Advice on buying your own commercial office space

Commercial Real Estate Investing
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Advice on buying your own commercial office space

Chris Rizzo
Wilmington, NC · Member since 2016 · 16 posts · 1 vote

I own my own business and was looking into possibly buying our office space.  We are locked in to a very good lease (with 3 years left and a possible 3 year tenant option to renew) which is making it tough for our landlord (who motivated to sell as he moved out of the area and doesn't want to deal with the property) to sell to an investor as the cap rate would be very poor. He is willing to sell to me at quite a bit below comparable units in our building.  CAMS seem very high at roughly $600/month. 

I have been looking into SFR, but figured this might be a great first step in investing as I could basically rent to myself. We have a stable business that is now almost 9 years old so I feel the investment is pretty safe.

One of my main concerns is how to structure this to maximize tax benefits.  My wife and I both have MASSIVE student loan debt ($200K+ each) and are on income based repayment.  So, our student loan payments are calculated from our adjusted gross income.  Therefore, keeping our taxable income as low as possible helps us on both ends.  

Appreciate any help you can offer!

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Andrew Johnson
Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes
9y

@Chris Rizzo  Just another perspective here, you've already got a "financial benefit" coming to you regarding your lease.  From what you're saying it's so far below market that's it's making it difficult for the owner to sell.  And this doesn't end up 12 months it sounds like you can keep it going for 6 more years.  That's a decent sized runway and your business needs then may not be the same as they are today.  Net result, you're walking away from Good Position A (below-market lease) for Good Position B (buy own office at a discount).  

If you buy another revenue producing asset (deprecation and mortgage interest can be used to offset those revenues) you might end up with:  Good Position A (below-market lease) + Good Position C (revenue producing real estate).    

Yes, this is horrible math but you would have to confirm that:  

C > A+B

So is buying this commercial unit that much better than the economic value of below-market rent for the next 6 years plus any revenue you could get from deploying your capital to another asset?  

The answer might be an easy "yes" but it's good to at least run through the exercise.  

The other thing to consider is that some of us (well, I'll just speak for me personally) use real estate investment as a form of diversification.  There's W2 income, stocks, bonds, real estate, etc. that can all provide revenue and/or appreciation.  By buying your office space you're (in a manner of speaking) "doubling down" on your W2 income.  And don't underestimate some of the hassle that comes along with it.  There's no landlord to call when XYZ happens, it's all on you.  And you'll be a part of other owners so assessments could pop-up from time-to-time.

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  • Ryan Funt
    Toronto, Ontario · Member since 2017 · 1 post · 0 votes
    9y

    I think this sounds like a good investment. I am sure your business will continue to do well in the long-run; however, this remind me of a situation where someone I know operated a business within a commercial building and stretched themselves to purchase it. Now, 10 years later the building was an incredible investment and doing significantly better than the business. 

    If your getting a deal, that's great! Keep in mind as the landlord you'll have a part in arranging maintenance and lowering the CAM.

    I hope

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  • Ash Patel
    Full time investor · Cincinnati, OH · Member since 2013 · 405 posts · 312 votes
    9y

    Would you purchase this property as an investment if your business wasn't located there?  Office condo's (assuming thats what it is) aren't the greatest investments.  

    Will your business potentially outgrow the space?  

    Are you able to buy it lower than current market based on your rent?

    If you purchased it and moved your business, could you rent it at a much higher rate thus increasing the value of the unit and sell or just cash flow?

    0Reply
  • Michael Bracken
    Investor · Garland, TX · Member since 2015 · 110 posts · 43 votes
    9y

    I run a business and lease space. I have thought about buying my own property. My thought however was, If I lost my business I would lose my day job income and my property anchor all at the same time. So I'm still renting the space and investing elsewhere.

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  • Chris Rizzo
    OP
    Wilmington, NC · Member since 2016 · 16 posts · 1 vote
    9y

    Thanks for the reply Ash...

    Would you purchase this property as an investment if your business wasn't located there? Office condo's (assuming thats what it is) aren't the greatest investments.

