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Welcome to the Clay & Company Blog

Clay & Company is a Houston-based commercial real estate brokerage, investment, and auction company serving the needs of governmental agencies, financial institutions, insurance companies, and individuals 
throughout the State of T
exas.

Our regularly updated blog covers local and national news, events, and happenings affecting Texas and the commercial real estate industry.

Category Archives: Leasing

Small-business Lease Q&A from Chron.com

by Ron Consolino for Chron.com

Q: I found space to lease for my new washateria, and the landlord has given me her standard lease contract. How do I know if I should just sign it?

A: Before you sign anything, make sure you understand and agree with the terms of the contract.

“There is no such thing as a ’standard lease,’ and landlords almost always negotiate,” says Benjamin Miller, who practices business and real estate law in Houston. Don’t lose sight of the fact that the “Standard Form Lease” represents the landlord’s wish list and, if not appropriately modified, may not serve your interests if issues arise.

A lease is much like any business agreement in that it sets out parameters of a business relationship. You cannot easily break or change a commercial lease. It is legally binding.

When everything goes as planned, most any lease will serve the parties well. The true test occurs when there are hiccups.

There are, in general, three kinds of commercial leases. With a gross lease, the renter pays the landlord a fixed rent. It is up to the landlord to pay all the expenses of operating the building. In a triple net, or NNN, lease, the tenant not only pays base rent, but also part of the building’s operating costs. These costs include property taxes, insurance and common area maintenance, or CAM. Hybrid leases have features of both.

NNN costs are shared according to the percentage of the tenant’s square footage to the total building square footage. So, Miller advises, “Pay attention to what is included in NNN costs and get the right to audit the landlord’s cost records.”

CAM is generally the amount of additional rent charged to the tenant to maintain common areas shared by all the tenants and from which all tenants benefit. Examples include: repairs, janitorial and trash services, and personnel costs associated with the property. Most often, this does not include capital improvements, tenant build-out expenses, legal fees, costs for services to other tenants and commissions to brokers.

Consider having your lease contract reviewed by an experienced attorney.

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Spec Office Development returns to West Houston in Full Force

The Woodbranch Development will offer very competitive rents, hovering near $20/sf.

The Woodbranch Development will offer very competitive rents, hovering near $20/sf.

Houston’s Energy Corridor is seeing a flurry of activity with multiple office developments announced in the last few weeks.  With less than 9% vacancy in class A properties, it’s no wonder developers are eyeing the area.

Trammell Crow, Mac Haik, Skanska, Lincoln Property Co., Stream Realty/Wile Interests, and Core Real Estate are all planning projects in west Houston.  The area’s  fundamentals appear to be right and if lenders can overcome their fears of over building (think Houston circa 1986), the developments may get off the ground.

Netherlands-based Stena Realty was the latest to announce its plans to build more class A space in the submarket.   Dubbed Woodbranch Development, the project will consist of two office towers with over 350,000 square feet of space.

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Retail Report: May 2012

Colliers’s recent Retail Whitepaper examines what is driving retail recovery and what will make retailers successful in the days ahead. A summary of the paper follows:

Retail’s dependence on a healthy economy and a fickle consumer makes it vulnerable, but as an investment category retail real estate presents attractive opportunities. For property owners, municipalities, and investors committed to the sector, opportunistic investments can materialize by thinking differently from the herd. This type of forward-thinking analysis involves digging beneath the top-line numbers to understand the factors and conditions necessary for asset performance and values to recover further, and how those elements will favor certain retailers and markets. This white paper aims to identify and analyze successful investment and branding strategies, and the retailers ahead of their peers in executing them.

