Published on:
Tuesday, May 31, 2016
Written by: Amy Sim

Prices are continuing to rise on home sales in Southern California like elsewhere through much of the country, with the typical real estate agent seeing fewer buyers. What this means for the average home buyer is less affordability. While that’s not good news for the typical family looking to move from renting to buying, it is a positive turn for investors. At the same time, commercial real estate provides options for investors who want to enter the market or add to their portfolios.

Read any news report and you’ll notice that first-time buyers are struggling to afford housing in Southern California. According to data from Trulia, the median first-time buyer in this area would have to spend 88 percent of their income on a home. Since this is impractical, it demonstrates the lack of options for the demographic.

How does this impact investors? With fewer buyers driving the market up further, expectations are growing that the prices will actually have to come down. As investors watch the housing market, they can capitalize on those properties.

Flipping Houses

While prices aren’t good for first-time buyers, they are still providing a profit for investors who focus on flipping properties. Redfin discovered that three of the neighborhoods in the country offering the best market for flipping houses were located within Los Angeles. Two of the hottest neighborhoods were Mt. Washington and Silver Lake, ranked at second and third for gains. This is the markup percentage between the purchase price and resale price.

Even though LA real estate is hot, much like the rest of the southern region, investors can locate older homes in need of improvement and make enough updates and repairs to warrant a high price at resale. They are grabbing these undesirable properties because of the potential they see in them.

Markups produced an average gain of $31,000 for 2015 in Mt. Washington while Silver Lake saw gains averaging $307,000. The tenth place neighborhood, Los Feliz, had gains that averaged $241,000. Flippers can do extensive remodeling and still walk away with massive profits. With interest rates remaining low for mortgages, investors with the cash for a down payment and the affordability to make the payments and pay for renovations will still see income potential in the increasingly expensive Southern California market.

Commercial Properties

Investors not interested in single-family dwellings for flipping can still find lucrative opportunities in commercial properties. If they talk to a real estate agent in Orange County, they will discover that multi-family dwellings have a vacancy rate of just 3.3 percent, which means new developments will be in high demand.

Industrial properties has the second lowest vacancy rate at 3.4 percent and retail has a rate of 4.6 percent. Both of these real estate subcategories offer potential for investors who are looking for a sound investment. These figures are according to the National Association of Realtors. An experienced real estate agent can provide guidance as to where the best possibilities for future developments exist.

According to the same report, the focus for investors today is in rentals rather than flipping. New construction is still low, which is a prime area for investors who want to take advantage of the economy. Since many buyers are looking to move to another rental instead of purchasing a home of their own, they will be looking at new-builds with more amenities and space than their current units. Investors will have no problem filling properties with tenants if they should choose this avenue.

Demand for housing will continue to increase as more people seek rentals. This growth is largely driven by Hispanics as well as other minorities. In fact, the increase is projected to be 77 percent minorities versus 23 percent whites in new rental units.

In addition to the lack of sufficient housing, the improving job market and income growth is helping propel multi-family housing forward. For non-residential real estate, technology companies are driving the demand for new structures. Office space is continually needed, which is the primary focus for many developments in the area.

The story for investors who are looking at Southern California real estate to add to their portfolio is the opportunities are still here. However, they are going to have to do plenty of research to discover the right areas to place their funds, not only in the type of real estate for investing but in the right location with continued potential for profit.

The 80/20 Rule of Tenant Improvements

From the Desk of John Scatoloni

In looking for office space, an often overlooked aspect of lease rate is the allowance for tenant improvements. The more space built-out to accommodate the layout, the higher the start rate will be, and with annual increase based on a higher base rate, the affect is staggering, often a 15-20% higher lease commitment over the term.

Avoid costly build-outs and delays in commencement by implementing the 80/20 rule in the search for office space. That is focus on 20 percent of the properties in the market that meet your general layout (i.e. number of private offices, size of open area and special purposes rooms) and leave the rest behind. In other words, focus where 80 percent of the intended space exists (residual improvements) and only concern yourself with the 20 percent of upgrade required to meet your firm’s ideal layout and negotiate a turnkey premise for the remaining 20 percent. This is not a complicated strategy but one often overlooked when tenants focus on building image, amenities, and lower incentive rates. Expensive build-outs costs time, money and valuable negotiating leverage and ultimately tenant improvements will drive the deal structure higher to satisfy the landlords required return.

