By Andrew Sorensen, CCIM
This statement generally comes into the minds of many prominent and successful businessmen and professionals, such as attorneys, doctors, architects and engineers.
Other comments come to mind as well. “Why am I wasting my money on rent rather than buying my own building?
But the most striking of all comments is…”We can purchase our own land and build it cheaper than that!”
After a long career in commercial real estate brokerage and development, and has developed several successful projects, I have responded to that question and others like it with a simple “Can you really?”
Only to find out later they were mistaken in their assumptions and the advice of well-meaning contractors, real estate brokers, and agents.
This presentation has been made to give prospective office building owners some food for thoughts to consider before entering into a decision to purchase land and construct their own professional office building versus purchasing a building within a master-planned commercial development.
This presentation focuses on a professional office building format.
Similar formats can be developed for retail and office/warehouse users and prospective owner.
Economy of Scale
Building a small building or project by itself cost more than building a larger project. Much of the additional costs are in the cost of on- and off-site construction costs, architecture costs, and construction supervision.
Generally speaking, it takes about the same amount of time to design and build a small project, but you end up spreading those same costs across fewer usable square feet – raising your per-square-foot cost significantly.
Architecture and Construction
Architecture, Civil Engineering, Structural Engineering, Soil Testing and MPE (Mechanical, Plumbing and Electrical) professional fees are almost always higher for small projects than they are on a per square foot basis for larger ones.
Larger projects often have details or systems that are repeatable.
More often, though the smaller projects may be conceptually easier to design, the professionals have fixed costs and dedicated resources that they have to bill for, and, again, these costs are spread over a smaller usable area, thus increasing the cost on a smaller development.
New owners also often work through “design-build” contractors who hire the least expensive architect they can find to do the job.
Often, these are residential architects who have little or no commercial experience and an understanding of good commercial design.
Residential design and construction methodologies may actually reduce the overall life of the building as they were never intended to be used the way commercial buildings are.
Similarly, contractors typically do not have the development experience to help them avoid mistakes beyond what they do best – construction.
However, construction often only accounts for a fraction of the overall cost and energy expended on a project.
Land Planning and Parking
One of the biggest mistakes with an inexperienced contractor or architect is the land planning of the site and building.
Typically, the client approaches the contractor or architect and tell them what they want, which in most cases never takes into to account the long term sustainability of the investment.
For example, many times these types of project are designed with limited parking and both the architect and contractor will say that “the parking meets code”. Indeed, that may be the case, but that may not be what you need.
Development Rule #1
Never build a project based on only your current need or the City’s minimum parking requirements!
All commercial developments should have a minimum of 4 parking spaces for every 1,000 sq. ft. built. Medical office uses should achieve closer to a 5 to 1 parking ratio.
Clinics may even need a larger parking ratio. Which brings us to the next rule:
In order to achieve these ratios, you can generally only build a building on any given parcel of land a maximum of 10,000 sq. ft. per acre, or a 25% coverage factor of the site.
Therefore, on a one-acre parcel of approximately 43,560 sq. ft., a 25% coverage factor equates to a maximum building size of a little over 10,000 sq. ft.
This Rule holds true regardless if the building is either one or two stories. This doesn’t account for how odd-shaped lots, unusual setbacks, difficult entrance locations or traffic patterns reduce the parking area available on the site.
Usable Vs. Rentable Square footage
The difference in the design of a one-story building and a two-story building generally has to do with the need to construct a common area elevator and interior staircase “core” in any multi-story building.
Secondly, a secondary staircase, by code, is also required. This staircase can sometimes be designed on the outside of the building.
Most quality buildings have the second staircase inside the building. The design and need for the interior “core” of a building’s design can also create more interior hallways space.
The bigger the floor plate of each floor the longer the hallways and the possible need for a third exiting staircase system.
A building with a “core” that is greater than 15% to 18% of the total gross building size, including elevator, hallways, mechanical rooms, and staircases generally does not make much economic sense.
Example: Renting a 1,000 sq. ft. of “usable space” you would have to pay rent on approximately 1, 150 to 1,180 sq. ft. of Rentable space.
Remember in order to finance the “core” you have to charge, on a prorate bases, the same rent and operating expenses as any of the “useable” rented space.
Building Operating Expenses
Multi-story buildings cost more to operate, and construct, than a single story building. Buildings operating cost can vary base on design.
Purchasing Your Land
Generally speaking, any given building design built on any given land parcel should probably cost about the same.
In my 35 years, I have learned that the “secret of the deal” is what are your land costs?
Most real estate professionals do not understand development. They will show you and quote all sorts of cost per sq. ft. scenarios and truly miss the mark about what the total land cost is.
All land parcels come with certain unpredictable utility costs. This can be true of both on and offsite construction cost.
Two parcels side by side can vary substantially in bringing the proper utilities and capacity to a site.
Comparing a land purchase based simply on the purchase price is one of the biggest mistakes future building Owners make.
