The Commercial Condo option. Users have choice.
For users of commercial real estate, options were typically limited. If you were a larger business or manufacturing concern, acquiring or building your own facility was a viable option. Users of less space however, typically sought out leased premises, as ownership was not a viable, nor available choice.
In recent years we’ve seen the rise in popularity of the commercial condo option. They are now more prevalent within the commercial real estate market.
To explore this further, we are joined today by Daniel Kolber, Partner-Investments with Takol Real Estate Inc. (www.takolrealestate.com)
YPLP: Daniel, how did Takol Real Estate Inc. get its start?
DK: TAKOL is a company owned jointly by my business partner, Takashi Yamashita, and myself. We met through mutual friends, had accumulated corporate real estate experience (myself as part of senior management at a publicly traded REIT, and Takashi with a multi-billion dollar commercial lender). Both of us not only wanted more out of our careers, but also a different vehicle to capture our passion for the industry., So TAKOL was born.
YPLP: Has TAKOL always had a focus on the commercial/industrial condo market?
DK: We have always had a focus on the commercial real estate space. However the office condo and industrial condo projects that we are currently engaged in came out of opportunities in the market combined with previous experiences that we both had in the condo space. The concept of owning your own commercial/industrial space is not new, but it has not been as prevalent in North America as in other parts of the world. With interest rates at historical lows and with our economy faring well, now is a great time for businesses of all sorts to consider owning rather than leasing their premises.
The Commercial Condo option
YPLP: For more modest sized users of commercial space, owning your own premises was not always an option. What has happened to now make this a viable option?
DK: Short supply historically restricted options. I suspect it was previously a viable option to some extent, but for whatever reason, presumably higher interest rates in comparison to low market rents, real estate developers were not willing to bring to market a smaller assortment of sizes for end users to purchase. Now rents are higher than they have historically been in the markets we are invested in, and obviously interest rates are lower than ever, so the mathematical ownership equation for smaller sized users (and the developers who provide the space to purchase) makes sense. The math now is truly very compelling for the end user to own their own office space, or their own industrial space, just from a value creation perspective. In addition, as a condo owner of real estate, a business can depreciate it and benefit from that accounting perspective. Landlords have always done this, and with our projects the end user can be their own landlord, enjoy the freedom of making decisions about their interior space, and manage their accounting accordingly.. Ultimately, there’s the strategic advantage of owning your own business space – why be tied into a 5 or 10 year lease if your business could change? If your business needs to grow and it is tied into a further 7 years on a lease, how do you do that if your building and your landlord cannot accommodate you? It can leave a business somewhat constrained. By owning your own space in one of our projects, if you need to grow (or to downsize) you can consider acquiring adjacent units in the building complex, and if that isn’t possible you can always sell your premises (or sublet it) and move to alternate premises. Alternately, you can strategically downsize e.g. if you currently own two condo units, and only need one of them, you sell one, keep the other,or you sell or sublet the whole premises, or acquire something smaller. This type of flexibility is rarely available with a leased commercial premises or a condo project with only large cumbersome units and restrictive layouts. We believe the ownership model has many strengths that have not been explored by the smaller-sized business owner as it just has not been made readily available by real estate developers. We are excited about servings this under-served market with a quality offering.
Buy vs. Rent Analysis
YPLP: The buy vs. rent conundrum would seem to be at the heart of the decision here. How do you lead the prospective buyer through this analysis, and what factors are important for them to consider?
DK: We provide all prospective clients with a “buy vs. rent” calculator/spreadsheet to show them how an owner can create equity over a 10 year period by owning units in one of our projects (for example, our Ottawa project has a calculator at our project website – www.twenty-two83.com). We make it simple to project value and compare numbers. For example, when exploring a new car, most dealers’ websites have a friendly buy vs lease calculator. We do the same as step one. Subject to an owner’s mortgage rate and the quality of the building, as ownership can cost a bit more per month (vs. leasing) from a cash operating perspective, but we point out the longer term financial benefits of equity creation. Also offsetting this minor operating difference is the value of the improvements in your space. At the end of a typical lease, the landlord owns the improvements vs. a condo situation, whereby you own the improvements and can sell them to capture more value. We do not show buyers the shorter term tax advantages of depreciating their investment, as that is for them and their accountant to discuss. We just look at the bigger picture of equity value creation.
What about Flexibility?
YPLP: I am sure the question of future needs often arises. How do you deal with the inevitable question of what options are available should a user’s needs change? Would leasing space not provide them more flexibility?
DK: As discussed above, we believe that ownership provides different strategic flexibility over leasing options. Some buyers of our commercial units in fact buy more space than they need, and sublet what they do not need in the short term, believing that their space needs will increase over time. We have seen other condo owners acquire adjacent units as they grow, holding them for 25-30 years before selling to the market. In their words, ‘It worked out well’.
Is this a good way to deploy capital?
YPLP: What about the deployment of capital? Are smaller companies not better off investing their surplus back into the business, and not focusing on real estate acquisition?
