Would like some advice on a small office building - Posted by Tom

import · March 23, 2004, 12:19am

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import · March 23, 2004, 12:19am

Posted by Tom on March 23, 2004 at 01:19:19:

I am looking at a small office building in Northern Jersey. It is 11000 square feet and two stories tall. The current gross income is 132000 and expenses are 58,000. The price is 1.24 million. The cap rate is around 6.0.

Here is the interesting part. There are two spaces that are vacant that when they lease, will bump up the gross income to 169K. If the expenses are bumped up to 60K the the NOI would be 109K. The resulting cap rate would be close to 8.8. The owner is willing to hold the closing until after the two vacancies are leased for up to six months. If after six months is up it is my option to buy or do nothing.

There is a parking lot that is 10,400 square feet across the street. That is buildable up to three floors. Two floors of office space and the bottom floor a parking lot.

Also the owner has an assumable loan of 710K at 8% over 25 yrs. I will assume it and would like to get a second mortgage for the remainder. Then refinance when the new NOI is achieved. Any mortgage brokers?

My question is what would you do?

import · March 24, 2004, 5:05pm

Re: Would like some advice on a small office - Posted by Thomas Mote, CPM

Posted by Thomas Mote, CPM on March 24, 2004 at 18:05:13:

Tom:

Sounds like you may have yourself a live one here, and could turn into a good investment. If I can be so bold, I need to get some clarity so I can at least tell you what I would do. Here goes:

Why would the cap rate go up as a result of lease up? Hint: Typically you keep the cap the same, as NOI goes up, up goes the price, etc. If anything, the cap should go down once the building is leased up – lower risk factors, etc.
Why would you underwrite at a cap rate of 6% if there are two vacant spaces in the building? Unless you can borrow at 6% and there is no risk don’t even think about taking a 6% cap rate.
What is the percentage of occupancy overall, and how does this compare to the market? Looks like about 80-82% in this property right now–let me know if I missed it by much.
I assume you are using competitive market numbers for your leaseup, but are you including any tenant improvements in your capital plan?

Sorry for the barrage of questions. The assumable loan is a good thing (OPM), the second may be harder than you think, but worth pursuing.

Unless the lot across the street is a prime retail spot, or you can run a standalone parking operations (cash) from it, I would see if you can get an option (at least a right of first refusal) so you can focus on the income producer in the picture.

My advice: figure out where your break-even point is on occupancy (assume blended or current rental rates/opex), see where you are now, and how much room you have to move once you figure in all of the debt service you are talking about. My guess is that you will have a high occupancy threshold, meaning aggressive rates to pay the bills, meaning lower NOI overall. Nothing wrong with that approach if you go into it thinking that way.

Build your expense model off of the BOMA or other industry standard model (glad to help offline) so you know you have it all taken into account and can figure out what it really costs to run this building.

Last, not least, do not let the current owner get any benefit from locking up his deal, with you on the line, while he leases up the vacant space. That is your premium to use as the new owner, and he will only jack up the price of the property once the NOI goes us (at least I would). If the market is right, underwrite with some conservative numbers and leave yourself some time to lease it up, but you should get the $$$ benefit of that instead of having to pay for it at sale.

Let me know if I can help further. I love this type of project and you are off to a great start!