Location and capacity of power, water, sewer, gas, and the offsite roadway costs may severely impact the “great land deal” that was made in the purchase of the property.
Land Purchase Evaluation
Most purchases of land are based on what a buyer views were good value for the property. Often a real estate professional will assist them in that decision.
One of the most important questions, and therefore:
In buying a parcel of land one must ask is “what is the cost of the land I am buying in relation to the size of the building I am planning on building?”
For example, An owner purchases an acre parcel for $500,000 and is planning on building their 5,000 sq. ft. office on the parcel.
What just occurred with the economics of this transaction?
The Owner of the land just paid $100 per sq. ft. for land for each sq. ft. of the 5,000 sq. ft. of the building he plans on building.
Conversely, if the Owner was to build an 8,000 sq. ft. building on the same parcel his cost of land for every square foot of the 8,000 sq. ft. the building would now be $62.50 per sq. ft.
Keep in mind that the size of the building built on the parcel may have to do with pre-leasing requirements, all the design and parking limitations outlined in Rules # 1 and 2.
With this price per square foot of land to building cost information on can better conclude and estimate the general hard constructions, on- and off-site roadway and utility costs and soft costs.
Building Construction Rules of Thumb
A typical one-story building shell with, with a sustainable architectural design, glass, stucco and stone elements should cost in the $60 to $80 per sq. ft.
A two-level or multi-story building would cost more. Structural load levels in a multi-level building can vary and the cost of construction can also vary.
Caution should be made at comparing building shell costs with finished building shells for sale.
Often, building shells for sale do not include the interior floor being poured, the heating and air-conditioning units on the roof, interior electrical panels, plumbing design, or insulation.
Soft Cost construction expenses are some of the most misunderstood, mismanaged and underestimated expenses in the development and construction process.
Most Soft Cost expenses are not part of a General Contractors contract to construct the building.
The following is a list of major Soft Cost line item expenses:
- Civil Engineering
- Soil Testing/Compaction
- Building Construction Quality Assurance
- Surveying and Staking
- Traffic Study
- Interest during Construction
- Finance Fees
- Loan Document preparation
- Lease Commission
- Marketing and Advertising
- Space Planning
- Environmental Evaluation and Remediation
- Building Plan Check
- Building Permits and Fees
Many of these costs are fixed costs and it doesn’t matter, to some degree, to the size of the building or project.
Remember in the “Scale of Economy” section, a big project can absorb the Soft Cost expenses better than a smaller project.
Similarly, one of the most significant costs, the outline above, that can turn a project upside down are “contingencies.”
These contingencies can come in various ways and times. Mistakes by the designers, contractors or even the city can delay the project or take unscheduled time and money to fix.
Most often, these contingency costs come in the form of unforeseen issues in the site work – items such as buried rubble or rock, or blue clay or other unsuitable material that has to be removed and replaced with good material from somewhere else.
While these rarely affect the entire site, they are almost always expensive to address. Again, Economies of Scale help to spread these additional costs – or concentrate them in a small rentable area.
Smaller projects cannot survive sizeable cost overruns as well!
It has been my experience that if these development practices are followed, the outcome of the project and building will provide the Owner with not only a building that provides him and his company with the pride of ownership, but creates lasting value.
A small “one-off building” does, however, have the economic problem of not being able to control any of the surrounding areas that it has been built in.
The neighborhood may be well established, but the lack of any master-planned covenants and restriction could have a severe economic effect on the long term value of the asset.
Whereas a building in a larger planned commercial mixed-use business park will ultimately have more long term investment value.
None of the above reflects the cost associated with completing Tenant Improvement. Those costs vary widely based on layout use, design, and quality of finishes.
One of the important factors to consider that is difficult to measure is “Risk”.
All real estate development and construction projects have risk associated with them. Interest rates can change. A lender can go out of business before the project is finished.
Cost of construction can change. Professionals who design and plan the project can make mistakes.
City building department can add a requirement in the construction and the design of the project that cost more money. Contractors cannot pay their bills resulting in liens on the property and the list goes one.
The “Contingencies” line item sometimes helps will the necessary funds to weather those storms, but the “risk” is that the contingency funds may not.
At some point in the “risk” analysis process, it is less risky to purchase a building than build.
The range of the costs of a one-story professional, completed office building shell should be:
- Hard Costs $60 $80
- On-off Site $25 $35
- Soft Costs $25 $40
- Land $50 $100
Total: $160 $255
The decision to build or purchase space is fraught with uncertainty and risk. Like all investments, education and experience is key to success.
Much of my real estate career has been spent in dealing with the issues of successful office development and brokerage.
I have worked with many professional clients in the medical, legal, retail and general business disciplines and have learned these Rules – and live by them.
In general, I try to learn from their experience so that I can avoid making the same mistakes.
Similarly, I offer to you a glimpse into my own experience to help you make your decision.
These Rules are universal, and navigating the uncertain waters of development needs an experienced developer that understands them.
If you have any questions or would like to discuss your individual building needs, please do not hesitate to contact me.