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.