What can you do at the beginning of the site selection process? Start by implementing the 80/20 rule, then, gain a clear understanding of what are standard improvements in the market. This is easily accomplished by inquiring with your broker what tenant improvements have been included in past deal and lease comparables. The details you obtain will provide an understanding of where a particular landlord in the market sets the bar for “standard improvements” to the space. Armed with a focus on the right 20 percent of the spaces in the market and a clear understanding what landlords provide as standard improvements, you have a real opportunity to reduce your fixed expense in office rent.

Simply put, avoid the costly tenant improvement trap which landlords utilize to increase the base rent through the proposal process. The tenant improvement allowance trap often leads to economic creep, which is when the negotiated base rate creeps up with every subsequent request for improvements, alternatives and additions. A 5-10% increase in base rate can easily result, and higher cost living adjustments often accompanies this increase. The end result is that your total lease commitment over the term can reach a 15-20 percent increase over office space that meets the 80/20 rule.

Avoid paying for economic creep by applying the 80%/20% rule. Understand that many of these improvements to deliver the space are in fact market standard. The landlord would have improved the space regardless to meet the market Remember that a tenant improvement allowance is a direct investment in the property, an investment that is borrowed by the tenant for the term of the lease, and subsequently not transferable at the end of the lease. Align your intended layout with a space that exists on the market, look for properties that meet the 80/20 rule and understand what standard improvements to insist to be included in the rate.

“-30-“

Tenant Tip: Major shift in leasing rates between LA & West San Bernardino County; nearly the same, no longer a major discount to head East for lower rates alone. The rationale for heading East is still better designed buildings, newer construction and lower rates and a better price to own. However, the price distinction is fading fast as vacancies are at a historic low and demand is strong. Best advice; focus on the buildings with the best features, newer construction to avoid deferred maintenance costs, and buildings that your company can expand within for the next five years.

By JONATHAN LANSNER, Staff Writer

The folks who own and manage the region’s biggest properties may be seeing a future chill in their climate.

Local commercial real estate executives remain generally optimistic, but that enthusiasm is decidedly tempered, according to the latest biannual edition of the Allen Matkins/UCLA Anderson Forecast. It surveys local real estate executives about their three-year outlooks for key industry segments.

A broad economic revival brings strong job growth, and a modest amount of new development keeps many property owners in a good spot for property values, vacancy rates, rent increases as well as for future development opportunities.

“There is still room for improvement, but people are smart enough to know that six-plus years into a recovery that things don’t go on forever. They getting more cautious,” says John Tipton of Allen Matkins, a law firm well-known in real estate circles.

Here’s how the Matkins/UCLA survey saw key slices of Orange County’s commercial real estate market.

Office: Orange County’s optimism score trailed only Los Angeles among the six California markets tracked.

The survey found shrinking optimism over two years for Orange County’s office vacancy rate, but that cooling enthusiasm may reflect the limited amount of empty space. Hopes for rising rental rates are strong, but still at a two-year low.

“This was a market that was hit very hard in the downturn,” Tipton says. “So it is coming back a little late. But once it got its footing, the last couple of years it’s been among the strongest markets in our survey.”

Apartments: Limited vacancies puts landlords in a good spot, until new development puts pressures on rising rents. Orange County optimism ranked fourth of five California markets tracked.

“People still need a place to live,” Tipton says. “But supply is starting to meet demand.”

Industrial: Orange County ranked fifth out of seven California markets tracked for optimism for warehouse and factory spaces. But the local markets remains strong with virtual no empty spaces.

“The market is always going to be tight,” Tipton says. “In all coastal communities, it’s not like there’s a ton of industrial space. The land costs so much, so there a ton of warehouses in the Inland Empire where land is cheaper.”

Retail: This is the first time this survey has tackled this real estate niche, which has shown surprising resilience despite the draw of shopping dollars to online merchants. Orange County retail optimism was second only to Los Angeles, among the six California markets tracked.

“What you do see is that people still like to get out of the house,” Tipton says. “But they don’t want to go to their enclosed mall or Kmart.”