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  • Retailers’ corporate success now hinges far less on absolute price than it does on corporate strategies for reinvesting in technology, elevating the in-store experience, and redefining the service aspects of the retailer’s offering.
  • Technology investment takes the form of channel diversification: improving and integrating brick-and-mortar, online, mobile, and catalog operations.
  • Real estate investments include opening new stores, experimenting with smaller prototypes and upgrading existing locations.
  • While “Location” has always been the most important to real estate success, quality tenants are proving equally important at separating a retail project from it’s competitors.
  • Retailers “ahead of the curve” in reinventing their physical spaces elevate the shopping experience to focus on every aspect of their business that matters to their customer.
  • Retail is becoming more about service and less about “stuff.”
  • Successful landlords will be those that remain focused on maintaining a unique tenant mix and be willing, if necessary, to accept lower rents short-term to achieve the long-term payoff of owning a commercially viable property with stable (or rising!) occupancy rates and cash flows.
  • Another option is to develop tenants internally: incubating new retail concepts that will eventually take space.
  • And, landlords and owners (and their lenders) have to be willing to demolish vacant or under-utilized spaces, foregoing short-term cash flow, to create new retail zones.
  • Metro markets poised to outperform in the next decade exhibit one or more of the following attributes:
  1. An improving housing market: For May, the Five states with the highest number of improved markets are Texas (11), Florida (10), Michigan(8), and Pennsylvania/North Carolina/Iowa (6).
  2. Potential for favorable demographic shifts: The big shift will likelybe demographic, as the 78 million Millennials move into their prime household formation years and and a way to move out of their parents’ basements.
  3. Ability to cultivate job growth and a skilled labor force in energy-and knowledge-based industries: Job growth is occurring in areas dominated by industry sectors that either were more resistant to the recession or began to improve earlier in the recovery like powerhouse Texas cities of Houston and Dallas.
  4. And proximity to intermodal infrastructure: Big changes are coming for metro areas proximate to intermodal infrastructure, such as deep-water ports and rail lines, as macroeconomic dynamics shift import/export demandand the Panama Canal expansion nears its scheduled 2014 completion. Current growthtrends favor East Coast and Gulf ports.

Full report here.

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Ground Control

Owners and developers unearth opportunities through creative land leases
By Philip “Fred” Himovitz, CCIM
Reprinted from From CIRE Magazine, Mar-Apr 2012

Editor’s note: Originally published in 2006, “Ground Control” is one of the most popular articles in CIRE’s archive. Author Philip “Fred” Himovitz updated the article for republication.

Commercial real estate developers and investors often favor total fee ownership of income property. The propensity to own — and the emotions attached to it — sometimes can result in misguided decisions and strategies and lost opportunities. Relinquishing ownership of income property is really a question of when, not if.

Once developers move beyond the notion of ownership as an investment goal, new opportunities that may not have been visible before, such as ground leases, become apparent. In its most basic form, a ground lease, or land lease, separates the ownership of land from the ownership of the improvements on the land, such as an office building or a shopping center. The landowner leases the land to the developer of the improvements, who pays rent for use of the land.

Typically ground leases are long-term and include set rent escalations, eviction rights should the lessee default, and a reversionary right, which means improvements on the property revert to the landowner at the end of the lease term. While such lease terms do not particularly favor developers, ground leases offer some distinct advantages to them.

The two most prevalent types of ground leases are subordinated and unsubordinated. Each provides benefits that can enhance the developer’s yield and turn dismal or modest returns into more attractive and risk-mitigated ventures. They also give developers the opportunity to involve multiple partners without negotiating formal partnership agreements.

Ground leases transfer control — not ownership — of a property and, for the landowners, they are considered one of the most secure forms of real estate investment. But landowners may be considered preferred investors and may be open to developers who offer them a stake in the improvements erected on their land, in exchange for other considerations such as rent abatement for vacancy. Such a quid pro quo can substantially reduce risk to a lender.

Lease Structures

In a subordinated ground lease, the landowner offers the land as collateral for the developer’s mortgage, giving the landowner a significant stake in the development risk. The subordinated ground lessor is considered a secondary lender with junior rights behind the primary lender, usually a bank or other financial institution.

Normally the ground lessor has a future claim on the improvements, as most ground leases require improvements to the land to revert to la

ndowners at the end of the lease. As such, ground lessors usually consider the downstream value of the improvements in establishing a rental rate. On the other hand, a ground lease that provides for the removal of any improvements at the end of the lease, such as relocatable metal buildings, modulars, portable plants, or parking lot appurtenances, would factor that eventuality into the rate as well.

