An office at $64 a foot that still won't pencil as a conversion

A broker sent me a three story office building from 1963, about 22,000 gross square feet, asking $1.4M. That's $64 a foot for a structurally sound building, which sounds like a gift until you start adding.

What I have so far. Rentable is maybe 18,500 after corridors and stairs. Local architect's first pass says 18 units, mostly one bedrooms around 700 feet. Hard cost quotes for full residential conversion in this market are running $175 to $200 a foot on the gross, so call it $4.0M at the midpoint. Soft costs (architecture, engineering, permits, legal, the fees you pay before anyone swings a hammer) at 15% of hard is another $600k. Carry and contingency, another $500k if I'm honest with myself. Acquisition plus all of that is roughly $6.5M, or about $360k a unit.

Comparable new one bedrooms in this submarket rent at $1,375. Eighteen units at that, minus 8% vacancy and credit loss, minus operating expenses I'd guess at $6,000 a unit, gets me to roughly $165k of net operating income. At a 6.5 cap that's a $2.5M building. I am four million dollars underwater before I start.

So either my construction number is wildly wrong, the unit count is wrong, or this building is a demolition candidate that someone dressed up as a conversion. The floor plate is 66 feet deep with a center core, which the architect says is workable. The plumbing is all stacked at the core, which she says is the expensive part.

What I actually want checked is the $175 to $200. Is that a real range for a wet conversion of a 60s office, or am I quoting ground-up numbers to myself?

2 replies

2samantha_ruizAU4APRO6

Your construction number isn't the broken part. $175 to $200 all-in on gross for a full wet conversion is inside the range I've seen bid, and I've seen worse when the building has a masonry facade that needs new punched openings.

The part that kills it is the rent. $1,375 against $360k a unit of basis is a 4.6% gross rent to cost ratio before expenses. You need something closer to 9 or 10 to survive that cost stack. Every conversion I've looked at that worked had one of three things going for it, and you have none of them: an acquisition price near land value, rents that support $300k+ basis, or a public subsidy filling the gap.

Ask the broker what the seller actually needs. $64 a foot is not cheap for an obsolete 1963 office in a $1,375 rent market. Cheap would be $20.

2stephen_ok9CO2CPRO6

@keystone is right about the rent side, though I'd push on the cap rate too. You used 6.5 on a converted 1963 building with a 60 year old structure behind new drywall. Whoever buys that from you is going to price in the roof, the elevator, and the fact that nobody really knows what's in the walls. If the exit is 7.25 your $2.5M becomes $2.28M and it barely changes the story, which is sort of the point. The gap is so wide that the exit assumption isn't what you're arguing about.

The thing I'd want before spending another hour is the seller's basis and how long they've owned it. If they bought it in 2016 at $110 a foot they are not selling at $25, and you can stop. If it came through a foreclosure or an estate at a low number, there's a conversation. Sale price history is public in a lot of states and completely unavailable in others, so you may have to just ask.

Also worth pricing the alternative: what does the dirt sell for with the building gone, and what's demolition on 22,000 square feet of 60s office with likely asbestos in the floor tile and pipe insulation? Sometimes that's the actual comp for the acquisition price.

An office at $64 a foot that still won't pencil as a conversion

2 replies