Potential Commercial Investment

[Joshua Kaufman]

My brother and I have a private/hard money lending company. We're hoping to expand our portfolio and are looking at a commercial building. This will be our first foray into the commercial world and I have some questions.

The building is about 5200 sq ft with 4000 sq ft on the first floor unit and 1200 sq ft on the second (walk-up) unit. The building is currently owned by both tenants (legal firms) and is being sold because the first floor tenant is retiring and moving out of state. The second floor tenant will stay and is willing to take a market-rate lease. Because of the owner-occupation, there are no leases to examine as far as type, escalation, maintenance costs, etc. Is there a "normal" lease type that we should use for the future tenants?

We're looking at a cash purchase since the property is in a flood zone and any financing will require expensive flood insurance. The tenant that is staying may be willing to take back paper on the purchase. Running the numbers based off average market rents in the area, the building is between a 5% and 7% cap rate based on the negotiated purchase price. I understand just enough about accounting practices to be dangerous, but I know the cap rate can be effectively increased by depreciation, etc. Considering that we're in the Northern NJ area, is this worthwhile?

We're worried that 4,000 sq ft is quite a large space and as it's laid out, it's not easily divided. Any build-outs would come with some hefty costs. The broker feels she can rent it, but I can't imagine her saying otherwise and pushing me away from buying the building. Has anyone had experience with renting spaces on the larger end?

Thanks all - I appreciate the insight and help!

[Jeff Kehl]

@Joshua Kaufman you should not be paying a market rate 5-7 cap for a property that is going to be mostly vacant. Especially don't pay cash without getting an independent appraisal of value.

I say this because in my area there is a lot of vacant office space right now so it is very hard to lease up.

That could be completely different in your area so I would suggest you find out on your own without involving the agent that may have a vested interest in the sale closing. 

Pretend like you're looking for a 4.000 square foot office in the area and see what you can find and what rents they're charging (comparable rent survey). Try not to go much further than 3 miles out and less if it is an urban area.

You can find properties to rent on Loopnet and by talking to commercial agents/brokers at other realty companies. Also call any national chains like Marcus and Millichap, CBRE, Cushman Wakefield that operate there.

When you're doing this, make sure to chat them all up and ask how the office rental market is there. See if they have any data they will share.

I have bought office property here even though the market is soft but I have paid very low prices so it gives me room to lower rents and bide my time.