Office
Think Big, Buy Small
Low interest rates and ownership appeal spur businesses to buy rather than lease office space.
By Beth Mattson-Teig |
W
hile rent discounts
and concessions may entice some tenants, many small-business owners are
forgoing the attractive lease terms available in depressed office
markets in lieu of one very powerful incentive -- real estate ownership.
"We're seeing more demand than ever
before from folks wanting to own their buildings, especially from the
small-business owner," says John Wanamaker, CCIM, a broker at Coldwell
Banker Commercial Property Showcase in Orange City, Fla. The
small-business sector is a relatively untapped niche that is gaining
the commercial real estate community's attention. The ownership trend
provides real estate pros with a number of new business opportunities,
including brokering sales, building small and mid-size office
properties, creating small-business office parks, and developing office
condominiums.
Wanamaker's company is
catering to the local small-business clientele by constructing office
buildings ranging from 2,400 square feet to 21,000 sf, such as the
recently completed 21,000-square-foot Mercedes Homes property in Orange
City. "Traditionally, [the single-family home builder] had always
leased space, but we were able to show them how they could take some of
their working capital to buy the building and lease it back," he says.
Mercedes Homes moved into approximately 16,000 sf and plans to lease
the remaining 5,000 sf to one or more tenants.
Across
the United States, less-than-25,000-sf office building sales have been
increasing since 1999, according to Marcus & Millichap and CoStar
Group. In 2003, 29.4 million sf changed hands -- an 8 percent increase
over the 27.1 million sf sold in 2002 and a 24.6 percent jump from the
22.2 million sf sold in 1999.
Why Buy?
Extremely low interest rates and available financing are driving the
surge in small-building investment. Although the 10-year Treasury
reached 4.79 percent in May, interest rates are still at historic lows.
As they increase, "they will continue to limit interest by [small]
companies. But right now rates are very, very attractive," says Drew
Augustin, CCIM, SIOR, president of NAI Olympia Partners in
Indianapolis.
Buyers
also are taking advantage of the ability to amortize loans for terms
longer than the usual 10 to 15 years. Small Business Administration
loans allow qualifying buyers to obtain 90 percent financing and the
ability to amortize loans over 25 to 30 years, which translates into
very low monthly payments.
While current
interest rates and attractive financing make it economically feasible
for small businesses to purchase real estate, owners are opting to buy
rather than lease for myriad other reasons, including personal
investment, rent stabilization, and increased control over their
property. "In 1999 and 2000, there was nothing I could do to talk
people into buying real estate," says Robert A. Miller, CCIM, president
of the Miller Group in Atlanta. But today, with Wall Street's
unpredictable returns and continued volatility, companies are pursuing
commercial real estate as a viable investment option, he adds.
Miller
recently represented a company owner who decided to purchase land and
build his own facility after leasing space for more than 20 years. "He
looked at a lot of options with existing space, but he had it in his
mind to own and build value in the real estate," Miller says. The
client purchased a three-acre land parcel in Dacula, Ga., on which he
plans to construct a 15,000-sf building. Although the buyer likely will
pay more than he would to rent the property, he is getting the exact
space configuration he wants and creating value, Miller says.
Scaled Down Office Parks
The biggest buyer hurdle is that small buildings are fairly difficult
to find: Most markets' inventories of high-quality properties less than
25,000 sf are limited. But this is good news for commercial real estate
professionals looking to capitalize on the demand with new projects.
Developers
are responding to the growing demand for small blocks of space by
creating business parks, such as the Town & Country Office Park in
Frisco, Texas, geared entirely toward small-office users. "There are a
lot of small businesses out there that don't want to get involved in
large, multitenant buildings," says Jon Albright, president of Jon
Albright Real Estate Services in Collierville, Tenn. One of the draws
of small-business parks is that they often are located near owners' and
executives' homes. "We are also seeing national and regional companies
locating in these parks because they are close to the majority of the
residential base," he says.
Traditional
office parks are geared toward large users, but developers such as
Albright and Coldwell Banker Commercial Property Showcase are intent on
delivering the same park-like setting on a smaller scale. "We take a
large tract of land, subdivide it, and build a cluster of office
buildings," Wanamaker says. Since developers can generate cost
efficiencies through economies of scale, it is cheaper for users to
purchase buildings in parks rather than to acquire land and do the
planning and construction themselves, he adds.
Albright
currently is working on three small-office park developments in the
Memphis suburbs. Halle Park Professional Centre, a 10-acre office park
under construction in the heart of Collierville includes 23 buildings
ranging from 2,400 sf to 7,700 sf. Although companies locating in the
park can own or lease, ownership interest is increasing. "With interest
rates where we have enjoyed them for the last several years, it is more
prudent to own versus lease," Albright says.
Crazy for Condos
Office condominiums present another affordable option for
small-business owners and investors. Condominiums long have been
popular with dentists and doctors, in large part due to the high
buildout costs associated with medical space. Now a variety of other
businesses and professionals such as attorneys, advertising agencies,
and real estate brokerages are exploring condominium purchases.
Many
view them as good investments. "People want to increase their real
estate holdings. They own their own homes, and they want to own their
business locations as well," says David E. Gunter, CCIM, president of
Commercial Group Realty in Dulles, Va. Roughly 1 million sf of office
condominium properties have been built in the Dulles market in the last
four years, he says. For example, Ridgeview is a 53,000-sf, two-story
class A office condominium building under construction in Loudoun
County, Va.; units range from 1,500 sf to 2,800 sf, and prices start at
$215 per square foot.