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California’s Industrial Booms With Online Retail Growth

Feb 02, 2016 Allison Nagel, Bisnow San Fransisco

California’s industrial market is a busy one, with the warehouse side being driven by more online shopping and developers optimistic in their outlook for the next three years, according to the latest Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey.
Barbara Emmons, CBRE vice chairman, Allen Matkins / UCLA Anderson

CBRE vice chairman Barbara Emmons says it’s an exciting time from the warehouse perspective because companies such as Amazon need less retail and more warehouse and distribution.

Jerry Nickelsburg of UCLA Anderson Forecast – Even though the vacancy rates for warehouse are extremely low, those surveyed expect them to go down even further, says UCLA Anderson Forecast senior economist Jerry Nickelsburg. The outlook remains strong for the next few years, according to the survey.

Mark Payne, Panattoni Development partner Panattoni Development Co partner Mark Payne says the industrial market is very busy, with a lot of demand both from tenants leasing space and owner-users who want to buy.

Tom Bak, Trammell Crow Senior Managing Director

Even those anticipating a correction in three to five years, such as Trammell Crow senior managing director Tom Bak, are building steadily for space to deliver this year and next. That quick turnaround works well with industrial buildings, which are pretty straightforward in design, he says.
John Tipton, Allen Matkins partner
The Inland Empire, where there has been a rush to develop, may have increased vacancy rates going forward, and Allen Matkin’s John Tipton says it will be interesting to see how China’s contraction affects that area. External forces such as interest rates or global woes could affect the market, but overall, Barbara says, the fundamentals are solid. No one is overbuilding, lenders are cautious and it’s all looking good for the next few years, she says.

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Economic forecast shows optimistic future for commercial real estate

The outlook for commercial real estate growth in California through 2018 is looking pretty good — that’s according to the latest Allen Matkins and UCLA Anderson Forecast Commercial Real Estate Survey.

Researchers surveyed developers throughout the state who said they’re optimistic about the next few years. Several of them are already planning new commercial projects, including office buildings, warehouses and multi-family housing.

The survey released Wednesday states that the Fed increasing interest rates has not dampened optimism for the future of commercial real estate in California.

Jerry Nickelsburg, senior economist at the UCLA Anderson Forecast, said that for Orange County, Los Angeles and San Diego, the survey shows markets tightening in the next three years.

“What this means is the markets are not overbuilt, and demand is still pushing supply,” Nickelsburg said.

He said that industrial space vacancy rates in the Inland Empire will be higher in the next few years, but rental rates will continue to rise faster than the rate of inflation.

Optimistic outlooks for developing commercial real estate also has positive outcomes for job growth and the economy, Nickelsburg said.

“What that means for local economy is increase demand for construction workers and increased demand for building supplies. All this is a positive development in economic growth in Southern California,” Nicklesburg said.

January 27 2016
KPCC’s Business & Economy coverage is a Southern California resource provided by member-supported public radio. We can’t do it without you.

Investors don’t seem to mind.

by Kenneth P. Riggs Jr., CCIM, CRE, MAI, FRICS

“Price is what you pay; value is what you get.” — Warren Buffet

As we look to 2015 and beyond, the commercial real estate market is enjoying much positive press and continues to be a favored asset class relative to stocks, bonds, and cash. After the most recent commercial real estate downward cycle in third quarter 2008, followed by a rebound in 1Q10, we are at a new crossroads where prices are clearly outpacing valuations. This is the final phase of our up cycle, and the key question is, how long can this phase run? When we think about investments and investment cycles, we are coming to realize that the more things change, the more they stay the same. In other words, be worried when the market starts to say, “This time it is different.”

Economic Fits and Starts

In our search for how prices and values are aligning themselves, we first need to examine the economy. The outlook for the U.S. economy is much brighter than it has been since before the Great Recession. Besides more than 3 percent growth in gross domestic product in 2Q14 and 3Q14, inflation remains low and the unemployment rate declined to 5.8 percent in October 2014. In fact, job growth has improved enough that employers are on pace to add the most jobs on an annual basis since 1999, according to the Bureau of Labor Statistics.

