This article appeared in the fall issue of Urban Land on page 161.
Almost $20 billion in commercial real estate traded hands in the Washington, D.C., metropolitan area in 2018 in at least 290 transactions, according to brokerage firm Newmark Knight Frank—and that is only counting transactions over $20 million. Each of those transactions involved a story. A buyer had to find a seller, they had to agree on terms for the purchase, and then the buyer had to get to closing.
The D.C. area is similar to other metro areas in how this process works, but with some local nuances. There are three general ways a buyer of land or a building finds a seller in D.C.—the property can be publicly marketed by a brokerage firm; the property can be partially marketed with a broker involved but with a limited number of potential buyers; or the transaction can happen completely off market with no intermediary between the buyer and the seller.
Fully Marketed Deals
The vast majority of deals in D.C. are marketed by one of the large national brokerage shops. This is almost universally the case for existing buildings and valuable pieces of land.
The process begins with the broker making a pitch to a potential seller. The broker presents not only his or her qualifications to sell the property, but also what the broker thinks it will sell for—the broker opinion of value, or BOV.
The seller selects a broker and that broker puts together an offering package that gets distributed to as many potential buyers as possible. The broker usually will meet potential buyers at the property to show it to them; the broker then collects offers from any interested groups. Typically, a first round of offers is followed by a round of “best and final” offers.
The seller may interview potential buyers and then select one. Both parties execute a letter of intent setting out the most important terms of the transaction and then sign a longer, legally binding purchase-and-sale agreement.
The standard in the D.C. area is for a purchase-and-sale agreement to give the buyer 30 days to study the property and make sure the buyer understands what it is that is being bought, and then another 30 days before the transaction closes and the deed changes hands. A small, refundable deposit is put up during the initial study period, with a larger, nonrefundable deposit required at the end of that period.
The publicly marketed process can have many variations. Recently, the amount of capital looking to invest in real estate has reached its highest level since the Great Recession. This tends to compress the time available for getting a deal done. “A lot of shops are making offers having done more work than they would have in the past,” says Drew Flood, an executive managing director at Cushman & Wakefield. “There’s still a study period in D.C., but it’s tightening from the traditional 30-day period to 21 days.”
As the nation’s capital, Washington, D.C., has had its share of foreign buyers of real estate for decades. They are part of the current crest of money looking for deals and part of the reason the process has accelerated. “Many foreign buyers right now are what we call ‘insti-viduals,’” says Marshall Scallan, a colleague of Flood specializing in capital markets. “They are institutional in size but they are actually just individuals. They can move at a speed that is based upon one or two people’s desires.”
The investors are also more involved than they used to be. If a property requires any amount of work, and certainly if there will be a development component, then a Washington-based group is involved, but that local operator is no longer acting on its own. “In the past, most deals were put under contract by an operator that then went and found their equity,” says Flood. “Today, it’s 100 percent the opposite: sellers don’t put deals under agreement unless the local operator has their own equity or the operator has outside equity in tow.”
This change is not all for the best. “I think it might be interesting to have deals trade the way they used to,” says Flood. “Sellers might benefit from a price perspective if we put deals under contract and then gave operators a chance to go find their equity. As deals get harder to execute, it would improve the depth of the bidder pool.”
The “R” Word
The publicly marketed process helps participants avoid the ugly “r” word”—re-trade. A re-trade takes place when a purchaser contracts to buy a property at a certain price but before closing declares that the price needs to be lower. Re-trading puts the seller in a bad position because the seller has invested time and effort in the transaction and is not in a good position to find a new buyer.
Whether a request for a change constitutes a re-trade is in the eye of the beholder. After all, the point of the study period is to discover whether the property is what the buyer initially thought it was. It might not be: environmental issues may be discovered or problems may arise with title.
But how big does the issue need to be for it to merit a price reduction? “Sellers want to believe that there’s some cushion built in for diligence, and there’s a bandwidth of findings that should not rise to a re-trade,” says Terra Weirich, vice president for investments at Washington-based Bernstein Management Corporation.
For buyers, a lot is at risk when asking for a price reduction once they are already under contract. “I think that most people that are successful and have been successful for a long period are honest,” says Joe Ersek, founder of the Ridley Companies, a local D.C. real estate investment and development company. “And that really means not re-trading for a large amount because people who do get a reputation, and the next time they want to purchase something, the seller will wonder whether this particular buyer will re-trade again.”
A fully marketed process means that, in addition to the seller, a broker is involved who will be policing reputations.
Another class of deals in D.C. can be defined as “partially marketed.” In these deals, a broker is involved and will earn a commission, but for one reason or another, the deal is not marketed to all potential buyers. One reason for this is that the broker is being strategic with a commodity that is scarcer than land or capital right now—time.
“To get people’s focus, you’re launching earlier to a select group,” explains Scallan. “That’s different from how it was done just a few years back. It’s because of a lack of bandwidth on the financing side and because of the amount of product that is available on the sale side. Ultimately, what you’re trying to do is to get someone to pay attention and dig in. If you don’t get what you think you need, you can always open it up to a wider group.”