"We have
experienced a good bit of vacancy [in Dulles], but we have not seen a
dramatic drop in rents," Gunter says. "So we still have relatively
strong rents and a shortage of lease space available for the
small-office user." Those market conditions, coupled with low interest
rates, have created strong demand among small companies looking to buy. "What you have is a mind shift in the small-office users, many of which
are individually owned businesses that have begun to look at the
ability to lock in their space costs under long-term, attractive
financing," he says.
Demand also is
spiking due to interest from buyers who want to purchase commercial
real estate for investment purposes but can't afford entire buildings.
Free-standing buildings typically are more expensive than condominium
units, which can sell for as little as $150,000.
Developers
are responding to the demand by delivering a wide variety of projects
in both suburban and urban settings. Historically, office condominium
developments have resembled a townhouse-style design. "We're still
seeing those, but now we're seeing a class A condominium [property]
with a nice common area and attractive lobby -- a much more professional
building similar to a multitenant building," Gunter says.
Investors
also are taking advantage of the growing demand by converting
multi-tenant buildings into for-sale condominiums. Executive Plaza in
Garden Grove, Calif., has struggled with low occupancy for years;
however, when an investor purchased and renovated the 40,151-sf
building in late 2002, it took just one month to fill the empty space,
says William Hugron, CCIM, CIPS, CPM, a managing director with the
Charles Dunn Co. in Newport Beach, Calif. The key was converting the
multitenant building to 12 for-sale condominiums. The units are a
minimum of 1,000 sf and sold for approximately $160 psf. Since the
property is located in a working-class neighborhood, the marketing
strategy targeted labor unions and other related businesses. "Labor
unions started buying because members lived in the community," Hugron
says. New owners include a workers' compensation attorney and a medical
rehabilitation facility catering to union members, as well as a
residential mortgage firm and real estate brokerage.
Comparing Costs
Continued demand is putting pressure on small-office sales prices in
many markets. Last year's $131.20 psf median price was 7 percent higher
than 2002's $121.82 psf median and nearly 22 percent higher than 1999's
median $102.62 psf price, according to Marcus & Millichap and
CoStar Group.
For
example, buildings in the 5,000-sf to 10,000-sf range in Indianapolis
are selling at a premium -- approximately $125 psf to $175 psf, which is
about equivalent to replacement value, Augustin says. Mid-size
buildings in the 10,000-sf to 20,000-sf range offer a slightly larger
selection and more opportunities. Buyers often purchase mid-size
buildings that need significant improvements and spend a substantial
amount of money on upgrades, so the total cost is about 70 percent to
80 percent of replacement cost, he adds.
Demand
certainly has buoyed prices. Some office buildings where occupancy is
down 50 percent from three years ago still have the same asking price. "That's where the owner/occupant has a huge advantage over other
investors, because they can come in, negotiate down the price on an
empty building, and as soon as they move in they have good rent coming
in," Miller says.
Despite discounted
rents found in office markets around the country, owning is still a
cost-effective alternative for many buyers. In Orlando, Fla., for
example, class A office vacancies range from 18 percent to 25 percent
across the metropolitan area, and rents have dropped from between $20
psf and $22 psf to $16 psf and $18 psf. However, Coldwell Banker
Commercial Property Showcase is selling its office developments for an
average of $12 psf, Wanamaker says. "So even when they discount rents,
it is still less expensive to own," he says.
In
fact, the abundance of for-lease office space in many markets also has
put competitive pressure on sales prices. "The demand is up, but the
pricing has started to drop where it makes sense to buy, because there
is still a significant amount of vacant space for lease -- and most
office tenants do lease rather than buy," says Michael G. Mullinix,
CCIM, principal of Mullinix Commercial Real Estate Co. in Campbell,
Calif.
Controlling Their Destinies
Many small businesses are opting for ownership as a means to better
control their real estate -- everything from costs to their ability to
expand and contract. Companies also buy to hedge against market shifts.
For example, the dot-com explosion in San Jose, Calif., created a
feeding frenzy for real estate in the late 1990s. Rapidly growing
Internet and technology companies exhibited a voracious appetite for
real estate, and rents doubled, tripled, and even quadrupled in some
cases. With choice real estate encumbered by larger tenants, small
companies found costly rents as well as limited lease option
flexibility. "Small-office users got squeezed out in many cases,"
Mullinix says. "That was a real eye-opener for these small businesses."
Even
though the bottom dropped out of the technology market in 2000, and
large vacancies have produced bargain rents, many small businesses are
wary of encountering a similar situation in the future. "The people who
survived that bust are now trying to buy buildings because they don't
want to be vulnerable to the whims of the marketplace," Mullinix says.
Mullinix
recently sold a 12,901-sf building in San Jose , Calif. , to the Santa
Clara County Association of Realtors. He represented the association,
which purchased the building for about $3 million in February. "They
wanted to control the building so they could put money in to modify the
building for their own use and not lose that money after the lease term
was up," Mullinix says. The association also wanted the visibility that
came with owning its own property.
Regardless
of whether small businesses are pursuing existing properties, new
buildings, or condominiums, ample opportunities for commercial real
estate professionals exist. "Educated real estate professionals can
sell their worth by performing a show-and-tell exercise analyzing and
documenting the various cash flows, comparing lease alternatives to the
various buy alternatives, and allowing the client to make an informed
decision," Augustin says.