However, a variety of headwinds is still holding back the progress that many economists had been predicting, with each setback causing forecasters to recalibrate their expectations. These recalibrations have been triggered by a workforce participation rate that has declined to 1978 levels, as the wages of the majority of workers remain relatively stagnant. In addition, the federal debt has ballooned to nearly $18 trillion, while major entitlement programs are underfunded. The housing sector has improved slightly, but the young adults we have relied on in the past to purchase homes are burdened with oversized amounts of student debt. Furthermore, many of the economies in Europe and Asia are contracting, and territory disputes from the Ukraine and Russia to Iraq and Syria have given rise to new acts of terrorism. However, in the end, the U.S. economy appears to have many resilient elements in place to withstand future disruptions in the financial markets.

Each quarter, Real Estate Research Corp., a Situs company, surveys some of the nation’s leading institutional investors about the economy and reports this information in the quarterly RERC Real Estate Report. As demonstrated in Figure 1, commercial real estate has been consistently rated higher than the alternatives, even as the economy has been recovering.

Flush With Liquidity

Despite the macroeconomic uncertainties, the global and domestic markets have provided investors more capital than they know what to do with. With investors searching for a place to park this capital (with good risk-adjusted and safe returns), the result has been asset prices pushed to all-time highs — which is making the market nervous. We see this in the stock market, with record-high performance, and we see it with commercial real estate, which, with its attractiveness as an asset class, including return performance, ability to hedge against inflation, and tangible nature, has attracted a great deal of capital.

Put stocks and real estate together and you get an idea of just how much in demand these two asset classes are. According to Bloomberg, investors are rewarding retailers’ efforts to spin their properties into real estate investment trusts. Sears Holdings recently announced plans to create a REIT for its properties, and shares increased 31 percent.

RERC also examines the amount of capital available for investment and compares it to the underwriting discipline. As shown in Figure 2, investor ratings for capital availability have greatly outpaced the discipline (or underwriting standards) for capital in 3Q14. It is worth noting that the last time the availability of capital outpaced discipline to this degree was in 2Q07 — shortly before the credit crisis that preceded the Great Recession.

The comparison of the availability and discipline of capital shows that we are again at an inflection point. The flood of capital chasing commercial real estate continues to pressure property prices to increase, especially for high quality assets in top markets. Some investors have noted that, given high prices, there is already too little product to invest in, which further drives prices higher and returns lower.

However, RERC expects values and prices to continue to increase as long as interest rates stay low. If RERC’s history of availability of capital versus the underwriting discipline holds up, this bull commercial real estate market has another 18 to 24 months to run. This is not to say the market is right, but it is the market.

It All Depends on Interest Rates

Although the Federal Reserve has concluded its recent quantitative easing program, monetary policy remains accommodative, with the federal funds rate remaining at 0 percent to 0.25 percent for “a considerable period of time.” The Fed’s target unemployment rate has been reached, but its target inflation rate is elusive, and growth remains slower than expected.

The market and most investors anticipate that the Fed will raise short-term interest rates in mid-2015, stating that it is too risky for the Fed to leave rates at current record lows much longer (in case the rates need to be lowered again when there is another recession). Others believe that the Fed will leave the funds rate very low for several years due to global pressure, as troubled economies in the rest of the world would be forced to pay higher interest rates.

As shown in Figure 3, risk-free rates in other developed economies have followed the U.S. trend to keep rates low, and as shown in Figure 4, 10-year Treasury rates have been declining for several decades. Despite the Fed’s clear message about their intent to increase U.S. Treasury rates at some point, some investors have become complacent, expecting Treasury rates — as well as interest rates — to stay low for much longer. Continuing low interest rates will be another significant benefit for commercial real estate investors.

Value vs. Price

As long as Treasury rates and interest rates remain low, the global investment environment for commercial real estate will be very attractive. Investors will continue to purchase real estate, prices will continue to increase, and values will continue to chase prices, as capitalization rates on a broad market perspective will further compress.

As shown in Table 1, RERC’s value vs. price rating for commercial real estate overall dipped slightly to 5.3 on a scale of 1 to 10, with 10 being high, during 3Q14. However, with the midpoint of the rating scale at 5.0, a rating of 5.3 indicates that value vs. price can still be found in commercial real estate overall, despite the slight decline in this rating during the past few quarters.

On a property sector basis, the value vs. price rating increased for each of the sectors (except for the hotel sector) during 3Q14. As shown, the industrial sector retained the highest value vs. price rating among the property types. However, all sector ratings were higher than the midpoint of 5.0, which means that prices still have room to climb before properties become overpriced (compared to their value) — at least as long as interest rates remain low and cap rates have room to further compress.

