September 2007: by Jos Herman

Owning your business... owning your property

As mentioned in my article in the previous issue, I noted that office vacancy rates have reached record lows. There does not appear to be any rental rate relief in the near future.

With the drop in vacancy and increase in rents, capitalization rates are also being driven down by high demand from purchasers. Capitalization rates are lower than previous years due to the exceptionally high demand for properties. The likelihood of continued rental rate increases together with capitalization rate compression will continue to attract buyers and drive pricing. These factors have combined to provide owners of property with substantial gains in value.

So as an owner of a business, does it make sense to continue to lease your space or look to own the property outright?

Some questions to ask include:

• What rent are you willing to charge yourself for occupying the space?
• Are you willing to take on additional space and lease the remainder to other tenants?

As the property owner, you have the ability, much like in your own business to negotiate the terms and pricing. If you decide to own the property and decide to lease all or a portion of the space for your operations (effectively becoming an owner-occupant), as a tenant, you are seeking below market rates, while also acting as landlord looking to maximize rental rates at market.

Determining Cash Flow
Feasibility of owning your building requires a look at the associated cash flows. If you are looking to take on tenants, analyzing the cash flow allows you to determine your rate of return. In order to make reasonable cash flow assumptions, you should obtain documents related to the building operations. Look to obtain such documents as the rent roll and operating statement for the property, property tax notices, and leases. By obtaining the leases, this determines which tenants are approaching their renewals. Such tenants may be motivated to negotiate early renewals to lock into longer-term deals that take advantage of today's rental rates.

Net Effective Rent
Another number crunch that you will want to consider is a calculation of Net Effective Rent. This calculation analyses the effective rental rates or, in other words, the net return to the owner after providing for tenant incentives, such as free rent and tenant improvements. The calculation could also factor in other costs, such as any broker fee commissions on the property.

Cost to Do the Deal
When looking at other costs to proceed with completing the purchase, these transaction costs are not limited to:

• Legal
• Financial advisory fees
• Land Title transfers and the like
• Broker fees
• Appraisal fee
• Financing costs

And certainly not to be overlooked is the costs of any construction required. Construction costs have escalated given the shortage of trades and demand for office rental space. The rising costs have translated directly to increased rents and higher prices.

So, the assumed result…rental rates would have to reach significantly higher figures in order to have new office construction in a city like Saskatoon to justify the construction costs. When considering that the cost per square foot of building or buying a residential property can be in excess of $200 psf and compare that to investing in your commercial property, which can be half of the cost, it warrants a second look.

Based on the other emerging trends, we have out-ofprovince investors interested in purchasing real estate in Western Canada and companies that are growing and looking for more space. For the business owner, it has affected where you can lease space and what happens when your own lease comes up for renewal. With these trends, this may create opportunities for the business owner to revaluate the real estate portion of their operations.

. . .
About the author
Jos Herman, CA, is with Assante Financial Management Ltd.

Disclaimer
Please contact a professional advisor to discuss your particular circumstances prior to acting on the information above. The opinions expressed are those of the author and not necessarily those of Assante Financial Management Ltd.

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