Another reason a deal might be partially marketed is that the seller, and the seller’s broker, may be trying to figure out exactly what it has.
“I was having lunch with someone,” is how those stories often begin—this one from Ersek of the Ridley Companies. “They were quietly shopping their properties through a couple of brokers, but they weren’t being widely marketed. The friend I was having lunch with thought one of the sites near Dulles Airport [in Northern Virginia] could be a data center site, but that was not feasible because there wasn’t enough electrical power coming to the site. They wanted to sell the whole site, but we said we’d take a piece of it and develop self-storage.” In this way, a seller found a developer, just not for the use it originally anticipated.
A third reason why a broker may be involved but a full marketing process is not taking place is that the transaction involves something unique that requires a more focused effort.
Timing could be an issue. “Perhaps a REIT [real estate investment trust] has to dispose of something before the end of the year,” suggests Weirich. “Then you know that you are competing with fewer people than [through] a publicly marketed process.”
Alternatively, there may be issues with the seller or the property that do not lend themselves to a public process.
As an example, my firm, Monument Realty, recently purchased a property in the NoMa (North of Massachusetts Avenue) neighborhood of D.C. We were shown the property by Theo Bell, a broker at Epic Consulting. Bell had teamed up with another broker who spoke Korean, which was important because the owner was a Korean immigrant. In addition to the need to overcome a language and cultural barrier, there was a land use issue involving two neighboring property owners, so Bell was not showing the deal to other parties. This was a deal that was too messy to be publicly marketed, but Monument was able to work through the issues and is now designing a 310-unit apartment building for the site.
Residential Rights of First Refusal
One distinctive aspect of the acquisitions process in the D.C. region is the prevalence of government-mandated rights of first refusal on sales of multifamily properties.
For existing residential properties, three Maryland jurisdictions—Montgomery, Prince George’s, and Howard counties—give the local government the right to purchase the property, which allows the counties to keep rents affordable if they are worried that sale of a building currently priced at an affordable level might lead to changes that could increase rents. Although it can delay the sales process, this right of first refusal is straightforward.
The District of Columbia has long had a variation on this concept as a result of its Tenant Opportunity to Purchase Act (TOPA), which allows the tenants themselves to purchase any rental apartment building when it is offered for sale. Tenants, through a tenants association, can assign this purchase right to another party. This can dramatically slow the purchase process and lead to changes in the consideration being paid. One result is that developers will often sell newly built apartment buildings immediately upon completion, before any leasing has taken place.
“TOPA is certainly something unique about D.C.,” observes Weirich. “You cannot steal a residential building in D.C. because you have to go through this process that keeps everyone honest about what the price is.”
Off-market transactions may account for 20 percent of deals in Washington, Ersek says. “The acquisitions people may be spending 80 percent of their time on that 20 percent,” Ersek says.
“Knocking on doors just takes more time than flipping through a complete package that a broker has put in front of you. Putting together complicated assemblages can look good, but you have to always ask yourself, is it really the best use of time?” Not only does the would-be buyer have to find the owner, but the buyer also has to convince the owner to sell.
D.C. firm Redbrick LMD does most of its acquisitions this way. To invest its time wisely, the firm has to carefully target properties. “We don’t spend a lot of time on something unless we think we can win it,” says Redbrick managing director Thomas Skinner. “Are we a natural buyer of this property? How competitive will the process be? Why do we think we’re advantaged over someone else?”
Redbrick is putting the finishing touches on one of the D.C. area’s largest off-market transactions in recent years, a development project now known as Columbian Quarter, which is 7.5 acres (3 ha) of land on Poplar Point, directly across the Anacostia River from Nationals Park, home of the city’s Major League Baseball team. Redbrick can engage in 2.75 million square feet (256,000 sq m) of mixed-use dense development on the site.
However, it all began with a lender foreclosing on a property and then looking to sell it. Redbrick went on to acquire six more parcels.
“The most challenging thing was actually tracking down who owned the parcels,” says Skinner. “In one case, we thought it was owned by somebody from Guinea who had made a hard loan to somebody and then taken the property back. But they then had sold their interest to somebody from Kuwait who was living in London. None of this was on the public record.”
Overall, says Skinner, “It was three to four years of chasing people down and trying to figure things out. It could be for a 4,000-square-foot [372 sq m] piece of land, but we needed it to make everything contiguous.”
Although the only development to occur so far is infrastructure work, Columbian Quarter was one of the local sites competing for Amazon’s HQ2. Since that was awarded to a site in Arlington, Virginia, other large users, including potential federal government leases, are being pursued.
The acquisitions process in D.C. is rarely easy. But that, after all, is what makes it interesting and rewarding.
JOSHUA OLSEN is the executive vice president for acquisitions at Monument Realty, a Washington, D.C.–based developer and owner of all types of real estate. He is also the author of Better Places, Better Lives: A Biography of James Rouse, published by ULI in 2003.