Foolish to buy office building?

Question

2 partners and I are looking to purchase a small, 13-unit office building in a bustling local town in northern NJ.

My question is simple - Am I foolish for buying office space right now?

The Deal:

$1.8M for the property, which generates $20.5K in gross monthly income. It's fully occupied at the moment with leases into 2026. Owner will hold the note at 6% with IO payments for 3 years. 10% down.

Doug Smith · Answer

Commercial Revenue Generating properties like office buildings, apartment buildings, retail centers, etc (banks call it "CRE" lending) are typically evaluated from their net operating income, not gross. You get a Capitalization Rate (CAP Rate), which equals your annualized return by dividing the Net Operating Income (you had gross in your narrative) by the purchase price. I realize I don't have the actual NOI, but that price sounds super high for the gross income you're stating in your narrative. I was chatting with some of my lending buddies at big banks and they are all backing away from the CRE space including office because operating costs are increasing more quickly than rents. In my home market of Florida, our insurance rates have made it much harder to have positive cash flow on a CRE deal. Be careful the seller isn't unloading a problem on your. There is a saying "if you've been sitting at the poker table for more than 15 minutes and you don't know who the patsy is...then you're the patsy". That being said, I don't have the information I would need to say for certain, but that sounds as if that's a high price for the asset you're considering to buy. I wish you well in your project.

Rick Pozos · Answer

Yes, you are foolish.

At 100% things can not get better and only go wrong. Tenants file bankruptcy, go out of business, stop paying, but stay.

I dont think it is the gross income that matters. It is what is left after snow removal, cutting the grass, utilities, tenant issues, parking lot issues, property taxes, mortgage payment, etc. that make a difference. What would be left and what happens if 2 or 3 of the tenants move out next year?

Henry Clark · Answer

1.  Any NNN?

2.  As mentioned above- CAPEX exposure both building and parking lot.

3.  Analysis of current tenants and future potential tenant market.

4.  Are you locked in on the contracts with the current set of tenants? Can they automatically re-new, if so, how do those projections work financially.

5.  Types of current tenants.  Cost to get units ready to lease out again?  $10,000; $30,000; $50,000 etc.  Restaurant switched over to Dental office, example.

6.  Current Tenants- would some want to expand into units next to them, knocking down wall, etc.

7.  Never use an Expense Ratio %-  do a line item forecast.  Challenge each number.  Will your property tax rate go up after the sale?  Have you check with an insurance carrier?  These are your primary costs if not NNN.

8.  Audit the current revenue numbers.  Do they make sense.  Review each contract.

9.  What are your Loan terms and P/I relative to the cashflow after taxes?

10.  Although I/O looks great; everyone just failed.  And they failed during the housing bubble.  Run the numbers using commercial 25% down and Fixed P/I of x.x% with 5 year balloon and 25-year amort.  If you can't make it work with a commercial loan don't do the owner finance deal even though it is great.

11.  If you're truly interested in this project; always make an offer, that meets your needs.  Instead of $1.8mm offer $1.4mm as an example.  Subject to:  DD and financing, 3 day offer.  Then walk away.  Don't get into counter offers.  Go to the next deal.

Alex Houser · Answer

Thank you all for the great feedback! I sincerely appreciate your insight. My apologies for the lack of information - I was sort of just posting to get a temperature gauge for office rentals in general. That said, here are the actuals:

Unit count: 13 offices (sizes range from 165sqft to 2,800 sqft - it's a local mom & pop type commercial building in an A-/ B+ town that's growing)

Gross Rent: $20,801

Expense Ratio: 50.7%

NOI: $9,736 (year 1, after vacancy)

---

Cash Flow: $2,536 / mo

Cap Rate: 6.5%

David Robertson · Answer

I wouldn’t personally recommend it, as office vacancy rates are currently quite high. Even if you manage to find an office with an existing tenant, their lease could be approaching expiration, and without plans to renew, it can take an incredibly long time to secure a new tenant for the space. This long vacancy period can result in significant loss of income and added holding costs. Moreover, office spaces often face more competition, especially with the rise of remote work and changing demand in the market.

On a personal level, I prefer industrial real estate for several reasons. Industrial properties tend to have more stable demand due to the increasing reliance on e-commerce, logistics, and warehousing. Additionally, these properties generally attract long-term tenants with longer leases, offering more consistent cash flow

Andrew Syrios · Answer

I wouldn't say that office properties are necessarily foolish to buy but I would certainly be wary of it. Office space has taken quite a hit lately, especially with the move to work from home. The big thing to me would be how high is the demand in that area? I really would want to stay away from any office properties in depressed or even semi-depressed neighborhoods, especially large ones (like a 13 unit complex). They can just be too hard to lease.

On the other hand, if the area is doing well economically and its occupancy is currently strong (I certainly want a vacant or near vacant property) I think it's worth considering at least. I would still prefer residential these days though.

As for evaluating the deal itself, I would need more information to give you anything helpful and even then, I don't know NJ much at all.

William Yeh · Answer

As others have stated, you have not provided enough information to determine whether this is a good deal or not. The major pieces of information you are missing include NOI which includes deducting all of your operating expenses from your gross rents sans debt service, market dynamics (what are vacancy rates and asking rents like in the market the building is located in?), status of major building components (roof, HVAC, structural, electrical, plumbing), accounts receivable aging (are all tenants paying or is the $20,500 schedule rent?), and lease history to name a few.

Don't be lulled into complacency by seller financing either. Maybe they are offering financing because no traditional lender will lend on the building. Too many investors treat lenders as an impediment to their deal. We look at lenders (so long as they lend in the asset class you are considering) as an additional line of due diligence (they deeply care about their money and they are likely more sophisticated than you are). If you talk to enough lenders that do office lending and they all shy away from the deal, that should tell you something. Alternatively if they all love the deal, that's also likely a good sign.

You can get a dog of a property in a crap neighborhood that will yield a 13.6% gross cap (not saying yours is), but that certainly doesn't tell the whole financial picture of how the asset will perform.

Jaron Walling · Answer

@Alex Houser You need more numbers and a proper inspection to justify the price.

Summary of expenses

NOI

Cap Rate

Condition of the building systems

Foolish to buy office building?

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