intermediate investors, those most strapped for cash reserves, are running low on fuel waiting for the collision of buying power with what they fear is their last price adjustment they dare make before the notes are called and new refinancing is required. The NOI isn’t there, neither are the tenants or the buyers.

The good news is that we are seeing the dust of approaching vehicles just over the hill. There is the noise of oncoming traffic.

Those of us in the Northern Arizona commercial market are seeing a measurable increase in traffic. We are seeing more tenants, slight increases in rental rates and in general more activity on the retail and industrial fronts.

Although we are not yet ready to pop the corks on the Champaign bottles, we are least sipping some cheap wine in anticipation that perhaps 2011 will bring the collision between lower rates and pent up demand.

Barring any overreaching government intervention and further reluctance of lenders, I am now finally ready to at least acknowledge the prohibited collision is predictably logical.

Note: This post was originally written by Donald Teel for residential Broker-Owners. It is syndicated from REALonomics because of its relevance to commercial brokerages and investors. “REALonomics” is a registered trademark ® of The Teel Group, Inc.

The real estate industry is not too unlike an organization living in a state of collective schizophrenia. Figuratively speaking, we are hearing voices that are not real.

Our hallucinations are mostly self-induced; the voices we hear are actually our own mumblings and business babblings disguised as forces we do not control.

I’m now convinced the real estate industry is delusional but not in the classic clinical sense of schizophrenia. Rather, we are deluded by the notion that what we are experiencing is beyond our control.

Since we don’t have an alternative point of reference for our dilapidated and dysfunctional (not to mention unprofitable) business models, we willingly succumb to the voices that keep telling us all will be well and in time the market will return to normalcy (whatever that is).

We have come to actually believe there is a quick cure for our collective malady. We have long ago stopped taking the medications of self-reliance that can eliminate the voices and have instead turned to a political pill that only fuels the illness and delays the inevitable.

The Great Delusional Grip

Franchisors continue to pimp and prescribe, increasing their delusional grip on Broker-Owners, convincing them, mistakenly, that their brands are necessary as a market value proposition and to their survival.

To control the delusions and squelch the voices we pretend our economic survival can be optimized by merely changing the colors of the pills we ingest. We hallucinate about technology solutions that magically produce profitability through Internet lead generation. The voices continue.

For a long time we have believed the pseudo voices and their message as they tell us to hold on, wait and believe that change is coming in the form of a market rebound that will resurrect the old models and their former but temporary profitability. In reality we are trading our collective ability to transform our industry for a hope in the return of things past, of things long dead and gone. Have we surrendered our business sanity to the collective stupor of a beautiful mind syndrome?

It wasn’t long ago that I also experienced the paranoia that comes from thinking others can and ought to control the business outcomes of my company and that there were forces out to get me if I didn’t comply with the verbal orders of quiet, shadowy personalities hiding under stairways and standing in dark corners, speaking to me and intimidating me as a Broker-Owner.

Dumping Market Meds into the Drinking Water

As we prepare to enter 2011, our illness is becoming more pronounced. Others see the progressive changes but we do not. We do not know whether to take the generic market meds being dispensed by the National Association of Realtors or to reject them while hoping for an alternative magic that can somehow stop the insanity.

NAR is dumping its generic market meds into the drinking water in a giant shift from its fundamental and historic premise that home ownership ought to be based upon the self-reliance of individuals to a new socialist real estate state where wealth is shifted from tax payers to fund the down payments for otherwise under-qualified first time home buyers. It’s the same old repackaged sub-prime pill I will no longer swallow.

Schizophrenia is my metaphor for disordered thinking that is not aligned with sound economic reality in the midst of a market platform that has shifted under the feet of Broker-Owners.

On one hand, we know we are living in a time of great delusion and we desperately want to stop the voices.

On the other hand, we continue to pander to the hallucinations because we want a simple solution to a complex industry illness. We know the voices are not real but we cannot quiet them. We drink the purple water and we pop the multi-colored but phony economic pills that will temporarily muffle the sounds but never permanently stop them.