    - I am not sure if I would have a year ago when he wanted to sell to me a year ago before we negotiated a lease extension.  However, the area has grown like crazy (one of the fastest growing areas in the country) lately and commercial space is starting to go nuts.  Because of my good lease rate, he is offering potential investors who inherit my lease a nice chunk of money to subsidize my rent to give them a better cap rate.  All that being said, if I wasn't operating there I am not sure I would jump at this investment.

    - It is a unit in a medical building.  

    Will your business potentially outgrow the space?

    - I plan on adding another doc into the practice this summer and we should still have plenty of space.

    Are you able to buy it lower than current market based on your rent?

    - The agent did tell me he would probably accept the list price minus the incentive and I'm pretty sure he would go lower than that as he has mentioned in the past he would give me a better deal than an outside investor.

    If you purchased it and moved your business, could you rent it at a much higher rate thus increasing the value of the unit and sell or just cash flow?

    - I believe I could in this current climate but that could change at any time. That would have made me nervous a year or 2 ago as there were more vacancies on my floor.  I am currently at about $14.50 per sq foot.  I would say the going rate is around $20. 

    Here are the rough numbers...

    MY Purchase price (List price $260K):  $230K (comparables in the low to mid $300s)

    CAMS:  $600/month

    Taxes: $2K

    With my current rent of under $2K (goes up each year 3%), it doesn't make sense as an investor which is why he is offering investors cash back over term of the lease. 

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  • Andrew Johnson
    Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes
    9y

    @Chris Rizzo  Just another perspective here, you've already got a "financial benefit" coming to you regarding your lease.  From what you're saying it's so far below market that's it's making it difficult for the owner to sell.  And this doesn't end up 12 months it sounds like you can keep it going for 6 more years.  That's a decent sized runway and your business needs then may not be the same as they are today.  Net result, you're walking away from Good Position A (below-market lease) for Good Position B (buy own office at a discount).  

    If you buy another revenue producing asset (deprecation and mortgage interest can be used to offset those revenues) you might end up with:  Good Position A (below-market lease) + Good Position C (revenue producing real estate).    

    Yes, this is horrible math but you would have to confirm that:  

    C > A+B

    So is buying this commercial unit that much better than the economic value of below-market rent for the next 6 years plus any revenue you could get from deploying your capital to another asset?  

    The answer might be an easy "yes" but it's good to at least run through the exercise.  

    The other thing to consider is that some of us (well, I'll just speak for me personally) use real estate investment as a form of diversification.  There's W2 income, stocks, bonds, real estate, etc. that can all provide revenue and/or appreciation.  By buying your office space you're (in a manner of speaking) "doubling down" on your W2 income.  And don't underestimate some of the hassle that comes along with it.  There's no landlord to call when XYZ happens, it's all on you.  And you'll be a part of other owners so assessments could pop-up from time-to-time.

    1Reply
  • Priyanshu AdathakkarPro Member
    Realtor · Columbus, OH · Member since 2017 · 313 posts · 245 votes
    9y

    @Chris Rizzo I am assuming this is not a single tenant building with you the only tenant? If that is the case, properties like these are not valued based on comps if building A is priced at $X, it does not mean the property next door that is exactly the same in characteristics is also worth the same. The price depends on following: Vacancy, CAP rate, quality of tenants, quality of leases, amount of deferred maintenance and other such factors.

    As long as you are willing to sign a long-term leases (ie. quality of lease) you can always get good deals anywhere. The long-term lease and your option to renew play more to the advantage to the landlord and to the quality (price) of the property then it does you.

    Yes forming an LLC to buy the property and then leasing space back to your other entity is always advised.

    Pri

    1Reply
  • Chris Rizzo
    OP
    Wilmington, NC · Member since 2016 · 16 posts · 1 vote
    9y

    @Andrew Johnson Thanks so much the response.  Everything helps as I am new to this.  I guess I'll explain my overall goals to see if it makes more sense in that way.

    I have been looking to get into rental residential real estate buy and hold investing for a little while now.  My goal was to have 10 properties in the next 5 years.  As I mentioned, one of my major concerns is keeping my AGI low due to student loans.  That is partly what interested me in buy and hold investments as I have heard they are good in that way.  My goal is mostly for wealth building 10+ years from now so I can go part time or retire early instead trying to make a lot of profit now.  My wife is also currently in full time grad school so we should have an influx of monthly income to invest with when she finishes in a year (she will be making good money - low to mid $100s initially).  

