I am the first to promote how all the trends and developments in Sacramento’s central core are supporting significant increases in rents and property values. For the residential sector, If rents weren’t going up, we wouldn’t have market rate housing getting developed. The majority of sales over the last year have been residentially related sales (development or existing multifamily.) Industrial has been on a terror, with prices that have nearly double from just five years ago. Bacon CRE just sold a 35,000 SF industrial office building off of Richards Blvd to an owner user for $111 a foot. The building only had 16-foot clear height. 5 years ago, that building would have sold for about $65 a foot.
But if you are an office user thinking about buying an office building, don’t forget the fundamentals. Sales of Owner-User buildings have been driven by historically low interest rates, and values have been pushed up by low supply, rising construction costs and increased rents. When advising an owner-user client in the purchase of a property I recommend that the client consider the following:
- What is the exit strategy? If for some reason you need to move out of the building, will you hold the asset and lease it out, or will you sell it? Is the property single purpose or will it appeal to a broad base of potential occupants?
- What is the replacement cost? What would it cost to build the building from the ground up versus what are you going to be into the property for after purchase and renovation? You can get into a property, for what seems like a great buy, but after you finish renovating the building for your needs, your total cost could exceed replacement cost. That is ok if the property works for you, and in the long run, the market supports the investment (based on projected value appreciation.)
- What is the Property worth as a leased investment? Just because you are an owner occupant does not mean that you should pay an over market price for real estate. Certainly, as an owner-occupant you can justify paying more than what an investor would pay, but be sure to consider what an investor would pay if the building was valued as a leased investment (at market rents.)
- Is there upside beyond market appreciation? Consider a small building that sits on a large lot. Perhaps ten years down the road you can sell the site to a developer, or you can develop it yourself. Many properties have a mid-term use and a long-term use. Consider a 4,000 SF office building on a 12,800 SF parcel in midtown. Right now, the building is the perfect owner user building for a professional firm paying big rents on Capitol Mall. However, could the site be redeveloped for a nice mixed-use project? 1810 S Street is a great example of this.
There are so many benefits to owning, but don’t get caught up with the emotional side of things. Consider the fundamentals and if the price seems like a stretch, you might be better off as a tenant. Let an owner take care of maintenance, taxes, capital improvements and assorted management headaches. You can focus your energies on building your business.
Tom Bacon, CCIM, has been assisting commercial real estate clients in Sacramento since 1991, with an emphasis in office properties and Occupier representation.