Purchasing a small Office Building

[Scott Trench]

Hi Folks - I am fishing for more advice from the experts in the forums here. 

I am getting increasingly serious about purchasing an office building here in Denver in the next few months. 

My rationale: 

- Office is essentially not trading right now on the market. The locations I am looking at (suburbs reasonably far from downtown and the Tech Center) have seen 3 total transactions in the last year. There's a lot for sale as well, and a lot for lease. It's just not moving at all. I like this. I think that this is the "blood in the water" thing that investors talk about. 

- The examples have incredibly good math on paper. I believe that the spaces I am looking at would rent for $25-$30 per sqft. On a 4,650 sqft property listed at $1.1M, that's $116K - $140K per year in Gross Rents, and after NNNs, I believe I'm looking at a 10-12% Cap Rate on asking price. The property has been sitting for months. There are many like it. 

- Even if it takes me 6 months to find a tenant at $25/sqft + NNNs, I would still generate more NOI in year 1 than on a multifamily property with similar square footage. Even if I have to wait 6 months and spend $50K on a different buildout, I'm still doing better by month 15.

- I believe that companies and the economy as a whole have begun a long-term shift towards back to in-office. And, that this return to office will manifest itself first in suburban areas with relatively less competition and shorter commutes for local workers, and that re-absorption of inventory will take a lot of time in urban areas with tons of vacancies. Thus, I am interested in suburban space near major cities, not the downtown inventory that is trading for pennies on the dollar, but often involve massive office complexes that will have huge holding costs until they get leased up. 

I'd love to get beat up on this thesis. My worry is that while I am clear on the risks (extended timeline to get a tenant in, and expensive buildout) that I am not being nearly conservative enough - do I risk this thing sitting empty for a year, or years, and finally renting well below my implied rate? 

The market just has so little volume that it's hard to tell what's realistic or not in the near-term. 

But, this smells like a serious opportunity from where I sit. Things have to go really bad from here, as I see it, for the office to underperform alternatives in the next few years, from a cash flow perspective.

[Don Konipol]

Quote from @Scott Trench:

Hi Folks - I am fishing for more advice from the experts in the forums here. 

I am getting increasingly serious about purchasing an office building here in Denver in the next few months. 

My rationale: 

- Office is essentially not trading right now on the market. The locations I am looking at (suburbs reasonably far from downtown and the Tech Center) have seen 3 total transactions in the last year. There's a lot for sale as well, and a lot for lease. It's just not moving at all. I like this. I think that this is the "blood in the water" thing that investors talk about. 

- The examples have incredibly good math on paper. I believe that the spaces I am looking at would rent for $25-$30 per sqft. On a 4,650 sqft property listed at $1.1M, that's $116K - $140K per year in Gross Rents, and after NNNs, I believe I'm looking at a 10-12% Cap Rate on asking price. The property has been sitting for months. There are many like it. 

- Even if it takes me 6 months to find a tenant at $25/sqft + NNNs, I would still generate more NOI in year 1 than on a multifamily property with similar square footage. Even if I have to wait 6 months and spend $50K on a different buildout, I'm still doing better by month 15.

- I believe that companies and the economy as a whole have begun a long-term shift towards back to in-office. And, that this return to office will manifest itself first in suburban areas with relatively less competition and shorter commutes for local workers, and that re-absorption of inventory will take a lot of time in urban areas with tons of vacancies. Thus, I am interested in suburban space near major cities, not the downtown inventory that is trading for pennies on the dollar, but often involve massive office complexes that will have huge holding costs until they get leased up. 

I'd love to get beat up on this thesis. My worry is that while I am clear on the risks (extended timeline to get a tenant in, and expensive buildout) that I am not being nearly conservative enough - do I risk this thing sitting empty for a year, or years, and finally renting well below my implied rate? 

The market just has so little volume that it's hard to tell what's realistic or not in the near-term. 

But, this smells like a serious opportunity from where I sit. Things have to go really bad from here, as I see it, for the office to underperform alternatives in the next few years, from a cash flow perspective.

 You’re thought process is good, BUT, if your market timing is incorrect, or the specific property you purchase lacks tenant demand, you can get stuck with an “alligator” for a long time.  

Twenty years ago I purchased an old car dealership at auction in Bryan, Texas for about 10% of REPLACEMENT value.  It was in fairly good condition, and I KNEW I could easily lease it out, or lease sections to various business, or sell it for double or triple what I paid. 3 years later, having not even received an offer to lease AT ANY PRICE, I sold it for $25,000 LESS than I had paid. Additionally I spent $35,000 on property taxes, $17,000 on insurance, $35,000 maintenance and repairs.  
The investor I sold to spent 2 more years without a tenant. Finally, he leased the property (actually about half the property) to a tile distributor.  The distributor later decided to consolidate warehouses and signed a long term 3N lease for the whole property.  The investor ultimately tripled the value of the property.  Timing, timing, timing.  Being “right” but early can be fatal. 

A difficult, but safe approach is to pay for a 6 or 12 month option to purchase the office building.  Then test the market and try to elicit tenant interest. If you obtain letters of interest, you can exercise your option. If it looks like a tough go, you can walk away or renegotiate price.  

If I wanted to get more involved and spend more time on investing (like if I was 20 years or more younger) I would make extensive use of options. I used them with a lot of success throughout the years, but they were never a mainstay of my acquisition techniques.  Good luck