How much should I offer for the building I live and work in?

August 6, 2007 5:34 PM

I live and work in the same building, which I lease from an absentee landlord who does little more than collect the rent. Over the years, my business has become quite prominent and is quickly outgrowing the space. I now have the means to buy the building from my landlord, but need advice on making the initial offer. Much more pertinent, specific info inside.

As far as value goes, here's the latest deed info from the assessor's office:

Residential Appraised Value - $62,000
Residential Assessed Value - $12,000
Commercial Appraised Value - $168,000
Commercial Assessed Value - $54,000
Total Appraised Value - $230,000
Total Assessed Value - $66,000

I rounded the numbers accordingly. As for the location, it's in a revitalized section of a Mid-Western city's downtown (population 500k). Downtown real estate prices have ballooned over the last decade, but leveled off in the last couple years.

I'd like to expand the building into the parking lot to the West, which I'd say is itself worth $75k.

The previous owner purchased the building and parking lot in 2001 for $120k, and sold it for $200k two years ago. Our current landlord has not done improvements to our building, or any of the others he purchased nearby. I have the feeling that he's willing to sell, if the price is right (as is always the case).

The building is broken up into 3200 square feet of commercial space on the first floor (which I lease), and three lofts on the second floor (I live in one). The only real leverage I have in negotiating a price is that the first floor has been completely customized for my business, and if I were to leave, the cost of whiteboxing it for the next tenant would be very expensive. I'm more than half way through a five year lease, and I think it's time to belly up to the table.

So, any ballpark estimates on what you think I should offer? I know there are other variables that need to be considered, but based on the initial values I mentioned, what do you think a fair price would be? Has anyone gone through a similar situation, and have tips to share?

posted by (bb|[^b]{2}) to work & money (7 comments total)

What is the rental income your landlord makes on the property each year?
posted by extrabox at 6:09 PM on August 6, 2007

As it stands:

$2,200 from commercial
$1,500 from lofts (2/3 are rented, the third has sat vacant for over a year)

$3,700 total
posted by (bb|[^b]{2}) at 6:38 PM on August 6, 2007

That's per month, right?
posted by amtho at 9:03 PM on August 6, 2007

Right.
posted by (bb|[^b]{2}) at 9:11 PM on August 6, 2007

The property generates ~$41,400 per year. The estimates above are a bit high.
posted by (bb|[^b]{2}) at 9:17 PM on August 6, 2007

I know someone who was in a similar situation. They made their offer, and the landlord decided that if they could offer to buy the place, then (a) they could afford to pay more rent, and (b) they clearly wanted to stay, thus were unlikely to move out if he jacked up the rent.

So he declined to sell and jacked up the rent instead.

Perhaps employ a little fiction when making the offer, so as to avoid conveying points A and B.
posted by -harlequin- at 2:10 AM on August 7, 2007

Some of your offer structure depends on the terms of your existing leases (considering the commercial space and the living unit as separate leases), and what your alternatives might be. Assuming you have something like 2 years left on the commercial lease, and that you can't cancel it without some penalty, you'd have a potential liability on that of up to $52,800 for the 24 months remaining on the commercial lease. If you were willing to move out of your loft immediately if the deal didn't go as you wanted, you'd have only the unexpired portion of your lease there (possibly a yearly residential lease?) as an obligation, and there are often cancellation clauses that limit a tenant's liability to 2 or 3 month's rent. Let's say you could leave with 3 month's rent as your loft lease liability ($750 x 3 = $2250). So, your current obligation to your landlord is for something like $55K, at the outside, in round numbers. Maybe less, depending on what kinds of contingency clauses, if any, you have in your commercial lease.

If he could remodel the commercial space to attract a new tenant or tenants willing to pay your rate, for less than the value of your obligation, he'd be money ahead to have you move out early. But there are often issues that are negotiated in leasing agreements regarding leasehold improvements, that could minimize his costs for refurbishing the premises. If he did want to sell, and felt you could be replaced with a lessor willing to pay higher rents, getting you out by refusing to sell to you could be excellent strategy for him. And possibly, you could telegraph the situation that harlequin describes. So, those are some of the downsides you have to protect.

On the other hand, looking at it from the landlord's current perspective, who bought the property for $200,000, and has rented it for $41K annually, with a long term tenant, he's had very little risk or additional expense on an investment that fully repays his cost in under 5 years, before depreciation or taxes. That is a pretty good rate of return (something north of 18%, before depreciation) in commercial real estate, in many North American markets. If those rents are fair market value for the property (you're only paying $0.6875 per sf? - that's pretty low even for Class C space), even if he has to put some money into repairs or remodeling in the next several years, those costs may be acceptable for a property with that kind of continuing cash flow. The remaining time on your commercial lease is a declining asset to the landlord as time goes on, and at some point within a year of the end of your lease, more or less "drops out" of most leverage considerations, as a rational landlord has to be willing to find new tenants, and in many markets, will usually start that process actively a year or so in advance, if you come to no agreement on a new lease by then.

I think the key to this is going to be to find a commercial broker willing to work with you to price an offer in line with existing market conditions in your area, which can be highly localized factors, depending on your market. Much of the value side of preparing that offer is going to come from you, as projections of what the value to you of the real estate is, over market rates, for not disrupting your business by a move. The low end of the offer range is going to be something the broker supplies, based on comps for that area, and considerations regarding your costs for your expansion plans. 5x annual rent sounds pretty reasonable even for Class B or C space in a medium sized mid-Western city, and you yourself acknowledge that "Downtown real estate prices have ballooned over the last decade, but leveled off in the last couple years." In many markets, 10x or even 15x annual rent is a starting point for purchase valuation on retail property, but that varies a lot with local market conditions, hence your need for local broker's knowledge. If you do work up an offer on your current premises that a broker can endorse, the broker may be able to make the offer "blind," meaning that they wouldn't disclose your identity until negotiations were complete, and perhaps not even through the closing process, if that would aid you.

Of course, as regards those expansion plans, you've also got the wild card factor, that in order to make this a continuing suitable location for your business, you're going to have acquire the parking lot adjacent to your business, and perhaps get new zoning and construction permits, in order to expand the current location to allow for the growth you anticipate. All those "ifs" add up to a fair amount of risk, and opportunity cost, even if everything goes your way. If it all doesn't go as you'd like (you get your building, but not the parking lot; you get the building and the parking lot, but don't get zoning to expand, etc.), you'll need contingency plans in place. And though it's beyond the scope of your question, once you really look at the market and the specifics of your current property, including costs for expansion, you might find that now is the time for a move, after all.

It would be very helpful to work with a broker experienced in your area with assembling parcels for development, particularly in a downtown area where your plans for eliminating existing off-street parking could spark political resistance to zoning and building permits. And if you intend to finance the purchase of this, you might want to involve your accountant in the discussion early on, if you use an accounting firm with good ties in the community. Finally, I've found that it doesn't hurt to discuss matters with your bank at an early stage, if you'll be planning to finance your purchase and expansion.

Rather than just cooking up an offer on the current property, it might behoove you to first do some shopping for comparable space, as you have now, and as you anticipate you would want to have, after your expansion plans. See what the local market conditions really are, and go see some other possibilities. You'll be in a much better position to realistically value your current situation, and you'll make some contacts with brokers in the local market that may prove fruitful in the future.
posted by paulsc at 4:46 AM on August 7, 2007 [4 favorites]