commercial office space

[Konstantin Komkov]

Hello, I am new to commercial side of real estate. I am looking at how commercial office space is appraised. There are around 50 similar commercial office spaces, when they were build in 1990's they all were sold at approximately $120 per square foot. But recently they were sold at a very different prices per square foot. Some are really 1.5 times more than the others. My question is how it could be explained? From the outside they all look the same, but different square footage of cause.
Thank you ! K

[Chris Mason]

"My question is how it could be explained?"

Some might have a strong NNN tenant in place with 10+ years left on the lease, and it might be a big corporation that you can take to court if they ghost on paying their rent, while others might be office suites broken up into small offices on 6-36 month leases with shaky tenants like a nutrition supplement MLM that uses the office for 3x a week rah rah meetings on how to recruit more people into the pyramid scheme, that are immune to law suits b/c you can't squeeze juice out of a rock. In the middle of those two extremes might be a small business with 3 years left on their lease, but they've made improvements to the property that aren't cheap to remove, such as perhaps a dental office (dentists might be pissed that I put them in the mid-risk category, but all the dentists going out of business in 2020-2021 taught us that American consumers apparently regard dental care as an optional and "luxury" spending item). 

You wouldn't pay more for a home with a really strong tenant b/c even the strongest tenant typically has <12 months left on the lease.

Take a look at the cap rates. Made up nice round numbers, and yeah these are extreme just to highlight the concept:

MLM tenant: 8% cap is appropriate based on comps, paying $100k/yr. $100k / 8% = $1.25m.

Dentist: 7% cap is appropriate based on comps, paying $100k/yr. So $1.428m

Edward Jones Financial Advisor, and Edward Jones is the guarantor of the lease (not a franchise owner[1]): 6% cap is appropriate based on comps, paying $100k/yr. $1.67m.

You might say "that's bs, the offices are identical!" -- and someone more cynical who has been around the block a few times might say "yeah but Edward Jones is a solid tenant, that's super low risk, and they've been there for 15 years already, and are 2 years into another 15 year lease." 

To make it equivalent to a house or a triplex, you could think of the tenants as the "neighborhood." Both your tenants and other tenants contribute to what that "neighborhood" looks like.

Other things that come up are neighboring businesses. To switch to retail in order to use an extreme/silly example, take an organic vegan gluten free small grocery store with 1 year left on their 10 year lease. Six months ago, the property owner was silly enough to let a cigarette store move in next door. That's a giant red flag for that grocer potentially declining to renew their lease, vegan gluten free customers don't want to walk through a cloud of cigarette smoke to get to their ethically sourced non-GMO organic avocado, and obviously the "no smoking within 50 feet" sign is going to be ignored by the customers of that neighboring business, who are all a bunch of smokers. A residential landlord doesn't necessarily have any influence over the financial success of their tenants, nor do they care b/c they can just re-fill the unit in a month anyways. 

A commercial landlord DOES care, and CAN impact the success of their tenants, and may NOT be able to re-fill the unit in a month. Back to your office space, are you going to let an optometrist rent the space next to a law office? Sure, why not, that actually adds to the professional community, I'm sure the accountant one unit over wouldn't mind either. Are you going to let an optometrist rent a space next to another optometrist? I don't know, but you would 100% want to check in with the existing optometrist, maybe they don't get "walk in" business anyways and do not care and wouldn't mind the like-minded neighbors (I've had mortgage neighbors before, and do not care -- I do mortgages they don't, case in point office mortgages across the country, so I wind up getting business from them), but an ice cream shop is going to be LIVID if you rent the unit next store to a frozen yoghurt shop, since that's a LOT of walk-in business that's now getting split two ways

And then to make it really fun, here's the question I'll throw back at you. Say it's 40% vacant. How do you determine the value now? 

[1] I have no idea if Edward Jones locations are franchise or corporate.