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The Truth About Office Condos

by admin

By Alan Kleber

During the last three years, South Florida’s commercial real estate market has witnessed the arrival of a relatively new occupancy alternative: the office condominium. For industry professionals, office condos are just that, a new occupancy alternative that after a bullish entrance has been welcomed with a healthy dose of skepticism. Just like with residential real estate, a new trend is something that should be carefully considered before diving into the deep end.

For traditional space occupiers, the office condo is much more than just another occupancy alternative, it’s a strategic, long-term business opportunity. A well-located, well-timed condo play remains a solid investment for an entrepreneur where rapid growth in population and business creation, strong demand for office space, rising lease rates and low interest rates all bode well for office condo buyers.

At the end of the day, the office condo buyer who takes the time to follow solid real estate fundamentals such as price, location, business model and a keen understanding of the converter will be successful. Similar fundamentals exist in the residential world as well. For a select group of businesses, the ownership of space delivers the optimum facilities solution and provides a business opportunity that yields financial benefits not achieved via the traditional office lease.

With that in mind, the following points are key considerations that should be reviewed by anyone attempting to gain an unbiased understanding of this new alternative to the traditional office lease.

The Converter/Developer
The converter is the ownership group that either converts a traditional leased building to an office condo or develops a new project as an office condominium. It is abundantly clear that the success of a project from a buyer’s perspective is firmly grounded on who the converter is and the experience that they posses in all facets of the office condo continuum. If the converter does not buy the building correctly and apply the appropriate pricing fundamentals, the project will be challenged.

The Buyer
Office condo ownership is not for large public corporations or businesses that do not have a firm handle on their growth expectations. Office condos are best suited for companies that are, for the most part, stable in their space requirements. It is appropriate to dispel a myth about the perception of the space flexibility inherent with an office condo. If a business firmly believes in its growth expectations, and the converter apportioned the unit sizing correctly, the buyer can purchase smaller incremental units and successfully offset the costs via third party leasing.

Pricing Fundamentals
Believe it or not, for the buyer, the pricing of the office condo is secondary to the importance of the converter, for it is the converter, rather than the market, who establishes the pricing. For the pricing fundamentals to work in favor of the office condo buyer and converter, it is necessary for the converter to purchase the building at an appropriate price (below retail pricing) that allows for a return on their investment while at the same time pricing the asset in alignment with the after-tax cost of leasing. This is where some of the converters missed the boat, for they did not perform this due-diligence up front. They simply purchased a building for “x” amount of square feet and embedded a desirable profit without any consideration to the market fundamentals.

Financial Considerations
Assuming the office condo is priced per the fundamentals outlined above, there are several significant financial benefits inherent to owning office space comparative to leasing office space. The three most significant benefits are long-term cost containment, wealth accumulation (equity build-up) and initial up-front capital costs.

In leases, the rental rates are increased yearly based upon a negotiated amount. When the lease renews, it is subject to an adjustment based upon market. Historically over the last several years, rents have increased across all submarkets. In ownership, the buyer has an option to lock down long-term facilities costs based upon a fixed-rate mortgage. This uniquely provides for fixing and containing facilities expenses so that the business owner can plan and not succumb to dreaded surprises.

From an equity build-up perspective, by virtue of paying down debt-service every month, an owner has increased their net worth. This is where office condos provide an opportunity that leases do not. In the event the condo owner requires capital for their business for an acquisition or expansion, they have the ability to fund such an initiative through the equity built-up in the underlying office condo asset. Oftentimes, especially taking into consideration the SBA 504 program, the amount of equity required to purchase an office condo is actually proximate or less than the capital required to outfit an office space beyond the allotted improvement allowance in the event of a relocation.

Interest Rate Considerations
Given today’s interest rate environment this is the perfect time to consider ownership as an alternative. Due to the interest rate compressions over the last couple of months, the cost of ownership has decreased. Subject to purchase price and amount financed, interest rate compression can effectively reduce debt service costs from $1.00 to $2.00 per square foot. Comparatively, for most sub-markets in South Florida, leasing costs have steadily increased over the last several years.

ALAN KLEBER IS A SENIOR DIRECTOR AT CUSHMAN & WAKEFIELD OF FLORIDA, WHERE HE LEADS THE FIRM’S CORPORATE ADVISORY PRACTICE SPECIALIZING IN OFFICE TENANT REPRESENTATION. HE CAN BE REACHED AT (305) 533-2860 OR [email protected]

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