Monday, June 4, 2012

How To Buy an Office Building with Growth Potential

            Some investors buy into an office building for current income and possible long-term appreciation in value, there are also investors who seek out growth situations; i.e., office buildings which for one reason or another are throwing off less than their maximum income.  Such an investor may be interested in increasing the building’s income so that it can be resold at a substantial increase.  Others will want to retain the building for its income.  A syndicator frequently is in the latter position.  He cannot syndicate a building which is already showing its maximum income since the interest he takes in the property (in return for his services) will reduce the return to a point where outside investors will not be interested.  So he must look for a building which can be purchased at a price relatively low in relation to its potential return.  If he then can develop that potential, he will be in a position (and entitled) to take a share of the return himself.

            While in may respects the procedures in buying a property for public syndications are the same as for private investment, there is one significant difference.  The syndicated property must be more salable as an investment, both in terms of lesser risk and a more regular return.  The public will buy such a property much more quickly than one projecting a far-off return (for example, upon refinancing) or depending for its success on special circumstances.

  1. Selecting the Property:  The property to be syndicated should have as many attractive features as possible.  These include large and impressive size, pleasing architectural design, a known name or address, and location on a full block or a corner.  These will make it easier to sell to investors as well as to tenants.\
  2. Figuring the Profit Potential:  In most cases, the property as presently operated will not be able to throw off the rate of distribution which is necessary to make the syndication a success.  It is here that the syndicator earns his pay, for he must think up ways to make the property more profitable.  There are no hard and fast rules for doing this;  it ultimately depends on the experience and imagination of the people involved.  But for illustrative purposes, here is a list of possible approaches for an office building:
    1. Convert the basement -  Man older buildings have extensive basement space which was intended for storage or similar non-income purposes.  Such space can be converted into a restaurant or retail stores.  In one case, a building had a delivery ramp into the basement; it was converted into a garage which returned a sizable annual profit.
    2. Close up an entrance – Many buildings have separate entrances on the main street and on the side street.  Closing up the main entrance creates a valuable commercial space; at the same time, the building retains its address even though its entrance has been changed.
    3. Automate and update – Since the biggest operating expense is payroll, cutting labor costs is an important way to increase the return.  Automate such services as Doorman, Concierge, Security, etc.  if and only if it is possible to do so without diminishing quality of service provided to the tenants.  Update electronics and install technological amenities which are being offered by the majority of competition.
    4. Grant food service concessions – A common sight in many large office buildings is the mobile coffee dispenser which services the tenants.  This and similar concessions can add to the revenue from the building.
    5. Consider an outside cleaning service – In many cases, it will save you money to have the building cleaned and maintained by a professional organization.  Although they must charge you enough to make a profit, they very often are so much more efficient, through the use of mechanical aids and time-saving techniques, that your cleaning bill is substantially reduced.  Even if you do not engage such a service, review you own staff carefully to see if costs can be cut.
    6. Reduce the cost of utilities – In one case, a syndicator purchased three adjoining buildings and was able to have them all serviced by a single electric meter, which saved a considerable amount.  In another case, however, the building owner was realizing profit by paying for electricity at wholesale rates and selling it to his tenants at retail. 
    7. Rent out management office – Very often in a building formerly owned by a small group, the management offices will be quite lavish an sometimes used by the owners for other business purposes.  This space can be converted to rental use, while the management office is put elsewhere.
    8. Modernize the premises – Modernization is an excellent way to increase a building’s profitability since it paves the way to higher rents.  However, never modernize a building located in a deteriorating neighborhood unless you feel sure the trend is being reversed.
    9. Add escalator clauses to renewed leases – Even though the compeititve situation may not permit higher rentals, your bargaining position may be strong enough for you to add escalator clauses for taxes and labor when leases are renewed.  These permit you to recapture such increased costs in the future in the form of additional rent.
    10. Refinance the mortgage – This is a common procedure in syndications.  But you should be absolutely sure you have the fight to prepay the present mortgage.  Also remember than money conditions in the future may not make refinancing as profitable as it now appears.
  3. What to Look Out For:  Assuming the property you have in mind has the necessary profit potential, you must then ascertain the possible risks and verify the historical data that have been presented to you.  In this connection, the following points should be kept in mind:
    1. Length of present tenancies – You will have considerable difficulty in syndicating an office building in which many leases are expiring in the first few years, even though there is every indication that the tenants will renew.  If you are offered such a building, it may be worthwhile for you to buy it personally and hold it for a year of so, until renewals are made.  Before you sign the contract of sale, it is important to check every existing lease to determine that the present tenants are bona fide, to see if any leases have short-term cancellation clauses, and to verify the schedule of renewals.
    2. Length of leasehold – If the proposed syndication is of a leasehold, the term remaining must be sufficiently long to make it salable.  On occasions, a shorter leasehold of, say 35 years is offered, but this will normally interest only the professional investor.
    3. Trend of neighborhood – This is one of the most important factors affecting future projections.  A building with very fine “historical operating costs” can turn out to be a failure due to a shift of the business section or of the particular industry or trade to which the building caters.  And in a smaller community, a shift of only a few blocks can be a disaster.
    4. Taxes  For both of these, it is not sufficient to rely on the historical data alone.  The local tax assessor, reading the purchase price in the newspaper, may check his records and decide his appraisal value is much too low.  This is a particular danger when you purchase from the builder since the original assessment, based on cost, may never have been changed.
    5. Repairs – An understated amount for repairs may indicate a skimping on necessary maintenance, which will mean extra expense in the near future.  An unusually large amount for repairs in the past may indicate that the seller found it necessary to do considerable work in order to make the property salable.  Or it may merely mean that amounts which should have been capitalized were deducted as repairs for tax purposes.
 If you are in the market to purchase an office building or other income producing property do not hesitate to call me.  We provide acquisition, disposition and property management services.  Sims Commercial Real Estate  815-791-7467

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