The third and final installment of my 3-part series on office condos (click for Part 1 and Part 2 on the Brenner Blog) was entitled “Does it Pay to Buy an Office Condo,” a detailed financial analysis of commercial condominium ownership. When I initially tackled the subject back in 2013, there was already a strong argument for ownership. But more recently, a potentially game-changing new financing program makes it virtually a no-brainer for many firms.
While the 90% financing available through the U.S. Small Business Administration provided the opportunity for many companies to own their facilities, the newly unveiled 100% program opens the door to ownership for many more. I therefore needed to rewrite part 3, which makes this part 4 of my 3-part series. Using the example of an office condo I am marketing in Boca Raton and some reasonable assumptions, I will show how you can own your office for approximately half the cost of leasing.
First, a little history lesson from the now defunct part 3. As rental rates skyrocketed in 2004 -2007, the office condo emerged as a vehicle to lock in the cost of office space over the long term. Prices increased driven by strong demand and limited supply. Developers reacted by building new projects and converting leased properties to condos. The market quickly overheated as the combination of increasing supply and the recession helped to burst the bubble. As values declined, an opportunity re-emerged for companies to take advantage of attractive prices, historically low interest rates, and little cash outlay thanks to the SBA. While prices have rebounded to some extent, there are still excellent values available in the condo market.
I am currently marketing up to 17,862 square feet of office condo space at Congress Corporate Plaza in Boca Raton at $165 to $173 per square foot. I used 1,000 square feet as a benchmark for analysis. Actually I can sell from 7,100 to 17,800 square feet, but the price per foot will remain relatively constant regardless of size. If you’re looking at 5,000 square feet, multiply to total cost by 5, for 10,000 square feet multiply by 10 etc.
Why own rather than lease? It becomes a question of whether you want to pay an investor an 8% retum, or pay the bank 4% interest. Personally, I like 4 better than 8. Let’s consider that an investor buys my condo for $165 per square foot and wants a market return of 8 percent. He will charge a tenant $13.20 per square foot ($165 x 8%). Asking rental rates at the property are currently at $15. If you decided to buy the property for $165 per square foot (with 4% in closing costs and a 25 year loan at 4%), your mortgage payment would be $10.87 per sf, or $2.33 per square foot less than the cost to rent. And a chunk of that $10.87 is paying down your principal.
The effective rate in the chart below is an annual effective cost of occupancy. Based on our assumptions, asking rent plus operating expenses plus 6% sales tax on rent in Florida comes to an effective cost of occupancy of $22.07 for renters.
Now let’s say we can buy and compete limited renovations for $175 per square foot and take a 4% SBA loan. In this case, our effective cost of occupancy on a cash basis, is $18.50. Renters therefore save $3.57 per sf. Even if we can negotiate the rent down by a dollar or two, owners will pay less than renters.
But that is only a start. $4.25 of the mortgage payment goes to paying down the debt. The annual cash flow to the buyer is $18.50, but the effective cost is down to $14.25 per sf. And if the property value increases by a conservative 2% annually, that equates to another $3.30 per sf, reducing the buyer’s effective cost of occupancy to $10.7,5 less than half of the cost to lease.
In addition, this is 100% financing, and your mortgage fees and points and even your renovation costs can be rolled into the loan. There is no out of pocket cost. A renter would be responsible for first, last and security, but a qualified buyer could get into their new space with zero cash outlay. And did I mention that renters pay 6% sales tax on both rent and operating expenses? They even pay sales tax on real estate tax. One other key factor: rental rates contain escalations generally ranging from 3 to 4 percent annually. So three years after signing, the mortgage payment hasn't changed for the owner, but rent will have increased by approximately $1.20 per sf.
So does it pay to buy an office condo? I don’t think there is any doubt for many companies. There are many additional factors that I covered in parts 1 and 2 of this series. In part 4, we are covering only the financial aspects, but the numbers look highly enticing. Purchasing an office condo is a decision that should involve your financial and tax advisors and we provide this analysis as an illustration of a potential opportunity. We hope this article has stimulated your interest in the office condo market. As experts in the market, we can show you some great opportunities put you in touch with the touch with the right lenders and help you to build equity while controlling your overhead.
(1) The sale price is based on the unit's asking price plus some allowance for improvements. The lease rate is the current asking rate.
(2) Closing costs are estimated at 4% and are financable on SBA loans.
(3) This is 100% SBA financing available to qualified buyers.
(4) Current rates are at 4% with 25 year amortization (5) Total cost includes estimated closing costs
(6) Total cost (5) including closing costs (2) and improvement costs can be financed at 100% with the SBA
(7) Annual debt service is based currently available mortgage rates and amortization terms. Note that a large portion of the payments is equity which reduces the loan balance.
(8) Real Estate Tax and Condo fees are paid as expenses on the condo just as Common Area Maintenance (CAM) and Taxes are covered in the rent. Condo owners also pay for reserves for roof replacement and common area improvements. These are not charged to renters and are estimated at $1.38 per sf in 2015.
(9) 2% annual appreciation is a conservative estimate used in Real Estate Investment Analysis. Results will vary based on market conditions. At 2% annual appreciation, it will take 2 years to cover closing costs.
(10) The condo effective rate is based on the monthly mortgage payment plus the taxes and maintenance fees. For the lease, the effective rate includes 6% sales tax. There is no sales tax on mortgage payments or condo fees.
(11) The effective monthly rent expense on the condo is mortgage plus taxes plus condo fee. Monthly rent is comprised of base rent plus common areas maintenance (CAM) plus 6% sales tax.
(12) Tax benefits on condo ownership include write-off of mortgage interest, taxes, condo fees and closing costs plus depreciation. On a lease, all rent is expensed. Consult your tax advisor to determine the tax benefits of owning versus leasing.