Not sure how to assess commercial unit need

[Sarah Moore]

We're considering 4 commercial properties in our area. These include multiple office and retail spaces. I'm good with the underwriting, and know that the numbers would work. The only hesitation I have is that I am not 100% certain about the office space rental market. I'm still new to this arena and don't want to make a costly mistake if I can avoid it. 

What advice do you have for determining if the demand is there for prospective commercial (office space) tenants? 

[Chris Mason]

Commercial leases are in the 3-5 year range. So most of the pre-covid ones have already rolled.

I'd focus on the ones that are about to roll. The business who signed a 5 year lease in August of 2019, that's up in August of 2024.

I'd go walk my happy butt into that office space. I know a commercial tenant (colleague) who is paying to rent an office space big enough for 40 employees, but only 5 people are willing to go to the office, so it's a ghost town, obviously they will not be renewing. If a potential buyer were to walk in there, it would be obvious that this tenant isn't renewing, and they'd be a fool to include that rent in their own underwriting numbers. 

Be cynical and conservative, subtract out the rent from any ghost office. Consider making judgement calls beyond just the obvious ghost offices, too.

At this point, since we're at about the 5 year mark, I think things are mostly stabilized. And if that means it's "stable" at 35% vacancy, then don't pay a dollar over what makes sense with perpetual 35% vacancy. The listing broker is going to have a proforma assuming 10% vacancy, throw it in the trash, which is EXACTLY what we are doing on the lending side. 

If that 35% vacancy ever shrinks to 15%, hey, that's your upside, that's why buying an office in 2024/2025 is going to be like buying homes was in 2009/2010 at the bottom of the market. More millionaires were made by those bottom of market home purchases than most other times, I suspect that's what we're looking at for offices this year and next.

Let me know if you want to run financing numbers.