We are becoming more and more desperate because we are on the edge and are finding it more and more difficult to distinguish reality from fiction. The market meds do not help because they create an additional layer of fog that further weakens our discipline and stifles our resolve to take charge of our individual and collective illness.

Stopping the Voices

There is coming a time when we will have to make a deliberate choice between believing what the voices are telling us and the reality that we are operating our industry from a position of economic dependency that will eventually render us incapable of recovery.

Like many Americans who are waiting for the government to produce solutions, many in our industry are waiting upon the bureaucratic solutions of NAR to deliver a cure that will stop the voices. We have yet to recognize that NAR is but one of the many voices that create the madness that engulfs us.

Some of us are now realizing we have fallen prey to a placebo that can never deliver true economic healing. A few of us are now realizing we have fallen prey to a placebo that can never deliver true economic healing and that in the end we must once again, deliver our own cure.

CAP rate pricing strategies are increasingly difficult to pencil-out these days. After we doing the math we are often left shaking our heads. Owners are facing note calls and having some sleepless nights wondering how to score lending. Lenders are insecure and uncertain about what the Feds might do next.

Welcome to “ABNORMAL” where normalcy, whatever it is or was, exists no more. Welcome to normal defined by abnormality. Our CRE world is fast becoming a frenzied marathon that owners discover takes them nowhere, slowly. Yikes!

Enter Legislative Reform and No Risk Lending

President Barack Obama has signed into law a 2,300 page legislative act known as the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (HR 4173).

Download the Davis Polk Summary of HR4173

Although the bloated document’s proponents claim the new law will right the financial wrongs that created the current abnormal state of affairs in lending, others think it may create more uncertainty in the lending market.

Proponents of the legislation claim it will reduce systematic risk in lending and thus protect the banks and the lenders.

My question is fundamental to CRE investment. Can there be such a thing as “no risk” lending? And it such a creature can be created in Washington’s legislative laboratories, will it be just another Frankenstein that further wreaks havoc on the CRE investment world.

The legislation translates into a myriad of government studies (such studies typically create abnormality) designed to formulate the regulations designed to provide the framework that will enforce all of the rules that will serve as the engine that will run the new lending vehicles.

New Bureaucracy to Protect Us from Them

Obama’s legislation is essentially an outgrowth of the notion that we all need protection. It’s designed to protect “us” from “them” with the “them” being predatory lenders.

Our new “abnormal normal” will create an army of regulators, perhaps thousands of them, who report to work each day in the Financial Stability Oversight Council (risk monitors), a Federal Insurance Office (risk regulators) and a Consumer Financial Protection Bureau, a group of guys and gals who will actually write the specific laws that they say will protect us all from risks associated with unfair lending.

Download the Davis Polk Summary of HR4173

My personal take is that we are entering an Orwellian Abnormality masquerading as the new normal that will in the end, create more uncertainty than ever before. And we all know what uncertainty produces…more uncertainty and subsequently hesitation and reluctance with respect to commercial underwriting.

People who know more than I predict it will take at least a couple of years just to create the formulas and rules necessary to enact the law’s theories into a set of understandable regulations and universal standards for our new normal.

What is the predictable response from lenders going to be while the bureaucracy is assembled and the rules for the new lending environment are penned and codified? Let me see if I can guess what the response of lenders will be…hmmm, how about wait, slow down and resist? Uncertainty always creates this response from lenders.

The Orwellian abnormality in lending is simply that a cadre of government soothsayers can formulate safe, no risk lending. My contention is that the theory of such a safe environment is in-and-of-itself, the ultimate uncertainty and therefore, the ultimate abnormality.

Download the Davis Polk Summary of HR4173

Has anything changed since Trump wrote his 1988 best seller? Yes, a lot has changed. The fundamentals of deal making have not changed and perhaps they never will.

Making deals is one thing…now, however, the renewed skill that is most in demand is how to shape the deals we are making.

Due to today’s unique economic times, I’m discovering there is a big difference between securing signatures and shaping a deal for long term performance.

In fact, shaping the deal may be the requisite skill now in most demand because there are fewer deals to be done and the deals that are getting done require more perseverance and targeted thinking.

