One of the biggest unknowns in commercial real estate in a tough economy is what your expected occupancy and rental rates will be. There is currently a glut of 15- to 30-year-old buildings for rent in northern Nevada. Owners are not typically giving much in the way of tenant improvement allowances, so it is often a take it or leave it scenario.
There is, however, a relatively scarce amount of Class A space that the landlord will build to a tenant's specifications. When we purchased the Bosma Business Center last May, we recognized that while the "bones" of the building were outstanding, each floor would need to be gutted and rebuilt to offer the type of office space that the commercial real estate market was demanding.
Our first task was to negotiate a fair price for the building. We simply calculated the cost of rebuilding the interior, and compared it to what the property would be worth after the improvements were made by capitalizing the after-improvement market rents and cash flow (EBITDA). The difference is what we calculated the building was "worth." Don't fall into the trap of comparing the cost to build new, or what the property was worth years ago when you consider purchasing real estate!
A significant benefit of purchasing the building was that by performing a cost segregation analysis on it, we were able to specially identify the tangible personal property that was able to be depreciated over five, seven and 15 years, versus the typical 39 years. Coupled with the IRC section 179 deduction, and bonus depreciation, the tax savings helped mitigate the cash outflow on the project.
We found that several banks liked our model, and because we were occupying a significant portion of the building, offered favorable loan terms. Our model was backed up by a very solid cash-flow forecast and supported by market data, which allowed us to take advantage of the lowest interest rates in memory. We also "structured" the purchase in a way the deal made sense to us, and the sellers. In retrospect, we simply followed the advice we normally provide to our clients to assist them in getting deals done.
We have had both good and bad surprises along the way, but have been fortunate to partner with some outstanding contractors and professionals that embraced our project vision. For example, I was surprised that there are still contractors who operate on their own timeline and budget. While short-lived on our project, it caused delays, so due diligence on the front end is very important. A favorite Entrepreneurial Organization axiom holds true, "it is less expensive to make mistakes on paper rather than in the field"!
Overall, we have found that rock bottom mortgage rates, favorable real estate prices and tax deductions are opening up opportunities for northern Nevada commercial real estate projects that build what the market is demanding. Businesses can save even more by buying an existing building and renovating it, rather than starting from scratch.
Michael D.Bosma, CPA, is managing shareholder of The Bosma Group. Contact him by phone at 775-786-4900 or by e-mail: mbosma@thebosmagroup.com.
