I’ve never owned a commercial building for my law firm. I’ve always been a renter.

I spent a fortune on rent in Class-A buildings all across North Carolina. I’ve had as many as seven office spaces at a time.

Truth be told, I never even considered buying a building. I was always so consumed with running the law firm that anything more involved than signing a lease was beyond my capacity. I loved being able to call the building manager to whine about lightbulbs being out or the toilet being clogged.

One of my best friends has owned his law firm space for years. He’s in a much better position to talk about buying versus renting. That’s why I asked Phoenix family law attorney Scott Stewart to share his thoughts about owning a law firm’s office building.

Take it away, Scott…

When is buying commercial real estate a good idea?

Are you an attorney, a landlord, or a commercial developer? If you are contemplating a commercial real estate purchase, I recommend you decide where you are in your practice and your life before getting into the commercial real estate game. While there might be long term benefits to your bottom line (and short-term tax benefits), the distraction from managing and growing your law firm might not be worth the risk.

The building Scott bought: a timeline

Following the 2007-2008 residential housing market crash, the commercial market in Arizona dropped substantially. This created commercial buying opportunities for those positioned to take advantage of them.

In 2012, I purchased the office building where I had been a tenant since 2005. This may surprise you, but it’s the only building I’ve ever “officed” out of (I’m not including our satellite offices, where I do not work).

The purchase price on the building was approximately 50% below what the seller paid for it back in 1988, almost 20 years before the “Great Recession.” That important bit of information came my way because I had been a tenant there for seven years and personally knew the owner.

What was I looking for? At that time, I was looking specifically for an owner-occupy situation. Most of the smaller commercial buildings on my “potential buy list” had been discounted some, but not nearly so much as the large commercial building I was already in. After careful consideration, I closed on this buying opportunity.

Our two-story building is approximately 16,000 square feet and is divided into four separate office suites. While my office suite has 6,500 square feet (our main office), the other three have between 3,200 and 3,600.

Keeping the extra space rented

Maintaining occupancy levels is tied to market forces and competing space availability. Over the last eight years, our building has never been fully occupied. This has been a financial drain.

Here’s why maintaining occupancy levels challenges the best of us in an economic downturn. When business tenants start fleeing Class A space, those commercial property owners begin offering substantial discounts as enticements to sustain occupancy rates. Discounted Class A properties compete heavily with other properties, including my Class C office space.

The big question: keep renting, or buy?

Rent or buy? That is the question. There’s no easy, one-size-fits-all answer.
Are you excited about ownership? How many hats are you willing to wear? You’re already the lawyer. Are you also willing to play the role of landlord? Are you planning to be the owner-occupant? Or would your rather just rent?

There are many factors involved in answering these questions:

1. Tenant problems

First, landlords must deal with all tenant problems. And building emergencies routinely occur after hours. How quickly can you fix a burst pipe? Replace a burned-out light bulb in a 30-foot ceiling? Find an HVAC repair person on a searing August afternoon? Or repair a clogged toilet and clean the soiled carpeting?

If you’re like me (in other words, if you’re the kind of person who dislikes dealing with other people’s “business”), then reconsider the role of large commercial landlord.

It can get ugly.

2. Tenant improvements

The larger the commercial space, the greater the tenant improvements tend to be. Getting a tenant to sign a three- or five-year lease may put you on the hook for substantial improvements. Most tenants will want to move some walls around. Factor building permits into your overhead. Making these improvements also means rounding up contractors to do the work, so now you can add a general contractor hat to your existing landlord and busy attorney hats. These can be very demanding, time-consuming responsibilities.

3. Market downturn

Sliding market conditions are always a possibility. If the commercial market heads south on you, then the bank could call your note, force you to sell, or push you into bankruptcy.

The potential for a market downturn hangs over your head in every market. The unexpected is, well, unexpected.

4. Cash depletion

Overhead can deplete current cash. With building maintenance, property taxes, tenant improvements and other surprises adding to overhead, you will always be dealing with the issue of current cash depletion. Say, for instance, you replace the commercial AC unit or pave the parking lot. These are capital improvements that get depreciated over a number of years, not expensed. Recouping such expenditures takes considerable time.

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5. Landscape management

Landscape management has its own host of problems. There’s trimming, spraying, cutting down trees, repairing sprinklers, replacing plants, reseeding grass, and attending to storm damage. Landscape expenses add up over time, even with xeriscaping.

If you already hate supervising the lawn guy at home, then you’re really going to hate doing it at the office. There’s nothing more unpleasant than standing outside in your suit while the irrigation guy explains why he needs to charge you another $2,000 for repairs.

6. Security

Landlord responsibilities also include around-the-clock security for tenants, along with your personal office space. A motion sensor is triggered at 3:00 a.m., someone tries to break into the building, and so on.

Who will respond 24/7 to all potential issues at the building? Yeah, you already know the answer to that question.

7. Traditional office versus work from home trend

One final factor to consider is the shift away from traditional office use. Many businesses are looking into permanent work-from-home arrangements, office hoteling with shared space, or some type of alternative arrangement. You’ve probably encountered this discussion in published articles, from talking to landlords, or in reassessing your own usage.

So are you ready for ownership? Be realistic. Think through the issues raised above. Nothing I’ve mentioned so far is a deal-breaker for many of us. But you ought to know what you’re getting into–before you make the investment.

Long-term commercial real estate values

Looking at long-term value, large commercial real estate probably isn’t a great investment overall in many markets.

Here’s how I’d look at the situation if I were contemplating a building purchase right now. I’d analyze my current law firm and cement my vision for the future of my firm and my life. If I planned to practice in the same location for ten to twenty years, and my practice area required “office visits,” then I would consider a stand-alone office building or office condo. The potential investment and tax benefits might be worth it in the long-term, but I would not plan on becoming rich from a commercial investment.

My personal philosophy has been heavily influenced by my father and grandfather. Both owned the industrial buildings from which they operated their businesses. For many years, both funded a large percentage of retirement by leasing out those buildings. Down the road, renting out your office building might finance a portion of your retirement. Or you could package it with the potential sale of your law firm.

The selling problem

I finally decided that it was time to sell. I was ready to get out, but that was more easily said than done. I put the building on the market about three years ago. Four potential sales fell through and I got frustrated. Then, over the past ninety days, two more sales have fallen through, and I am currently negotiating a third contract with the same “buyer.”

The current list price represents a substantial profit, but my fear is that I won’t get it sold before commercial prices plummet.

Most of the offers I’ve received have been low-ball, given that our location has appreciated rapidly over the past five to eight years. In the past ten to twelve years, downtown Phoenix has undergone a tremendous growth spurt. My building is three miles from downtown, where higher-end condos and apartments are being built. Land values in the area are increasing, notwithstanding the current economic situation. Overall, Phoenix seems to be faring a little better in the commercial area than the national average, at least so far.

That was then, this is now

Would I buy a large commercial property all over again? Probably not. I would consider purchasing an office condo or stand-alone building. Before doing so, I’d ensure my financial and cash situation was such that I was not leveraged, and I would plan on selling the space with my law firm.