A Closer Look at the Property Types

Additional Considerations

As 2015 continues, commercial real estate investors are encouraged to keep in mind the following points:
•The U.S. economy is resilient and will survive a looming short-term rate correction. In the long term (toward the end of the decade), the economy is positioned to demonstrate above-average growth.
•Global pressures will continue to keep 10-year Treasury rates below 3.0 percent in 2015.
•Commercial real estate will be a preferred asset class in 2015 relative to stocks, bonds, and cash, and this will continue to put upward pressure on prices and values throughout the U.S.
•Commercial real estate space fundamentals will continue to improve slightly, except in the multifamily sector, where vacancy is increasing due to supply additions.
•Required total returns and capitalization rates for the broad commercial real estate market will continue to compress in 2015, as long-term interest rates stay low.
•RERC’s total return expectations based on our value forecast and income forecast reflect a total return in the low teens for unleveraged commercial real estate assets, and a total return in the mid-teens on a leveraged basis for 2015.
•An increasing number of alternate property types (beyond the core property types) will continue to attract investors, including storage facilities, single-family housing, student housing, seniors housing, and medical office buildings.
•There will be continued expansion of investment products and opportunities for retail investors through private real estate investment trusts, single property-REITs, club investing, and defined contribution options.
•The market cycle is not different this time, but commercial real estate will see another strong year in 2015, only to be faced with another market down cycle looming out past 2015.

Office. The office market continues to struggle. The vacancy rate was 16.8 percent in 3Q14, which was only 10 basis points lower than a year ago, according to Reis. Despite that, effective rents increased 2.7 percent to $23.94 per square foot year over year. In addition, according to Real Capital Analytics, 12-month trailing transaction volume increased more than 27 percent to $121 billion in 3Q14 compared to the previous year, and prices psf increased by 6 percent to $245. RERC’s required pre-tax yield rate (internal rate of return) dipped to 7.9 percent, and the required going-in cap rate decreased to 6.1 percent in 3Q14. Figure 5 illustrates the spreads between RERC’s required pre-tax yield rates and going-in cap rates and 10-year Treasurys. Vacancy is expected to drop to 16.3 percent and rents to increase 3.7 percent by the end of 2015, according to Reis. Some metros are expected to outpace expectations, such as Portland, Ore., with stagnant cap rates in the office market, and Minneapolis, which is expected to see slightly higher rental growth than the national average over the next couple years.

Industrial. Vacancy in the industrial sector decreased to 9.0 percent in 3Q14, according to Reis, and was accompanied by effective rental growth of 2.5 percent YOY to $4.45 psf. Transaction volume increased by 6.0 percent, with prices increasing 17.3 percent to $77 psf over the past year, per RCA. RERC’s required pre-tax yield rate for the industrial sector declined to 7.7 percent, while the required going-in cap rate decreased to 6.0 percent in 3Q14. Reis forecasts the industrial vacancy rate to decline to 8.0 percent by 2016, and for effective rent to grow by 3.3 percent. Industrial vacancy is expected to decline even more in some markets, such as Sacramento, Calif., and Orlando, Fla.

Multifamily. The vacancy rate for the apartment sector increased slightly in 3Q14 to 4.3 percent, while the effective rent rose 3.91 percent during the past year to $1,117 per unit, according to Reis. As reported by RCA, 12-month trailing transaction volume increased 6.2 percent YOY to $104 billion in 3Q14, as the price increased 21.5 percent to $128,259 per unit, a new high. RERC’s required pre-tax yield rate declined to 7.0 percent, while the required going-in cap rate declined to 5.0 percent. Reis notes that due to expected completions of 444,000 units over the next two years, vacancy is likely to increase to 4.9 percent in 2015 and to 5.1 percent in 2016, although vacancy in some metros (San Diego, for example) is not expected to increase as much. Effective rental growth of 3.1 percent in 2015 and 2.6 percent in 2016 is expected.

