Thoughts on a commercial office building?

Question

Hey all:

Just wanted to get some ideas feedback on a building I'm looking at...

It is an office building that is single story/brick.  It is solidly built, in pretty good mechanical condition, but it is a bit dated and would greatly benefit from some cosmetic improvements/benefits.  The current owner is a motivated seller.  There are no stairs/ramps/single story so I don't think there are any ADA compliance issues.

It is just over 8k sq. ft.  it is dividend into four distinct offices.  Each of these larger offices is approximately equal in size.  They share a common entrance, but have their own bathrooms, reception areas and are subdivided into 5-6 individual offices per larger unit.   There is adequate parking in private lot(s) for each office.

The building has one tenant currently (1/4 occupancy).  The owner has kind of let it go...he is getting older and wants out, he wants to sell, not be a landlord.  He has not been trying to lease it all in the past year or so.  He has been trying to sell it, not lease it.

The one tenant pays just under $3k a month.  I think this is a little bit high for the market.

The asking price is $300k.

I am very intrigued in it...It is kind of expensive in terms of sq. foot cost...but it is in pretty good condition.  I don't think there would need to be a lot of money spent on it to bring it up to being a pretty spiffy building.  It is also in a slightly better neighborhood than where I have my other buildings...so it might be worth to pay a bit extra to get a better quality location/building.

If other tenants can be brought in, the building would be cash flowing tremendously.  The negatives as I see it are that the property taxes are too high...it is risky with only ONE tenant in it.  If they move, the building goes to zero revenue.  It also is probably going to take some additional capital to really get it going.

It is located in Michigan, in a nearby suburb of Detroit.

Any thoughts?

John Mocker · Answer

Robert,

Locally here in CT there are Commercial Real Estate Broker organiztions.  As some one outside the direct industry (I'm an Insurance Agent) I have learned a lot from attending.  One of the things the meeting includes is anouncements of new deals, closed deals, etc.   Those announcements often include the per sq ft lease rate.  If one of those groups exists in your area, see if you can attend.  If that is not possible, you may want to talk to a Commercial Realtor.  See who is listing similar properties as they should have some knowledge of what the rents should be, how tough the rental market is in the area, and what you should pay to get the return you are looking for.

Alan DeRossett · Answer

Sounds cheap maybe convert into a storage business. plenty of people need extra storage space.

Robert Plumpe · Answer

Jeff:

Believe it or not...that is rather expensive on a per square basis....I bought a couple of office buildings in reasonably good shape for $11/sq. ft.  They were unoccupied, but I am in the process of moving a business into one of the buildings, and will take maybe 3/4 or 80% of the space in the one building...so for me, that was a good deal.

Since the time I bought my buildings, I've seen ever cheaper/better? deals in the neighborhood.

None of these buildings are in Detroit....they are all functional buildings...no extensive renovations needed.

And yes, you are right that you could not build these buildings for the current market price...not even close.  Generally speaking, there is too much space/land/buildings in MI.  MI is generally a contracting state with a lot of problems...and while that is bad, it also creates opportunity.

I think there could be  a tremendous business moving "back office" functions from NYC, CA, and other high priced coastal areas to MI.  We have phones, electricity, the internet, mail, transport, and everything we need to conduct business.  If you do things right, land/buildings can be almost free.

I have noticed though that since the beginning of the year, there are fewer vacant commercial spaces in my neighborhood.  Buildings that had long been vacant now have tenants/businesses in them.

With one tenant, it is a precarious situation....they leave, then there is no question you are losing money, and losing big time.

Jeff Kehl · Answer

@Robert Plumpe  $300k for 8k square feet = $37.5/ square foot. That is far below that building can be built in even the cheapest areas of the country. That tells me no one and their brother wants to rent space there. So why would you want to buy their problem?

Well actually, there's a lot of risk in a property like that but also a lot of opportunity.

I went to college in Michigan so I know each individual area can be drastically different. It could be dying or growing but it's hard to tell without a very deep dive into the exact area. Actually the exact same thing is true in Georgia but the entire area is growing which is not true in Michigan so you need to be more careful.

The one tenant lease could possibly support the purchase price so you need to become an expert in that lease. How long is it for. How strong is the Lessee? If it is a strong tenant with a strong business this might be a good opportunity. Let them pay the mortgage while you fill the other spaces.

But also try to get a good idea of what the demand is for these spaces. If you don't find or create more demand I would pass.

Also, absolutely call out the current owner on ANY deferred maintenance. Make them fix it before close or credit you at closing to fix it.

@Joel Owens

Robert Plumpe · Answer

Joel:

I am not 100% sure...but I the property is owned free & clear.  The purchase price is free & clear from any mortgage or liens.  The property tax is paid up.  There might be water/sewer/trash bills unpaid...but these would be de minimis.

It is too late to contest for this year's property tax, but not a problem as that is paid up.  If I purchased, I would contest for the upcoming year, and I would probably handle it myself.  At least initially....

I believe the tenant(s) pay for electric/gas & internet & phone themselves, as each unit is individually metered.  I think the landlord pays for water/sewer/trash.  I further believe each unit has it's own HVAC.

Of course, the landlord has to pay for his insurance, taxes, and CAM (minimal as there is no grass/landscaping) and of course repairs/capital expenditures.

If the roof/HVAC/plumbing is good/reasonably good. I am not sure it would be bleeding cash at 1/4 occupancy.  Taxes are $1,000 month, that would leave $1,400 to other expenses/mortgage.  Not a great situation...but probably not to far in the red or the green either way.  The real question is can other tenants be brought in, and at what rent levels?  I think at one you are slightly losing/breaking even....two you are making money, three you are doing well, and at four you are really hitting it out of the park.  That is what has caught my attention to the deal.

Of course, if the property requires 100K+ in repairs/expenditures, then this is not a good deal...

Joel Owens · Answer

Offices unless medical tenants are generally on gross or modified gross leases.

If tenant is reimbursing some expenses then likely they are only paying for the space they occupy. So the property is likely bleeding cash at 25% occupancy or so.

Does the seller owe any debt on the property or paid off? How much depreciation recapture built up and deferred capital gains taxes?

The property taxes tax attorneys who specialize in tax protests generally take on for no cost and get a percentage of the savings. Has time to file appeal this year already passed? If so usually have to wait for next years assessment.

With gross leases tenants are generally paying an all in rent and that is it. So you have to look at if building is 20 years or newer the A/C and heating units, roof condition, parking lot, and drainage issues,etc. If the building is older than that many other issues to look at also.

The costs to fix those issues could be substantial over 100,000 or more for that size building.

If you think area is great get owner finance on the whole mortgage note with little down. Seller does not manage and gets paid small amounts of money over time so capital gains tax is less. On value add look at interest only note at 4 or 5 % to keep note payment low.

Strategy might be to lease up the other units at below market rates to stabilize quick and then have 3% annual rental increases in the lease versus 2 to accelerate bringing closer to market lease rate in the next 5 years.

You could also try a master lease.

No legal advice given.

Thoughts on a commercial office building?

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