S.E.C. Real Estate Observer

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Editor’s Note: This article first appeared in the January 1975 issue of the Real Estate News Observer.

Many investors and brokers shy away from office buildings, yet these buildings represent a major part of the income property field of commercial real estate. I am referring not to the high rise buildings offering 300,000 or 400,000 square feet of leasable space but rather to the office buildings containing 6,000 to 60,000 square feet. Quite often, these contain numerous minor or local tenants with usually a smattering of branch offices of larger firms.

There are some advantages to owning office buildings instead of apartments (where most brokers feel they are experts and are more comfortable psychologically). So, rather than dismissing office buildings, let’s consider a few reasons that office buildings can be attractive investments.

Almost all office buildings can economically sustain professional management, whereas apartments are generally owner-operated or a minimum of 24 units (36 is preferable!) is required to reasonably pay for professional management. A certain expertise is certainly necessary to operate an office building properly, although it normally requires considerably less management effort and time than an apartment complex.

As a general rule, office buildings do not have the ups and downs of rental rates that so often occur in apartments. This gives more stability to the in¬vestment, and the rate of return tends to be more constant.

Further, there is usually greater flexibility in how an owner can operate his property. Quite often a small rental concession to a capable on-site tenant can provide all the management needed. Also, there is not a great difference in the available depreciation (except on first-owner apartments).

Office buildings do not have the personal-property worries that are such a part of owning an apartment building—furnished or unfurnished. The tenants usually have all of their own personal property, and you don’t have to worry about soiled or broken furniture, and so forth.

I exchanged one 8,000-square-foot office building three times in five years. None of the principals made a profit moving into the building, but all had compelling reasons to make a transaction. However, all principals approximately doubled their equity-paper-cash positions com-ing out!

I sold another building of about 70,000 square feet that offered a unique situation. The national tenant was an insurance company. Additions and remodeling had been tailored specifically for the tenant’s particular needs. With three years remaining on their lease, we felt the tenant would renew the lease and accept a moderate rental increase. When they did not renew, the owners leased to another national firm at an increase of 25%. Their 11.2% return on their equity is now about 16% before depreciation!

Another 20,000-square-foot building offered a real opportun¬ity. The owners who had built and owned it for seven years were land investors and not efficient managers of their building. Under new ownership, the income was increased substantially, and the building resold for a $100,000 profit in just over a year. (As an illustration of what proper home¬work can do, my projected analysis of the building’s income and expense with good manage¬ment over a period of one year was only off by $200.)

I would estimate that upward of 75% of the type of office buildings I refer to do not have adequate parking facilities. One very nice and well-located building was constantly plagued by a 10–20% vacancy factor. We exchanged it to a new owner who bought several lots to the rear of the building for about $40,000. He secured new zoning for parking, and with this increase in parking space, he was able to raise rents, achieve 100% occupancy, and consequently in¬crease the value of his building by $175,000.

Some of the keys to working with office buildings are picking an appropriate location and checking nearby comparable. It is difficult to lease space for $7.00/square foot when there is good space nearby at $5.00/ square foot. Your comparables should include a thorough analysis of all existing and contemplated cost factors (i.e., systematic painting, a reserve for re¬pairs, possible tax increases, etc.). Don’t try to kid yourself that you can operate a building at a $1.60/ square foot per year expense factor when everyone else is fighting to maintain a $2.00 or $2.25 expense factor.

One developer I know is building a small building of 6,000 square feet. Available to all lessees will be – are you ready for this? – a tennis court and locker room facilities! Now that’s using your imagination. I’ll bet it will be fully leased before the building is finished!

Often, only the broker’s uncertainty prevents a client from venturing into office buildings. Some study and homework plus some creative thinking can make office buildings an excel¬lent part of an investor’s portfolio.