Outside of football, family and overeating, part of the joy of a holiday weekend for me is completing long overdue projects around the house. On Thanksgiving it was installing new lampposts and lanterns. As I was playing electrician, I recalled a recent conversation with a local real estate developer.
I asked him where he was finding the greatest margins in his real estate investments and without hesitation he said “apartments.” His primary reason was the minimal capital outlay for improvements. For example, if a new tenant moves into a commercial office building for five years, an improvement allowance can be anywhere from $15 to $35-per-square-foot in the suburbs. Very few tenants can utilize second generation space and they need to modify the layout to reflect their business needs. On top of this there are brokerage fees, attorney fees, and additional marketing costs to find a tenant.
For apartments, a prospective tenant may want to paint the walls, but most people do not gut an apartment to fit their needs. Instead they will rent another apartment that better suits them. Most of the time renters will take the apartment literally as-is, and their rent can be used to pay the landlord’s debt service rather than improvements to the premises.
What this ultimately goes back to is the discounted sales prices we are seeing in the northern suburbs for commercial buildings. Although buildings are selling for well below replacement costs, an investor must factor in buildout, additional fees and the downtime of having a vacant asset. Once these costs are considered, the sale price doesn’t always seem like a steal.