Office Building broken into Office Condos - buyer beware or potential good deal?

Question

I've pondered this investment for 3 or so years now, in fact one of the condos was avail in 2012 and when I called to write the check/submit my purchase contract, someone had beat me by an hour or so and lost out.

Cliffs notes version - some years back a group bought several of a cities dilapidated office buildings, convinced the city to give them loans, some were in the form of specials, etc - completed a few minor upgrades to the buildings, then condo'd out the buildings and primarily sold the condo's to out of state investors. The out of state investors ate it up even though on paper the deals didnt make sense, Most have been foreclosed on and for some reason there are still a few lingering around where the foreclosures have not gone through yet (foreclosures that should have started in 2008 or 2009)

2 of these buildings individual investors have been able to gain complete control of -- One in fact has his for sale right now - it needs some work but is 8 or 9 stories with a parking garage for $850k if I recall. I know the guy, not well and need to sit down and talk with him. I'm fairly certain he has nowhere near that in the building. Per the last article I could find on the building from April of this year when they gained control of it, vacancy rate was at 95% (when they started 3 -4 years ago vacancy rate was 40%) -- With the last floor they got back it sunk their vacancy rate back to 85%. Im sure they will fill the last bit of space.

To get to my point, the downtown area these buildings are located in has a lot of upside - lots of new projects going on, lots of demand for downtown residential here -- office space unless it's class A is a bit harder to rent though unless you have doorside parking - (Guess us midwesterners are lazy) I think this building is great, has a lot of history, however just has a poor marketing scheme and bad stigma with it. The one downside is no doorside parking, however the city put in a new parking garage literally steps across the street so parking would not be an issue.

The building I've been investigating is 11 stories, has 4 or 5 owners not paying their share of electric, maintenance fees etc, and all floors have different owners except one owner owns 2 floors which happen to be for sale -- I've noticed the owner (of the 2 floors for sale) recently had posts up trying to lease the office space - (crappy ad) and I've also noticed he tried to auction the floors (sale didnt go through) and he's also had liens filed on him by the condo association for not paying his share of the bills.

My thought was to find an outside investor or do this myself (floors could be had cheap) build an alliance with the floor owners who are paying their share and wrestle control from the non conforming owners, then reform the structure of the ownership of the building where it could be sold in whole again, hence creating value.

I'm very familiar with the building and know my city backwards and forwards, connections etc - think this building has had some horrendous marketing done for the office space, (no website, brokers in town not wanting to steer clients to this building etc) I definitely think this place could be turned around and once you pay the specials off (about $39k per floor) rents of $7-9 a sq ft (full service) would cash flow nicely - not to mention the upside one has if partnering with the other owners and changing the ownership structure.

Maintenance wise I believe one big complaint is the elevators (2 of them plus a freight elevator I believe) -- One sounds like it needs serious work. Mechanical wise I believe each floor has new HVAC equipment, modern data connections etc. (This should have been updated via the specials tax each owner is paying)

Have thought if you could get the electric company to install separate meters for each floor that would probably alleviate alot of the tension there.

I know this is a lengthy post - commercial is something that has always caught my eye and I've had great interest in. Have not completed a commercial deal yet -- like I stated was close and have spent hours and hours of due diligence researching commercial.

Would appreciate any insights -- hey, maybe someone reading this would be interested in partnering with me. Lots of risk but I believe lots of upside.

Nick L. · Answer

@Shane H.

Super interesting breakdown, thanks. I agree, it's interesting to talk this over with someone who shares a common interest. Whenever I start talking about merging condo titles or states that allow HOA super-liens my family tends to change the subject... maybe they are scared to admit how fascinated they are.

I agree that you could cut some expenses but even in your better case scenario $455/floor/month is nothing to get excited about. And the building is only going to need more TLC and face more competition as it ages further. My guess is that the Cali and local investors have found this out the hard way and that's why they're not buying the developer's floors even at their current bargain price.

However, maybe you can find a higher and better use for your space or for the building as a whole. Here are a couple of ideas that I have seen work:

1. Apartment conversions. You said that the downtown residential market was hot. Maybe you can throw $80-100/ft at one or two floors and pull in $1.50/ft. I haven't run the math but I bet that would work.

The downsides are the lack of parking and the fact that the other tenants and condo assoc. might object. You might be able to overcome both of those with negotiation though. For example some recent developments in my city have leased allocated parking spaces from adjacent city-owned lots. And if you talk with the other unit owners they might be flexible about changing usage to bring some life into the building.

Another issue to watch out for in residential conversion is unintended mechanicals work. For example the current elevators/sprinklers/electrics etc might be adequate for office space and grandfathered into code compliance. But the moment you touch them for residental conversion you will have to upgrade the whole systems.

Still, residential is usually a very compelling conversion case.

2. Creative/shared/incubator space. Essentially leasing to a bunch of small hobbyists and small businesses. Individually they have little or no credit or financial backing, but you can charge a premium for small studio-type workspaces and the overall tenant base as a portfolio can be stable. This can work even better with a single creative focus, like food & beverage or fashion.

