An office in a downtown high-rise was once considered the pinnacle of success. With sweeping views of the city, glamorous high-rise buildings - and the idea of being right in the hub of businesses downtown - was attractive. But the times are changing and business owners are not as interested in prestige as they are in creating value, enhanced by owning real estate, while saving money.
A portion of the downtown real estate market is being affected primarily by owner/user sales. (Owner/user is an industry term used to describe an owner of an office, industrial, or retail building who also occupies all or a portion of the building for his or her business needs.) Brokers are seeing more and more of these general office building tenants - especially from downtown high-rises - looking at other marketplaces and purchasing buildings instead of renewing their leases.
Consider typical downtown lease rates ranging from $2.50 to $3 per square foot. Add in parking costs (on average $150 to $175 per month per stall) and business owners are finding that working in these high-rises is not as cost efficient as moving outside of the area to a place with ample parking. In some cases, purchasers are putting as little as 10 percent down to own a building that comes with plenty of parking spaces. With building ownership, owner/users can control their business at a fraction of the cost and do not have to pay extra for parking privileges that, in some cases, do not exist.
In San Diego, opportunities are popping up all over the county, specifically in Mission Valley, Bankers Hill, and Uptown. As more opportunities are found outside of the downtown region, more businesses are likely to find themselves moving to save money in the long run. So far, the majority of the businesses making the change from downtown high-rises have largely been major law firms, engineering companies, and design firms. Large to mid-sized employee-intensive companies can no longer afford the inflated costs of doing business downtown.
The biggest catalyst of this trend appears to be the low financing required to own a property in other areas. Having to place only 10 percent down on a new building remains tempting to these owner/users. Financing can be sought through traditional commercial real estate loans or more highly leveraged SBA guaranteed financing.
Business owners are doing the math and finding that it's cheaper to buy a building and own it rather than to renew a lease. Businesses find that they can renew their lease for $2.50 per square foot per month, or buy their own building and end up with an equivalent rate of $1.50 per square foot per month. It is no wonder so many businesses are looking to move.
Plus, by owning and controlling the real estate themselves, owner/users don’t have a landlord to raise rents and force the business to move. When it’s time to sell the business, an exit strategy can be put in place that doesn’t normally exist in a lease deal. Other compelling reasons for ownership include flexibility to grow within the building, depreciation and other tax deductions, retirement investment, and building appreciation. Business owners create an additional leverage tool when they can sell a business combined with a real estate component attached.
Parking also is sparking this trend. Owner/users are desperate for office buildings with ample parking, as it often is critical to a business. To lease office space in cities where most people get around by automobile rather than subway or train, parking must go along with it. Parking availability can play an important role in determining a building's success. Parking rates are determined by the landlord's input, market comparisons, the type of facility, and the services offered to the tenants. Paying these rates can add a huge increase to a business’ bottom line.
For example, say a tenant leases 10,000 square feet and needs 30 parking spaces. Typically, a business only has to pay for half of the parking spaces at market value, which (at this time) is $175 per stall per month. If the owner has to pay for 20 stalls at $175 a month and signs a 10-year lease, then he/she will have spent more than $400,000 in parking. This parking can be just for employees and sometimes doesn’t include parking for clients and visitors.
Part of the higher downtown prices has to do with the fact that a majority of downtown high-rise buildings have traded hands over the years, creating major increases with operating expenses, taxes, and insurance that are being passed onto tenants. Many downtown tenants have to contribute their own working capital to tenant interior improvements. When the lease expires, these improvements become the sole property of the owner.
This is completely eliminated in the sole ownership of a building. It’s like putting paint and carpet in a new house after 3 years and then walking away - it can feel like a waste of money. If an owner/user owns the building, any building improvements can be expensed and controlled.
As long as interest rates stay attractive and tenants become more comfortable with their businesses, this abandonment trend will persevere, continuing as long as cost-saving purchase opportunities present themselves. As the trend continues, high-rise office buildings will need to come up with new solutions to keeping tenants in place. Otherwise, some downtown business hubs may become only a memory.
Stephen Dok is senior vice president for San Diego-based GVA IPC specializing in office and medical properties. Founded in 1975, GVA IPC (formerly IPC Commercial Real Estate) is a full-service brokerage firm specializing in the sale, leasing, consulting, and management of commercial real estate, including office, retail, industrial, apartment, land, life sciences, and investment properties. More information about the company is available online at (http://www.gvaipc.com).