The subordinated ground lease rental rate is usually a few percentage points above long-term permanent loan rates applied to the land value, which would correctly calibrate the risk-reward equation, including the risk of foreclosure, for the ground lessor.

The unsubordinated ground lease offers the landowner a more desirable role, comparable to that of the primary lender. This makes long-term permanent conventional financing more challenging for the developer, since the lender must assume the risk of lease termination and default. However, due to the senior position of the unsubordinated ground lessor, the ground lease rate can be lower and therefore much more attractive for the developer. The permanent lender recognizes the ground lease payments as an annual expense that will be factored into its loan underwriting. In total, the cash required in the deal by the developer is reduced while his yield is increased.

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In both cases, the developer’s requirement for cash in the deal is reduced because of the value that the landowner brings to the deal. The reduction in cash usually required causes the investment yield to increase when the income stream is extended into the future. The value of the future cash stream will be determined by a threshold discount rate, resource availability, and underlying assumptions — the same general market and economic model assumptions that apply to fee-simple land ownership deals.

Other considerations include the length of the remaining lease term, reversion covenants, and extension and renewal rights and options. Occasionally the ground lessor will participate in the cash flows by applying a lease rate as a percentage of the income that the rental property produces. This strategy can have the positive effect of averting a monetary default in the event of a “dark” project. It also has the positive effect of mitigating the risk that a first mortgage lender perceives if the lease is unsubordinated. For example, if prevailing long-term interest rates are 6 percent, a comparable subordinated ground rental rate might be 8 percent, whereas an unsubordinated lease might be priced at par or 6 percent.

Ground Lease Benefits

The potential to form a joint venture with a building developer can be attractive to the primary ground lessor. The yield values are enhanced by the security of the future improvements. Provisions against wasting the property, requirements to maintain the improvements, cure and notice rights, certain reasonable approval conditions, and the ubiquitous hazardous materials covenants are standard.

Clearly, an unsubordinated lease presents possibilities that offer an alternative investment vehicle that provides security to patient investors and can be traded, sold, or transferred in creative ways. For example, tax-deferred 1031 strategies are possible by trading into an income investment as a sandwich ground lessee-ground sublessor. The usual threshold is that the lease term be greater than 25 years. Since these instruments can take on the color of a security, real estate professionals who enter into these deals should carefully document all aspects of the transaction and seek advice from qualified securities professionals.

In addition, opportunities exist in some municipal ground lease situations wherein, under certain conditions, property taxes are completely or virtually eliminated. Likewise other tax benefits accrue to these sanctuaries because of the reversionary character of building improvements and the incentive-rewarding jobs creation. These areas of investment can offer a spectacular advantage over neighboring competing properties in pricing and yield.

Lease term and length influence the acceptability of ground lease deals. The current climate is cautionary because of the parochial need to own; however, institutional managers realize that it is all factored into the risk and yield and accept the challenge with appropriate lease drafting and terms that are favorable to the asset managers’ objectives. The environment is changing as the pressure for yield performance and risk mitigation goes begging. The challenge is pioneering in an area where heretofore only the creative and adventurous have explored.

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Legal Question & Answer

The following comes from the Legal FAQ section of TexasRealtors.com:

After the sale of a home [or other property] occupied by a renter, it was discovered that the security deposit was not transferred from the seller to the buyer as part of the closing. Now the parties can’t agree on who is responsible for the security deposit when the rental ends. Who is responsible for the security deposit?

Both buyer and seller could be responsible. Under the provisions of Section 92.105 of the Texas Property Code, the seller and the buyer may be liable for the security deposit and any refund of the deposit to the tenant upon termination of the rental. The new owner is liable for the return of the security deposit from the date he acquires the property. However, the seller also remains liable for the security deposit he received from the tenant until the buyer delivers to the tenant a signed statement acknowledging that the buyer is the new owner and has received and is now responsible for the tenant’s security deposit.

