Investing Trends

Office buildings can be very profitable, and long-term leases mean less management than with residential income properties.The downside? Nothing seems to go up and down as much as office rents and office occupancy rates.

Investing in office buildings can be very profitable. A friend of mine bought the office building that his law firm was renting, and rented it to his company. It generated cash flow from the start. Now that the original mortgage is paid off, the net income is a sufficient retirement plan by itself.

There are risks with office buildings. The biggest one is simply that the rental rates can go up and down with the economy. In the worst of times, the same number of people need housing, but there may be a major drop in the number of businesses, or at least the number that are looking for an office to rent. After the dot-com crash, for example the rent for many buildings in the silicon valley area dropped by 30% or more.

A drop of that much means losing the property for many investors. Suddenly having a large negative cash flow for years isn't an easy problem to overcome. But even worse is the fact that during these rough times, many office buildings are empty for a year or two, with no income coming in at all. I have seen office space and even whole buildings sit empty for several years.

You might think that long-term leases reduce this risk. They may to some extent. And the long lease periods that are common are one of the attractions of this kind of investment. However, lease or no lease, if the company in your building goes bankrupt during a recession, they will not be paying the rent. Suing them probably won't help at that point either.

Does this mean you shouldn't invest in office buildings? Not necessarily. If there is a low vacancy rate in the area, and the economy is doing well, you can have good cash flow from office space. However, because of the inherent unpredictability of future vacancy rates and rent levels, you should always plan to have a good chunk of cash set aside to cover the rough times.

You also want to get a higher rate of return than with something like residential rentals. Higher risk doesn't make sense if you don't make more for it. You might do okay breaking even on your rental houses while the renters pay down those mortgages, but you better have a good positive cash flow if you invest in office buildings.

Ideally, you want to buy a building that already has a the tenant or tenants in place, and with leases that have a couple years to run. There is not necessarily a line of tenants waiting to take their place, like there can be with residential rentals. Office buildings, and the tenants in them, are unique, and fitting the two together will almost always take a little time.

If you risk buying an empty building (probably a bad idea), start advertising before you close on the deal. You should also plan on a year without income. You should also be getting the building at a price that assures you of really good cash flow when you do get it rented - to make up for that vacant time period that will be eating up your money.

Talk to other owners of office buildings in the area, to see what their biggest problems are. Find out what the usual arrangements are, like who pays for landscaping, and how much the tenants are allowed to modify a building. Find the buildings most similar to the one you are considering, and see if you can find out what they are renting for. In other words, if you do invest in office buildings, you should do your research.