Your TIs are minimal or zero but income will be less than residential and you will have a lot of non-leasable space. I bet it would still be a better business case than the current Class B offering though.

If you could pick up the floors for $20k each and the condo assoc. was ok with the creative space concept, I think I'd be tempted to do this just as an experiment.

Shane H. · Answer

@Nick L.

Here is some of the nuts and bolts

• 5800 gross sq ft per floor -- floors could be rented as one unit, however many are broken down into varying size office suites -- most floors are completely finished
• "B" Grade building
• Gross lease is the norm - $7-9 psf
• 11 floors -- a fairly tall building for Wichita -- probably one of the 5 tallest buildings in town if I had to think off the top of my head

Summary of the floors - detail below:

• 3 floors still owned by CA investors who I can only assume have not made payments on their loans - floors are vacant per my last visit - they are not paying their condo dues
• 2 floors still owned by the deadbeats who have securities fraud charges pending against them and are the developers who condo'd out the building
• 2 floors owner occupy
• 3 floors owned by local investors
• Any floor owned by a local person was purchased out of foreclosure with the previous owners being CA investors -- original sale prices I was told was $300-400k per floor -- foreclosure prices $15-80k depending on when they were purchased, lower prices came later

Only 2-3 floor owners appear to be current on property taxes - some have not paid since 2009-2010

I believe floor 4&11 could be purchased for $20k or so total. Owner took out a mortgage in 2013 for $68k for the purchase of both

Condo association filed delinquent assessments on 3-24-15 this year for Floors:

1, 5, 4 & 11 -- not sure why they did not file on some of the others - per my understanding the original developers are not paying either, however thats probably a moot point since it would be like attempting to get blood out of a turnip.

Taxes per floor range in cost from $2700-$5100 -- the ones with lower assessments went and argued with the appraisers office once they bought out of foreclosure

Specials payable until 2023 of $4421 per floor (once this is done - helps a bit with cash flow -- specials were used to change some windows, make street level improvements and upgrade the heating/air)

Last Income statement I could get my hands on was from 2012 -- Expenses per floor at that time (doubt it's changed much except the owners association dues are likely higher to make up for the shortfall of the other deadbeats)

Monthly expenses of $2500-3100

I believe the mgmt company is ripping the condo owners off - charging $3575 per mo for the building for building maintenance, $3046.23 per mo for janitorial, $3300 per mo mgmt fee -- these are some big ticket items I could see cutting back on.

So rough financials per floor per mo

****************************************

$3383 per mo rent (5800 * 7psf/12)
(676) 20% vacancy allowance
(643) general/special taxes
(2600) rough avg expenses per mgmt company - think quite a bit can be cut here
---------------------------------------------------------------------------------
(536) rough loss per mo on a worst case scenario

$4350 per mo rent (5800 * 9psf /12)
(652) 15% vacancy allowance
(643) general/special taxes
(2600) rough expenses per mgmt company - think quite a bit can be cut here
---------------------------------------------------------------------------------
455 cash flow per mo on a better case scenario

When you put pencil to paper this is not a good deal as it sits presently, however per my understanding - if every floor owner (or if the expenses for the building) were truly spread out over the 11 floors and all 11 floor owners (or one joint owner) was paying their share the monthly expenses could be cut quite a bit. I have an income statement from 2008 for the 5th floor when most of the building was leased and everyone was paying their fair share - Net income of $11877 for the floor (that was after property/special taxes)

Presently I believe a few things could be cut out (they may have already) for ex, there was a 300 per mo mgmt fee charged per floor, $276 per mo per floor janitorial fee, $325 per mo per floor maintenance fee, electric of $615 to 1000 charge (thinking it's that high due to others not paying) on the 2012 statement I have.

So the upside for larger cash flow is there and if you could change the ownership structure the price appreciation of the building as well.

Maybe I'm wrong? Would like to upload some of the documents I have however still learning the forum and dont believe I can do that?

Nick L. · Answer

I've done a similar deal for a mixed use building in Milwaukee, WI. The technical term for this problem is "fractured condos". In my case there were 10 units. The developer had sold 2 of them. The other 8 eventually got QC'd to the bank and I was able to pick them up as REO. This was 3 years ago. It took me another year to acquire the 9th unit and right now I am finally under contract for the 10th and last one.

Based on your post and my experience I would say this could be a good opportunity provided that:

a. You know that you might never be able to acquire every unit in the building, or it might take decades. So you have other exit strategies as backups.

b. You buy the units at a price that reflects the assets as distressed.

c. You own enough of the units from the outset to control the condo association (typically 75%)

d. You have good cash and financing to do the initial deal and pick up other units opportunistically. Most lenders will not touch fractured condos regardless of the cash flow.

From your post, my first move after acquisition and lease-up would likely be to give the condo association some teeth against tenants not paying their share. Either they will start contributing and the association can build reserves, or they might be motivated to sell to you.