The transfer of the security deposit upon closing is now specifically addressed in the TREC One to Four Family Residential Contract. Paragraph 9(B)(5) now expressly states:

“If the Property is subject to a lease, Seller shall (i) deliver to Buyer the lease(s) and the move-in condition form signed by the tenant, if any, and (ii) transfer security deposits (as defined under §92.102, Property Code), if any, to Buyer. In such an event, Buyer shall deliver to the tenant a signed statement acknowledging that the Buyer has received the security deposit and is responsible for the return of the security deposit, and specifying the exact dollar amount of the security deposit.”

Texas Association of REALTORS® form 2210, Notice to Tenant of Change in Management and Accountability for Security Deposit, could also be used for this purpose with a few obvious changes.

Note: Section 92.105 of the Texas Property Code does not apply to a real estate mortgage lienholder who acquires title by foreclosure.

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How Corporations Evaluate the Decision to Own Real Estate

whartonThis report by the Wharton School of the University of Pennsylvania says there is no single answer as to whether a company should own or lease its real estate. See below for the reports summary and conclusions.

One of the most important capital decisions made by corporations is whether they should own or lease their operating real estate (offices, industrial and warehouse facilities, and retail space). This decision is generally viewed by corporations as a trade-off between the pres- ent value of rental payments versus that of the operating costs of owning the real estate, net of expected capital appreciation and the depreciation tax benefits from ownership. The rule of thumb is that only if the present value of future rent is less than the present value of costs of self-ownership of the space (net of depreciation benefits, and expected property appreciation), should the firm lease rather than own. However, as this paper demonstrates, this analysis is fundamentally flawed, lead- ing companies to own far more corporate real estate than is economically justified. This is true in countries such as Germany, where corporate users own as much as 75 percent of their real estate, as well the United States, where roughly 40 percent is owned by corporate users.

The correct model for the own-versus-lease decision must compare the present value of profits the corporation expects if it leases versus the present value of expect- ed profits if it decides to own its real estate. The key insight provided by this corrected approach is that the own-versus-lease decision revolves around the com- parison of the lost profits associated with moving corporate capital from core operations to real estate, versus the profits achieved by real estate owners. That is, capital freed up from real estate ownership generates the company’s core business rate of return, while rents reflect the rate of return earned by landlords on their real estate capital. Since most companies have higher expected rates of return in their core business than are achievable through real estate ownership, this decision model indicates that the vast majority of corporate real estate should be leased. The intuition of this result is simply that by moving capital from low-yielding real estate to high-yielding core operations, companies increase profits.

The model [in this paper] demonstrates that there is no single answer as to whether a company should own or lease its real estate. Instead, it depends upon the nature of the firm, the nature of the real estate market, the type of the real estate, and taxes. But the model demonstrates that high-multiple firms with high core rates of return, particularly if they are looking for real estate that is readily available in a competitive real estate environment, should lease. The model also suggests that for idiosyncratic properties in less competitive property markets, companies with low rates of return in their core business will gain by owning their real estate, particularly if the rental market is very inefficient. Our model can be easily applied to every property to determine if the firm should own or lease the property. A critical insight is that shifting dollars from EBIT-DA to rent can enhance corporate value, as the capital is allocated to higher return core businesses, generating greater bang on the firm’s limited capital, by freeing capital from relatively low-yielding real estate to high-yielding corporate operations. This decision also allows corporate management to focus its energies on its core competencies, which generally both lowers risk and adds value.

Source

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Energy Spurs a Recovery in Houston via The New York TImes

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REAL ESTATE
Energy Spurs a Recovery in Houston
By KRISTINA SHEVORY
Published: February 7, 2012
Rising oil prices and a boom in shale exploration are leading companies to add office space in the Houston area, most notably Exxon Mobil.

HOUSTON — In most cities, companies are holding tight, mothballing office expansions and delaying new hires. But not in Houston.

Powered by a rise in oil prices and a shale exploration boom, Houston is the first major metropolitan region to regain all the jobs it lost in the recession. The region added about 76,000 jobs last year, according to the Texas Workforce Commission, and is on pace to pick up tens of thousands more this year.

Oil and gas companies, from the biggest names like Exxon Mobil to the smallest independents, are dusting off plans to expand, relocate or put up new buildings. Last year, 1.8 million square feet of commercial space was vacuumed up, and real estate brokers expect the same or greater this year. “No question, it’s energy,” said Jim Arket, a senior vice president at Grubb & Ellis in Houston. “That’s been the plus multiplier of Houston.”

