CREJ - Office Properties Quarterly - September 2017
User-investor office acquisitions are an increasingly attractive option for a user who is willing to become a landlord and is looking to enjoy the benefits of owning the building he occupies as well as the enjoyment of low-subsidized occupancy cost from other tenant’s cash flow. As we witness a general increase in the sophistication of investments – and in real estate investment world, in particular – and a new entrepreneurial momentum in the economy, it only makes sense for business owners to buy user buildings and, by extension, user buildings with additional cash flow. There are negative trade-offs for this strategy and it’s not for everyone, but we’re seeing unprecedented interest in entrepreneurial business owners diversifying into real estate investing via the user-investor office purchase. Businesses big and small customarily lease their real estate and focus their capital on the business. The general thought is to let the landlord handle the real estate tasks, while the entrepreneur can focus on her area of business expertise: growing the company. It also is relatively customary for a business to deploy its capital in the ownership of the building it solely occupies and handle real estate tasks like maintenance and bills themselves. These businesspeople now have two foci: their business as well as managing and maintaining their building. What’s changing is that increasingly business users are deploying their capital in their business as well as their building, but offsetting the building expense with income from other tenants. This dynamic of additional building tenants requires the owner to become landlord in addition to all the tasks associated with investment ownership. As businesspeople become more sophisticated in investing in real estate (owning the buildings they occupy), it only makes sense that, by extension, these business folks would evolve into the user-investor role – a businessperson who owns the building she occupies, with cash flow from other tenants in a multitenant building. This isn’t a brand new phenomenon but, I submit, it now is a more popular investment vehicle as entrepreneurs get more sophisticated and more comfortable with real estate as a cash flowing investment. As I alluded to above, this user-investor role isn’t for everyone. The user-investor must wear three hats. An entrepreneur running her core business, a property manager maintaining the building, and an asset manager/landlord in charge of collecting rents, keeping books and holding tenants’ hands. This presents an opportunity for said user-investor to become a jack of all trades and master of none. Still, many companies are deploying this strategy as a diversification tool, a way to offset occupancy cost and as a strategy to acquire distressed real estate at well-below replacement cost with the utility only the user-investor can enjoy. One user-investor strategy is for a company to build a new building that is oversized and lease out the excess space to offset occupancy cost. New office construction costs are high, so the excess space would necessitate strong rental rates to maintain the replacement value of the building. For anything but the most high-end (e.g., medical) occupancies, it’s difficult for this strategy to succeed for the user-investor. Another more common and more successful strategy is for a buyer to buy an unstabilized building with some vacancy for well-below replacement cost and occupy the vacant suite. Our team has sold eight user-investor office buildings in the last couple years, and we’ve seen some trends and benefits for sellers and user-investors. For example, a seller may have a destabilized investment property that’s 75 percent full and a 4.5 percent cap on current net-operating income, and the seller would like to sell it at a pro-forma 8 percent cap. The pure investment buyer sees this opportunity and thinks the seller is keeping upside to himself, and so it sits. Would a user-investor pay above what the property is worth to a pure investor? I submit that it’s of value for the user-investor to do so, because he would benefit from the utility of having space to occupy as well as the benefit from additional income from the other tenants to offset the occupancy costs. The liquidity offered by the user-investor benefits the seller as well by making a market for unstabilized buildings that can’t be filled by valueadd investors alone. This new liquidity also is beneficial for the commercial real estate market as a whole. These buildings generally sell for below replacement cost and provide an opportunity for business owners to diversify their holdings. Further, the new owner can monetize her position by selling and leasing back, which is a whole other topic. There are distinct advantages for the user-investor from a management perspective as well. The owner is on site so he can respond quickly to real estate issues. It’s interesting to note that of the eight recent user-investor transactions we’ve been involved with, none of the buyers hired a third-party property manager. Some of these buyers are new to real estate management. I submit that the proximity of the owner to the building helps with management challenges, which is another advantage in lowering costs for the user-investor. User-investor office acquisitions are a great opportunity for a user to become a landlord by owning the building he occupies, enjoying low subsidized occupancy cost from other tenants’ cash flow and deploying the benefits of investment real estate ownership. It makes sense for business owners to buy user buildings with additional cash flow at below replacement costs, and it benefits sellers and the commercial real estate market. We welcome this nascent form of real estate ownership and the new energy these nontypical real estate buyers bring to the table.