Oh and check your state's laws about requirements to consolidate condo titles. In my state you need unanimous agreement from all owners and primary lienholders. But I believe in some others you only need 90% agreement. So you might be able to consolidate even if you don't own the whole building.

Shane H. · Answer

@Nick L.

I have some financials (not the most current) but shouldnt have changed much and some documents going over the expenses each floor had. Also will have GLA etc.

Will put that up a bit later tonight once the little one heads to bed.

Believe it or not, per my understanding most of the floors are decently set up and leaseable right away. Finishes are ok -- maybe at most need some paint/carpet. (I've walked the whole building but a couple floors at that time I couldnt do much exploring on other than the hallways.

As for TI's --I think on each floor it would be negligible, (havent been through every one with a fine tooth comb) however almost all are built out fairly nicely - may need some paint or carpet at the least. Downside - there is a lot of "B" grade office space avail (Though as I alluded to earlier, one building owner has completely turned his around over 4 or so years) and is 80-90% leased.

7-9 psf is gross lease, full service (ie internet/phone electric, etc is all included) -- I'm sure you could do triple net but per my market research that might turn people off and you'll need to lower your rental rate. No one else DT typically will market that way. For some reason there is just an overabundance of what folks are terming B grade office space DT and this would fit in that category. I've got connections as far as trim carpenters to convert an office to finer finishes, however due to the buildings age not sure if you could get it of to an "A" grade status or not....the #'s probably just would not make sense at this point. That being said, several projects are under way now, demand for DT residential is very high, one very large residential project that has been sitting for years just got the green light on the loan paperwork, more businesses prospering etc. So the upside is there. New airport opened, relatively new DT arena with development going on near it, new fitness center (HUGE) -- so lots going for it. I live here so I have a vested interest and may have some rose colored glasses, however have seen the changes first hand over the years and we are light years ahead of even 10 years ago.

Off the top of my head I think each floor has ~ 5800 sq ft to lease with varying office suite layouts.

Will add some more of the financials later.

Entertaining to talk about this with someone who shares my same interest -- many others I have spoken to tend to glaze over at the concept.

Nick L. · Answer

@Shane H.

So if I understand you right the breakdown seems to be:

• 2 floors mostly unoccupied, for sale together
• 2-3 floors owner occupied, would probably do a sale and leaseback
• 5-6 floors non-OO, investors may or may not be willing to sell

If that's correct, you should probably talk with the other investor owners. If you own 5 or 6 floors and they collectively own 5 or 6 floors, you would be in a good position to propose dissolving the condo and forming a partnership with yourself in the lead.

Can you go through some of the operational math? You suggested $7-9 psf. Is that gross, modified gross, NNN or absolute net? How many sq ft are there per floor? What kind of TIs would you have to give a tenant to get those rents? What are the condo fees, what do they cover and what financial state is the association in?

Shane H. · Answer

@Nick L.

I've spoken to one of the floor owners a couple times, one time 2-3 years ago at length when he agreed to sit down with me and discuss how he liked the building when I was considering purchasing another floor avail through foreclosure.

I think the other floor owners do not have the money (part of the problem with the building are the high expenses (electric, gas insurance, property mgmt, elevator maintenance) all shared and divied up per floor - and with only a few paying in to these expenses it just exacerbates the the problem, secondly 2-3 people are owner occupy and they just wanted the floor for themselves, really have no interest in being RE investors.

Where I see the opportunity is getting the building stabilized - getting the bad people out getting it leased up and getting the specials paid off - once this is done this would be an amazing investment. Lots of work and some money to be spent to get from point a to point b, however I've held back a bit due to no having deep pockets to weather the storm so to speak while getting the building stabilized.

Thinking it would be a good idea to see if I can schedule another sit down with the floor owner who had visited with me before. I'm open to a partnership and have no problem organizing such a venture. I think this can come together -- still lots of risk.

Been trying to brainstorm what to do to get the Brokers to stop turning their noses up at this building. It's kind of a "little/big town" -- decent sized city, however a good 'ole boy network is in place and everyone knows everyone. If you ever experienced such an environment.

Have any interest in investing in Wichita? HA

Nick L. · Answer

Ha ha, no, this guy made a bad business decision but I don't think he committed any felonies!

Back to your deal... I wonder why the owners of other floors don't want to buy the 2 floors that are for sale. Maybe approach them and talk to them about it. It would be much more attractive if you can control a lot of the building in one go. Maybe through an option if not an outright sale.

Shane H. · Answer

@Nick L.

Thanks for the reply. Out of curiosity, the building you purchased your condo's in...was it originally condo'd out by individuals with the names of Dave Lundberg & Michael Elzufon from the twin cities area in MN?

The timeline for the foreclosure sounds similar to what happened here and the building is close to their home operating area. Have a feeling they will be spending time in KS Jail with all the trouble they have caused down here.

Office Building broken into Office Condos - buyer beware or potential good deal?

Office Building broken into Office Condos - buyer beware or potential good deal?

Most Popular Reply

8 Replies