The resurgence can be partly tied to the lifting in fall 2010 of the government moratorium on deepwater drilling in the Gulf of Mexico after the BP oil spill. The bulk of the gulf’s drilling and profits comes from those offshore waters. Shale drilling has also bolstered balance sheets.

See full article here.

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Digital Revolution and Retail Real Estate

Urban Land Logo.ashx

The digital revolution: Store-based retailing will survive if retailers and landlords “embrace multichannel” strategies, says panel at the ULI Europe Annual Conference in Paris.

“The future of retailing is M-commerce [mobile commerce], S-commerce [social commerce], and QR codes [quick response codes],” Jonathan De Mello, head of retail consultancy at CB Richard Ellis, told the audience at ULI Europe’s session on the impact of the digital revolution on real estate.

These concepts—the new language of shopping and consumerism—describe the powerful capabilities that technology offers to retail brands. The ability to buy and sell goods via mobile phones and tablets, and their existence, arguably represent one large step in the evolution of the threat to store-based retailing that has existed since the launch of the World Wide Web in the early 1990s.

But the message from the panel was not quite so downbeat: these new forms of commerce are changing the way consumers use stores, not negating the need for stores altogether. -

Excerpted with permission of Urban Land. All rights reserved. Visit http://license.icopyright.net/3.9271-9626 for details.

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Retail REITs Help Entrepreneurs Get Their Start

Article reprinted from REIT.com

For many would-be entrepreneurs, just knowing where to start can pose an enormous challenge to striking out on their own.

Retail REITs are now rolling out programs intended to help these potential tenants start off on the right foot. Since the beginning of 2012, DDR Corp. (NYSE: DDR) and Kimco Realty Corp. (NYSE: KIM) have implemented two such initiatives.

In the process, the retail REITs are taking a creative approach to luring local business owners and franchises to fill smaller, vacant spaces in their shopping centers. While DDR’s new program helps fledgling small business owners incubate new concepts, Kimco’s program focuses on streamlining the process for business owners looking for franchise opportunities.

Set Up Shop in this Space

DDR officially launched its hands-on Set Up Shop program on Feb. 2. The effort is geared towards to small-shop leasing.

The first few months of a new business venture are critical to long-term success, according to Paul Freddo, DDR’s senior executive vice president of leasing and development. Set Up Shop gives participants access to a team of experts that will work closely with them to ensure their ventures get off to a good start.

Freddo says the program creates a win-win situation for both the company and the business owner. DDR can attract tenants to some of its smaller spaces that are usually more challenging to lease. In turn, the company is offering free rent to participants during the first six months that they are in the Set Up Shop program.

“It’s really about the flexibility, the shorter-term deal and free rent,” Freddo said. “The win for us is that it reduces expenses at the asset level.”

DDR has partnered with SCORE, a national nonprofit association for entrepreneurs, to help get the program off the ground. The association will serve as a resource for Set Up Shop tenants, and its volunteers will offer free business counseling.

The program will initially launch in specific locations within 24 Atlanta-area shopping centers. Freddo says there’s no limit on the type of small business that can be considered for the program, including general retail or service-oriented businesses such as investment counseling or tax services.

FastTracking Franchises

Kimco, on the other hand went the technological route. The New York-based REIT introduced its new FastTrack franchise program in January. FastTrack offers a way for entrepreneurs, franchisees and franchisors to find new opportunities within Kimco properties.

The company has tools on its website that allow potential business owners select a specific franchise and find pre-approved sites within Kimco’s portfolio to open their business. They can also search by location to see which franchises have pre-approved spaces within the center.

The program launched in January. Brett Cooper, Kimco’s Northeast region leasing associate and developer of the FastTrack program, says the company is also putting window signage in vacant spaces within their centers to let people know that it’s pre-approved for specific franchises. Ultimately, the goal is to attract smaller, local businesses.

“The smaller spaces are the toughest ones to lease,” he says. “It’s where the mom and pop shops are that have been vacant for us. This is a way for us to ramp up leasing in the sub-5,000-square-foot spaces.”

