Should investors buy special purpose buildings? – Orange County Register

Commercial real estate assignments move back and forth between buying opportunities and seller representations. Occasionally, we are asked to market a special purpose building or we find ourselves considering the purchase of a building for our clients.

These unicorns can portend great risk and should be assessed carefully. But before I get into how I warn shoppers about these beasts, allow me a little explanation.

An industrial building for general use is widely appealing to the world of buyers. Most structures fall into this category.

Electricity, warehouse clearance, cargo doors, and single-story offices are on the typical buyer’s wish list. If an address appeals to a narrow slice of occupiers, we call those buildings special purpose.

We witnessed this in the mid-1980s as our industrial market adapted to the boom in microelectronics manufacturing. Clients needed a hybrid between a high-rise office and a shabby, dirty place where things were made. Enter research and development or R&D sites.

Sporting more parking and a higher percentage of office space where engineers could work bolted to areas used for manufacturing. This type of product has been significantly overbuilt. Unfortunately, as the supply increased, the demand decreased as more of the production of this genre was shipped overseas.

So, we ended up with a whole class of industrial construction with limited flexibility – special purpose. Many have lain fallow for years. Those who secured the residents prayed for their longevity lest they be stuck with an expensive void.

Another we see is an upgraded facility with food grade infrastructure as they are rarely processed into anything else. Sure, the next guy might be able to use a cold or frozen space, but usually floor drains, washable walls and the like end up in the scrap heap.

Buying a plot with special upgrades becomes a challenge for a myriad of reasons.

Chances are the occupant will use the niceties and as long as they are in residence, the owner is golden. If he runs away, they scramble to replace his lease. You see, a substantial investment has been invested in the goodies and now the owner has to pay to remove them.

This assumes, of course, that what underlies it is marketable. Often it is cheaper to scrap everything and start fresh. We have seen it on the countless aerospace campuses occupied by Boeing, McDonnell Douglas and Beckman Coulter. Built specifically for the purpose they housed, no one foresaw a time when retooling would be required. Why would they?

Sellers are rarely willing to hear the downsides and their impact on the price a buyer might be willing to pay. In the case of the aforementioned campuses, the owners had to realize that the buildings had no value and that everything would be based on the land below. A bitter pill indeed!

Now for the good news.

If you’re lucky enough to find one with gigantic tenant credit and a long-term lease, there’s a big upside to be found. The bad news is a vacancy. However, because the location is so unique, there is no where to go. We call this a “sticky” rental. The upgrades cause the occupant to “stay” in place and not move.

Allen C. Buchanan, SIOR, is a principal at Lee & Associates Commercial Real Estate Services in Orange. He can be reached at [email protected] or 714.564.7104.