Retail. According to Reis, retail vacancy declined slightly to 10.3 percent in 3Q14, while effective rent increased 1.91 percent to $17.07 psf. Transaction volume increased 8.1 percent YOY, with pricing increasing 24.8 percent to $214 psf, as investors have been purchasing higher quality retail properties. RERC’s required pre-tax yield rate decreased to 7.8 percent in 3Q14, while the required going-in cap rate declined to 6.1 percent, although this has had more to do with abundant capital and easier financing than improving fundamentals. However, Reis projects that vacancy will be 100 bps lower at 9.3 percent and rents will step up to 3.3 percent annual growth in 2016. Retail properties in some metros — especially Florida markets like Miami and Orlando — offer strong investment opportunities due to improving fundamentals.

Hospitality. Smith Travel Research reports that U.S. hotel occupancy rose 3.9 percent YOY to 62.7 percent during the week of November 9-15, 2014. Revenue per available room and the average daily rate increased 8.6 percent to $72 and 4.6 percent to $115, respectively, according to PKF Hospitality Research. Hotel volume increased to $33 billion on a 12-month trailing basis in 3Q14, according to RCA, while the price per unit increased to $154,798. RERC’s required cap and discount rates for this sector decreased more than for any other property type on a YOY basis in 3Q14, as RERC’s required pre-tax yield rate and required going-in cap rate declined by 80 bps to 9.2 percent and 7.2 percent, respectively. PKF predicts that hotel sector occupancy will reach 65 percent in 2015, which would be the highest occupancy achieved since the recording of this rate started. Investment trends for hotel properties seem to be moving further out from core urban areas for example, Long Island, N.Y., versus Manhattan.

Value Expectations for 2015

Commercial real estate is a favored investment alternative compared to stocks, bonds, and cash, especially in these uncertain times. Not only does commercial real estate generate high risk-adjusted returns compared to other investments, property is tangible, transparent, a hedge against inflation, and offers reasonable return performance on capital and income. (Income is currently approximately 60 percent of returns.)

Commercial real estate has more than recovered the value it lost in the Great Recession, as shown in Figure 6, and with respect to return performance, broad market prices and values have room to grow for approximately 12 to 18 months. This does not mean that commercial real estate prices and values are sustainable, but for many investors, there are no other good alternatives, and as a result, many investors will continue to pay nearly any price for the value commercial real estate offers.

Kenneth P. Riggs Jr., CCIM, CRE, MAI, FRICS, is president and CEO of Real Estate Research Corp., a Situs company, and publisher of the RERC Real Estate Report. For more information, or for a special CCIM member discount to the report, please contact RERC at publications@rerc.com.
– See more at: http://www.ccim.com/cire-magazine/articles/323739/2015/01/sky-high-prices#sthash.N9c8Dpz2.dpuf

Thank you to all of our clients over our 11 year history. We have added team members, increased our office size and now have two offices (Los Angeles / Orange County and the Inland Empire). On behalf of our experienced and dedicated team, we are ready for a great year going forward and bringing success to all of our clients.

Best Wishes 2015
Managing Director
John Scatoloni

Assembly Bill 1103 requires documentation of a building’s energy usage anytime there’s a sale, lease, financing or other change involving the building itself.

By Ben van der MeerStaff Writer- Sacramento Business JournalEmail

A new state law affecting any transactions on most commercial properties is causing headaches and delays for brokers, property managers and others.

The law, Assembly Bill 1103, requires documentation of a building’s energy usage any time there’s a sale, lease, financing or other change involving the building itself. Passed in 2007, implementation of the bill was delayed several times because of problems with a state website where building data is entered.

But in the last year, the bill went into effect, including on Jan. 1 for non-residential buildings of at least 10,000 square feet, then on July 1 for buildings of at least 5,000 square feet.

Heather Johnston, an attorney specializing in commercial real estate transactions with Trainor Fairbrook in Sacramento, said the implementation portion is proving difficult. Not only are those entering the data often frustrated by the unwieldiness of the state’s website – for example, it doesn’t have a way to record information when a building’s tenants pay separate utility bills – utility companies are balking at providing confirmation data, citing privacy concerns.

Johnston said there are ways to estimate the information, but a full report of a building’s energy usage has to be disclosed to all parties before a transaction is complete.

“In every single situation, there’s a handful of difficulties,” she said, noting the legislation has created delays in deals being finalized, as well as added costs for property owners who pay to get a full measure of energy usage.