Negotiating Breakfast with My Daughter

Almost every day, we are all negotiating something. I did it this morning with my 9-year-old daughter. We negotiated about her breakfast. She wanted chocolate donuts, not one, but two! Once we formulated the premise for the sign-off, i.e., what each side had to have, we then had the core of the deal.

My position was clear. “You cannot have donuts for breakfast.” Her position was, “Donuts is the only way to make this deal work.”

Of course, like all parents, we often have to force the deal on our children, especially when it comes to property diet.

My daughter knows the limits when pushing dad around. We have long ago established the negotiating framework. She opened the shaping phase of the negotiations with “So, Dad…you said no donuts for ‘breakfast’…that means I can have one if we don’t call it ‘breakfast’…we can call it desert from last night’s dinner.”

Suddenly, I was reminded of the power of shaping the deal, rather than simply making the deal.

The negotiations were shaped and the deal finalized after a healthy breakfast of fruit, scrambled egg and one strip of bacon. On her side, she got half a donut placed in her lunch box. She got some of what she wanted…I got some of what I wanted and what I know as a parent she needs.

Shaping Deals with Adults who Fight Back

There is a big difference between negotiating and shaping a deal with a kid over whom you have parental rights and authority and squaring off with adult negotiators who fight back and refuse to be shaped.

In the commercial real estate arena the principles of shaping the deal are the same. And here they are for you master negotiators:

• Understand the financial framework of the deal; your side and the other side. Clint Eastwood once said in a movie, “A man’s got to know his limitations.”
• Create points in time where you give the other side what they want. If you cannot surrender a point today, when might you and how might you at some point in the deal.
• Engage in trade-offs that are tangible and represent real concessions…people are not stupid, so be honest and don’t try to smoke and mirror the other side.
• Keep reminding yourself that you may never have another opportunity to shape the deal in front of you. In today’s complex market investors and tenants are fickle and may not return to the table.

Of course, some deals cannot be shaped. When the numbers do not work, they simply do not work, period. You cannot shape a $30 per square foot deal in a $20 market, usually.

What you can do is shape the transaction, its terms and cash flow in a number of ways to create transitional value in the down market so that in 3, 5 or 7 years your value position is closer to the desired financial end point.

Say “No” too early in the process is often going to kill the transaction for all parties. Replacing “No” with “Let’s look at this to see if we can make it work” is the first step in shaping the deal.

Shaping the deal will protract the cycle, increasing the cost of sale; time is money. There are few quick-close deals in my market. The limited deals take longer. The economy has created Principals that are decidedly more hesitant and methodical as they wind their way through the deal.

Shaping is becoming the new norm and the skill-set required is not easily found and maintained. We have been spoiled by the easy deals that were part of the 2000 to 2006 real estate boom. These are gone, perhaps for good. The bar has been raised and shaping the deal is often a more powerful skill than simply making the deal.

As capital drys up, the pace of investment slows and qualified tenant pools shrink. Engaging in the science and art of shaping the deal always made sense but now it is the critical element.

Shaping the deal is the new watershed.

The information provided here is better than the far-reaching and biased reports I have read, while giving some real signals as to where the commercial property and capital markets are headed.

Click the image below to be taken to the pre-recorded webcast.

This presentation is Copyright © 2010, Marcus & Millichap and is used for educational and editorial purposes.

This was shot while tooling down Interstate 40 between Flagstaff and Kingman, Arizona. It’s all part of a new feature for this blog entitled CRE Road Kill. Stay tuned for more CRE Road Kill.

The following “60 Minutes” interview is an amazing story from the inside of the mortgage securities industry and how experts made money creating a disaster and are now making money cleaning up the disaster. Imagine being paid to run your organization into the ground…watch it.

Watch CBS News Videos Online

The following video was shot on a recent drive to Phoenix and is the first of what I hope will be a regular feature entitled CRE Road Kill. In this installment, I am addressing what I call the Tenant Trough, what it is the problems it creates for owners. In Part 2 I will talk about solutions…stay tuned.

Merriam-Webster defines “trough” as follows:

• a long and narrow or shallow channel or depression (as between waves);
• the minimum point of a complete cycle of a periodic function;
• the low point in a business cycle