Retailers such as Pearle Vision, Cheeburger Cheeburger, the UPS Store and other chain stores are among the 18 national retailers listed so far. Cooper is working on adding another group of 10 chain retailers to that list by the end of the month.

FastTrack is currently available in 46 of Kimco’s shopping centers in the Mid-Atlantic region. Cooper says the goal is to make it available throughout the company’s portfolio within the next six to 12 months.

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What every tenant should know before signing a lease

From the Houston Business Journal

Commercial-Lease-Agreement

The cheapest rent does not guarantee the best deal. Make sure your landlord is on firm financial footing. Find a qualified tenant representative to advocate on your behalf.

Those are some of the guiding principles businesses should follow before signing a lease, according to commercial real estate experts.

Committing to leasing space — whether in an office building, shopping mall or warehouse — is a major decision for any business, but one that owners and managers often make without being armed with all the facts.

The reasons vary — they are so busy running their companies that they often do not have the time to research the market and seek proposals, they have never negotiated a lease, or have only limited experience doing so.

Or, they take the word of a real estate broker who represents the landlord, not paying attention to the fact that their interests and those of the landlord are not always the same.

“They get lulled into a false sense of security,” said Eric L. Nesbitt, a real estate attorney in Denver, and author of “Negotiating Commercial Property Leases.”

“They drive around, see names and numbers on signs on buildings, call and deal direct with the landlord rep,” he said. “They have a good rapport and think they’re getting a good deal. But, at the end of the day, that agent is going to get the best deal they can for the landlord.”

The tenant may think they got a break because the landlord’s rep took 50 cents or $1 off the lease rate as a concession, Nesbitt said. But, other tenants got $2 off.

Given the relatively weak demand and excess supply of commercial space, tenants should use that imbalance to their negotiating advantage. It’s still a tenant market in retail, depending on the area one is looking to lease in, said Walker Barnett, principal with Colliers International.

However, that is not true with industrial. With a 5 percent vacany level, the industrial market is swinging back toward the landlord, he said.

To fill empty space, many landlords are offering incentives that go beyond cutting the lease rate. Free rent, whether for one month or more, has become increasingly common.

Another example is a more generous allowance for tenant improvements. Landlords pay for improvements to get space ready for tenants up to a certain amount, say $10 per square foot. If the cost exceeds the allowance, the burden falls on the tenant to pay the difference.

By offering a bigger allowance, the landlord is shouldering more of the up-front cost.

Long before negotiating a new or renewal lease, tenants should know the financial health of the property owner.

That is one of the most overlooked aspects of a transaction and one that could come back to haunt the tenant if the landlord is foreclosed upon or does not make good on promises to do renovations or other improvements.

“You have to ask a lot of questions,” said David Zimmer, national president of the Society of Industrial and Office Realtors. “A lot is relative to the size and sophistication of the tenant and the deal. Some information will be readily available.”

Zimmer suggests asking the landlord’s lender for a reference. He also said tenants should insist on a nondisturbance agreement in the lease. Under this provision, the lender honors the landlord’s lease obligations if the landlord defaults on his loan.

A nondisturbance agreement trumps a common provision in leases indicating the lease is subordinate to the mortgage or deed of trust, Zimmer said.

Nesbitt and Zimmer both recommend businesses rely on a qualified tenant representative to find the space that fits their needs and negotiate the best lease.

There is no extra cost since a tenant’s representative splits the commission with the landlord’s broker, an arrangement similar to what happens in residential real estate.

“We like to tell our clients that in most cases, not only are we going to work with you, you are going to save more money than if you try to negotiate on your own,” Nesbitt said.

That is not to say business owners and managers cannot find space on their own, perform due diligence on the landlord, and successfully negotiate a lease.

“Is it possible? Of course,” said Frank Simpson, 2011 president of Certified Commercial Investment Member Institute.

“It’s possible for a lay person to operate on himself but you really need a surgeon to do it. Why would you not want to use a qualified broker? You’re busy. You’re selling widgets. You don’t know the pitfalls, you don’t know the opportunities that the market is allowing in this climate.”

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