Own yer own office floor – it’s just good sense right?

A friend of mine recently chastised himself for not purchasing a small commercial property which sold for $700,000 some 6 months after I reported the asking price to be $1.2m. On the surface of it I can see his point, it does seem a bargain but is it right for him? Well lets see using my estimate of opportunity cost based on the interest rate and a little premium for risk of say 9% we have;
Cost to service $700k            $63k
Rates                                   $15k
Compliance and Insurance    $ 3k
Total Annual Cost in lieu of Rent    $81k

Now given that his current rental budget is $60k and he is hoping to move for less than $50k I told him he is far better off leasing his premises than looking at owning. Sure he is giving up the potential of a capital gain which has in the past a proven over a longer term but he is gaining considerable flexibility and choice with a number of  leasing options to locate his business. It’s an older building so 3% depreciation on the Value of Improvements (VI) is only $8k but this deductibility will certainly not be available in the future. Plus he would inevitably face the requirement to earthquake strengthen the building within the next 10 years.

What then of office tenants? Is it better to own your own office floor unit title in the city rather than pay the rent? And what of the new tax changes allowing deductions for depreciation on buildings, how will that change the viability of ‘own yer own’?

Owning your own home is a deep part of kiwi culture, the quarter acre paradise etc. but it is not a major feature of the Wellington office market with only a small handful of central city buildings held in unit title or company share structures.  Most CBD building owners are wealthy individuals or corporations who enjoy huge capital gains particularly when the market is on the up. So instead of funding someone else’s wealth why wouldn’t a savvy business owner want to create their own? I currently have 2 interested office tenants who would love to find suitable and affordable unit titles but alas my search is proving difficult with a lack of stock.

At the height of the market (2007) we can see sales of unit title floors tipping $5100 per m2 however the last sale in the same building last year was for $4000 representing a drop of 20%. I wondered if the current market represented good value? Lets look at an example using $4000 per m2;
Cost to service purchase $1m        $90,000
Rates and Body Corp                    $17,000
Total Annual Cost in lieu of Rent    $107,000

In addition these floors would have been purchased with an expectation of depreciating the building value calculated at 3% diminishing value or say $17k based on the current VI.  While that’s not an actual cost it does represent a cash benefit of $6500 based on the top marginal tax rate of 38%.

Now complicating matters further there is space to lease in this same building right now for $70-$80k per annum gross. So given the short-term difference of say $20k in favour of leasing can we say of the perceived wisdom of ‘own yer own’? The reality for most businesses and particularly anyone related to the IT sector, their outlook is subject to change where they will need to expand and retract staff numbers and overheads with some degree of fluidity. Owning your own commercial space is a great idea for an exit strategy for your business (e.g. selling the business but keeping the real estate with a long term lease on it) but it doesn’t necessarily allow for the flexibility many businesses would prefer. Until unit title owners realise that 2007 valuations are meaningless and 2010 values must account for new rental realities and the loss of depreciation, I suspect my 2 interested parties will stay in the leasing market.

March 18 2010 10:52 am | Uncategorized

One Response to “Own yer own office floor – it’s just good sense right?”

  1. Nick Powell on 18 Mar 2010 at 12:08 pm #

    Great Read, Nice to see some articles on Commcercial Real Estate

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