    If we bought, I was thinking of raising my rent to $2500 (current market rate) with a 5% increase per year.  So, if I did sell to an associate doctor down the road I would have that rental income at a solid cash flow rate.  The other thing I was thinking about (and I am not sure you can do this with commercial) is to use the equity in a few years that we would have in the commercial space to buy residential rental properties.

    I may be saying really dumb things, so please correct me if this makes no sense at all.  

    I was also a little confused by what you meant by "doubling down on W-2" when buying the unit we operate business in.  

    Thanks!

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  • Chris Rizzo
    OP
    Wilmington, NC · Member since 2016 · 16 posts · 1 vote
    9y

    Pri,

    You are correct.  This is a 3 story medical building.  The comps I came up with are that there are 2 other units in the building for sale.  They are both listed for mid $300s, however they have not sold and been listed for quite a while.  They are both the same size and both not on the ground floor. Is that still not a good comparable since they haven't sold?  I did look into the history and believe he paid $380-$390K for it back in 2004.

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  • Andrew Johnson
    Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes
    9y
    Chris Rizzo "Doubling down" just in reference to your business being a reason to purchase. Or just ask yourself, would you buy this an identical unit to yours that you weren't going to occupy for the same price? If the answer is "no" then you're making the investment (at least in part) for your business and not really diversifying. There's nothing wrong with that, just try to stay neutral with valuation. Speaking of which, comps are only what has be SOLD. Listing prices mean absolutely nothing. Make sure your unit is a prices well using sold comps.
    0Reply
  • Marian Smith
    Real Estate Investor · Williamson County, TX · Member since 2011 · 1k+ posts · 961 votes
    9y
    Small businesses all over the nation grapple with the same buy or rent decision every day. There has to be a business or real estate book...say written by a faculty of one of the top business schools...that goes over the decision. Do you use an accountant? Talk to him. There has to be a basic decision grid, pros and cons list. I know someone who just bought the office condo next to his to get more room...so there is one consideration...will you run out of space and have to sell to move? I also know someone who just moved his office closer to his house but still rents...must be some reason he rents as he makes a lot of money and could have looked to buy when he was looking to rent. Maybe an office mortgage hampers his ability to borrow as much as he needs to in his business. First guy paid cash even though he can write off his interest as a business expense. Maybe he bought it under a separate Llc and rents it to his business. Thats why you need to talk to an accountant.
    0Reply
  • Chris Rizzo
    OP
    Wilmington, NC · Member since 2016 · 16 posts · 1 vote
    9y
    Thanks Andrew. I'm having trouble finding sold prices for commercial real estate. Is there an easy free website where I can find those records as there is with residential?
    0Reply
  • Joel OwensBusiness Member
    Moderator
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    9y

    Medical office is different than regular office.

    How old is this building?

    If the building has some age to it then an owner/user or an investor looking to lease it out will have a ton of tenant improvements costs to be up to date with technology.

    As an investor you like newer buildings where doctors have a lot of money in the space and it's hard for them to move giving stability to the cash flow model long term.

    With 3 levels and you looking at buying the one unit is sounds like office condo.

    I typically do not like those as a minority owner you are not the controlling declarant.

    I know some doctor's that own retail strip centers and have so much space for the practice. I assume multiple levels this building has an elevator??

    If not and you cater to retirees for your practice then you want to be on the first floor as most cannot do the steps.

    What is the dirt worth for the location? There might be a higher and better use than the current building.

    What would your mortgage payment be versus a rent payment?

    You might need a tenant rep that does medical office space local to your area to give you insight on options.  

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  • John Thedford
    Real Estate Broker · Naples, FL · Member since 2013 · 9k+ posts · 6k+ votes
    9y

    I am not in this predicament. My rent (for my NFA business) is far lower than what it would cost to buy. I would encourage you to consider alternatives before you jump on this. If you purchase quality SFR, you may have more steady demand. When a commercial space goes vacant, it could sit that way for a LONG time. Sure, you want to be an owner/user but things change over time.

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