The idea behind the law was to increase market interest in more energy efficient buildings, similar to posting projecting mileage on cars for sale. Johnston said those are noble goals, but the execution needs work, and many commercial real estate industry professionals still aren’t aware it’s in place.

“When it had gotten around implementation, it had just fallen off the radar for most people,” she said. “If I had a recommendation for the state, it would be to fix the website.”

Encon Commercial Real Estate Services – Los Angeles

The Benefits of Using a Foreign Trade Zone

From large manufacturers to individuals, any size importer or exporter can take advantage of a foreign-trade zone (FTZ). However, many companies are unaware of the sizeable cost savings and other benefits they can achieve by taking advantage of an FTZ program. Utilizing an FTZ can significantly reduce costs from customs duties, taxes and tariffs; improve global market competitiveness; and minimize bureaucratic regulations. Outside the United States, there are many other names for FTZs, including free, foreign, or export processing zones. Below are some benefits of using an FTZ.

1. Deferral, reduction, or elimination of certain duties. FTZs allow the most duty deferral of any kind of Customs program. Companies can bring goods into the FTZ without duties or most fees, including exemption from inventory tax.
2. Relief from inverted tariffs. In some cases, tariffs on U.S. component items or raw materials have a higher duty rate than the finished product, putting a U.S. manufacturer at a cost disadvantage to an importer. However, by participating in an FTZ, the U.S. manufacturer pays whichever duty is lower. In many cases the tariff of the manufactured good is zero, eliminating any costs associated with importing raw materials and goods. There is no way to take advantage of inverted tariffs without operating in an FTZ.
3. Duty exemption on re-exports. Since an FTZ is considered outside the commerce of the United States and U.S. Customs, a company importing components or raw material into the FTZ doesn’t pay Customs duty until it enters U.S. commerce. If the good is exported from the FTZ, no Customs duty is due.
4. Duty elimination on waste, scrap, and yield loss. Since a manufacturer operating in an FTZ doesn’t pay duties on imports until its goods leave the FTZ and enter the United States, it essentially is paying for the duties on the raw materials after they have been processed. Thus, duties owed do not include manufacturing by products, such as waste, reducing the amount of goods taxed.
5. Weekly entry savings. Instead of filing an entry every time a shipment enters the country, an importer operating in an FTZ only needs to file one Customs entry a week, reducing bureaucratic headaches and costs associated with entry filings. There is a 0.21-percent merchandise processing fee for every entry, with a minimum of $25 and a maximum of $485 per entry, which is for goods with a value of over $230,952. A company with 10 shipments a week, each of which are over $230,952, would save $226,980 annually with weekly entries. Weekly entries also save on customs brokerage fees.
6. Improved compliance, inventory tracking, and quality control. FTZs allow companies to more closely track their inventory. By bringing goods into an FTZ warehouse that you control, you can identify and classify goods at the warehouse instead of at the port at a Customs control location.
7. Indefinite storage. A company can hold its goods indefinitely in an FTZ until a port opens up, or if there are quotas on a good, until they can be entered into U.S. Commerce without falling under quota restrictions.
8. Waived customs duties on zone-to-zone transfers. FTZs can be used to manage transshipping operations, saving money on manufacturing processing fees. While most companies are focused on using FTZs for exports, FTZs can also be used to take advantage of crossdocking and transferring goods from one FTZ to another without paying Customs duties. Many mid-level companies, in particular, are using this capability to transfer goods to FTZs both within and outside the United States.

TAKING ADVANTAGE OF AN FTZ PROGRAM

To take advantage of an FTZ, companies need to be able to track their inventory; trace manufacturing and production orders; determine whether material came from domestic or international sources; and classify goods for duty deferrals and reductions. How much a company saves by using an FTZ depends on the size of the company and its business model. Reducing merchandise processing fees alone can save a company a substantial amount of money.

Larger companies may want to consider using automation to help alleviate the burden of managing the FTZ process, particularly since with high-volume operations it can be extremely difficult, if not impossible, to manage manually. The data needed for classifying goods, for example, is voluminous and frequently changes and must be pulled from country-specific lists. Software that has this information in a central repository with automatic updates can pull information from different systems, such as import/export and warehouse management systems, and use that data for Customs filing and inventory management.