DK: Regarding your specific question, I think the key word is ‘surplus’. Sometimes, an owner cannot efficiently put that surplus to work in a business. The investment does not yield the highest returns. Therefore, if there is excess working capital or additional under deployed equity, then an owner can diversify their capital in an office condo yet still the investment feels (and is) related to the business. In my experience, every business has its own way of looking at their cost of capital and where they are best deploying their resources, and while we do believe that many organizations should own their own premises, it is not for everyone.
For small to mid-sized companies, we rationally illustrate that while the monthly cash flow required to own (i.e. to pay principal and interest on a mortgage, vs paying net rent) can be higher than with leasing, there are other real advantages, such as independence, control, and flexibility, in addition to managerial accounting and depreciation treatments that can offset that. We believe, as many owners do, in the long term there is a value creation play for the right product just by owning it over a 10, 20, 25+ period. And many companies, whether large or small, have excess cash flow. Pulling that excess money out of the company (via salary, dividend, or other) is perhaps not the most efficient use of capital, and perhaps the business itself does not require that capital to be reinvested at that particular point, so then investing that capital on a tax efficient basis into the business’ real estate is a prudent option.
The Commercial Condo option. Who does it appeal to?
YPLP: Who does a commercial condo development appeal to? I see several successful newer developments geared to the professional (i.e. Accountants, Dentists etc). The more traditional, or perhaps 1st generation developments were seemingly more traditional industrial in nature.
DK: Projects such as our office condo project at 2283 St. Laurent Blvd. in Ottawa make a ton of sense for the professional user, of course. This project is a Class ‘A’ office condo, offering tremendous common element amenities such as a boardroom, a meeting room, a business lounge, an extra private shower facility (go for a jog at lunch! cycle to work!), a 150kW backup generator, Cat6 wiring in the building, a central elevator to all floors, a great parking ratio, and mature landscaping. Plus, the project is located in an established business park with great public access.
By contrast, most other condo products are more industrial in nature, with loading doors for trucks, no common amenities, no fit-up of the office component available with the purchase price. Really just a bare bones commercial space, which needs work.….and that may be all that some users need. But professional users, and their clients, need more, national organizations need more. And a big part of our value at our TWENTY-TWO83 office condos is that the common amenities are a difference maker. These amenities, never mind the quality image of the building, create efficiency. One buys just what one really needs. Our amenities are common to all users in the building; therefore, you do not have to purchase an extra 300 sf so that you can have your own boardroom. In our project, you have the choice of using the boardroom or meeting room or business lounge in the building that is part of the common element amenities. You do not need to build your own washroom in your space becasue there are washrooms on every floor that are cleaned daily. So when we look at the cost to own our Class ‘A’ office space in comparison to other commercial offerings in Ottawa, which do not have the common element amenities that we offer, we are priced equal or better on a usable square foot basis per employee, which is what matters. This project is simply superior in both appearance and function. Plus, it is complete with your finished ceiling, lighting, HVAC, power, backup generator, and more!
Today’s users want amenities
YPLP: The newer users of space are after much more than just an empty box for their business. How do you address their needs for additional amenities?
DK: The users of true office space are looking for much more, you are correct. Today’s workforce works in diverse ways, so we offer choice! We have addressed these needs as mentioned above – we are giving our owners access to amenities on a cost efficient basis by including it in the common element. Some of our offices units are open plan; others have more enclosed offices. It appeals to various generations. Many professionals (doctors, lawyers, engineering firms, accounting partnerships, etc.) do not need a boardroom every day, they do not need a meeting room every day…so why pay for it every day? Having it accessible on a shared basis provides cost efficient flexibility to office condo buyers. Now, buyers of more industrial type space, they ARE looking for that empty box in many cases…our industrial projects may have 10% office and 90% industrial in the average unit. But we are offering high level amenities, layout choice, and building quality that are not readily found today in other projects in the Ottawa market. We believe that is a compelling investment opportunity for businesses.
Are Commercial Mortgage Lenders receptive?
YPLP: What about the actual purchase of the condo unit. Are you finding that lenders are receptive to your buyer’s needs?
DK: Yes, we have observed various lenders willing and able to readily respond to a buyer’s needs. Accessing financing for the right buyer to invest in projects such as TWENTY-TWO83 has never been easier.
How do you establish a condo Board?
YPLP: How do you setup a condo board, and who gets to sit on the board?
DK: Establishing a condo follows the rules and regulations set forth by the government authorities. We are the declarant, working closely with the authorities to meet their goals and those of our clients. The good news with Twenty-Two83 condo is it already is a condo corporation with a strong operating history. So we worked with the various city departments to re-package the units into small ones, better aligned with the needs of small and mid-sized offices in the Ottawa market. With each unit comes one vote. Therefore, an owner of one unit will have its one vote regarding condo decisions. If an owner wishes to serve on the Board of the condo, then she / he runs for election. The combination of vote and board participation gives greater control and peace of mind to owners as investors in commercial real estate that renting does not.
YPLP: Thank You Daniel. You have certainly helped to demystify commercial condominium investing.