Office building - ugly?

Question

I'm considering buying this 5-unit office building. It's in a stable, mid-sized Midwestern market with a low (5-ish%) office vacancy rate. Currently 3 of the 5 units are rented. One of the others was occupied by the owner's business, who has apparently moved out of state.  It's basically breakeven with 3 of 5 units rented. One more tenant and it's cash flow positive. If fully rented, it would cash flow well and would be about an 11% cap rate at list price.

Only problem is, my wife thinks it's too ugly. I think it's not that bad, but I've run it by others and everyone seems to agree: it's ugly.

I think if we just removed the mansard roof and painted over the outdated colors (including brick), it would look much better. However, the building is situated between two other buildings which are virtually identical. She thinks it would look odd if ours was updated and the others were not.

What do you guys & gals think? Open to opinions and suggestions. Thanks!

Mike McGee · Answer

@Katie Neason Our agent is checking with the owners of the other two buildings to find out if they're full. Of the three existing leases, one has been there since Jan 2015, once since Feb 2016 and once since Sep 2017. All renew at some point this year. I would make the purchase contingent on those leases being renewed.

@Ronald Rohde That thought has crossed my mine, though the other owners haven't indicated an interest to sell. Might be something I could do over time. Once I own them all I could give them all facelifts and maybe command more in rent.

Robert Plumpe · Answer

Mike:

OK, if you can get it for you want to pay, sounds like a reasonably good deal.

Let the board know if you are successful!

Mike McGee · Answer

They are split levels, so you enter between the floors. Stairs are required to go up or down. If I can get the property for what I want to pay, and get it fully rented, the cap will be substantially higher than 11.

Robert Plumpe · Answer

Hey Mike McGee:

I would only be slightly concerned about the appearance of the building.  Add maybe a 25 basis points to the cap rate?

Here in MI, there are buildings that look very similar to yours.  They were built in the very late 60's and early 70's I believe.

The thing I would be more concerned about is that it looks like 2 of the units are garden or basement units?    Do you have to go up/down stairs to get to the offices?  If so, the building would not be ADA compliant.  Of course, it is probably grandfathered in, as it probably can't be retrofitted.

HOWEVER, some prospective tenants will shy away from this type of buildings.  For example, attorneys that meet with clients that are ill/injured and in wheelchairs.  Also, some national businesses may not rent in buildings that aren't ADA compliant.

Not that this makes a huge difference, but maybe add another 25 basis points to the cap rate?

Finally, I would probably want to get a bit more than 11% if the building is completely full.  Of course, there might be other considerations if you think you can make improvements to the building/raise rents.  Interest rates have been raised, and they are clearly up in the short & medium term.  This is going to make mortgages more expensive and lower the value of assets.

You can get very high single digits and sometimes even break through 10% on REIT's.  If I own/manage physical commercial property, I would certainly want to beat returns offered in publicly traded REIT's.

Mike McGee · Answer

Interior looks sharp and updated. Physically in good condition, inside and out. Obviously haven’t had an inspection yet, but roof is fairly new, HVAC, etc. Parking is ample. Hope to find out soon from our agent whether or not the neighbor buildings are fully rented.

Bob Langworthy · Answer

I agree with @Brian Schmelzlen's points. If I were buying the building I would be less concerned with the outside appearance. A tenant will spend the vast majority of their time inside the building. What do the offices look like? Dated? Dark? Etc. If the offices look sharp or can be made to look good for a small amount of money, that would be of greater value to me (and most tenants) than the outside appearance. Also, is there adequate parking?

I'm sure your due diligence will include the age and condition of all systems, roof, siding and windows. If everything else checks out (financial, inside, systems, etc.) and the only problem is the outside appearance, I would be inclined to buy it.

Mike McGee · Answer

@Zach Quick One building is owned by a chiropractor who runs his business there. The other is owned by a local investor. My agent is talking with him to get info. Tenants there include a massage therapist and a State Farm agent.

@Brian Schmelzlen I'm happy with the type of businesses currently leasing this building and in the buildings next door. My agent has a client who is looking for office space in the area and thought he might be interested in this building. I told him to show him the property and see if he's still interested after seeing it. If he's not put off by the looks and if I confirm the neighboring buildings are fully leased, that should be enough evidence to persuade the wife!

Brian Schmelzlen · Answer

I don't think our opinion of whether it is too ugly or whether it should look like the buildings by it matters.  I think you should try to conduct some informal market research to determine if your potential tenants think that it is too ugly.

First, I would look at the buildings next door and what type of businesses occupy it.  If those are the type of businesses you want as tenants, and the other buildings are full then that is pretty good evidence that your potential tenants are fine with how the building looks.

Next, I would ask people in the industries that you want as tenants what they think about the building.  To be clear, I am not suggesting that you ask them to rent from you (although that could be a bonus), I am asking if they would be comfortable running their business there.  You would want to ask people who would be honest and not just try to give you the answer they think you want to hear.

If you find out that your potential tenants are fine with how the building looks, why should you care if its too ugly?

Zach Quick · Answer

@Mike McGee On the flip side, if this has listed for awhile, have you considered what would be holding back the owners of the other two buildings from pursuing this?

If they are owned by owners who operate businesses within those buildings then ignore my comments, but something to consider.

Ronald Rohde · Answer

I wouldn't care about the appearance. Who owns the other two? Underwrite a purchase for all 3? Thats where 1+1+1=5 with your paint and energy applied!

Office building - ugly?

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