Buying an office condominium versus leasing is gaining popularity.

It's pretty common knowledge by now that rock-bottom interest rates during the past several years have fueled a hot residential real estate market and kept mortgage refinancers hopping. These persistently low rates have left their mark on the commercial real estate sector. In the Twin Cities, they have encouraged the rapid development of a relatively new commercial real estate product, the office condominium.

Office condominiums have cropped up around the metro area over the. years, but have soared in popularity since the late 1990s. At first, low interest rates and a previously tight leasing market spurred business owners' demand for the buildings. More recently, the economic downturn caused a
slumping commercial real estate market and freed up developers to look for new opportunities. They discovered small firms' desire for office spaces they could own. Developers and entrepreneurs have created a gold star in an otherwise gloomy commercial real estate market.

In the past few years, developers have added about 1 million square feet of office condo space in the Twin Cities the size of a large downtown office tower. (The IDS Center in Minneapolis has 1.2 million square feet of office space.) Condos have primarily cropped up from Lakeville and Woodbury to Eden Prairie and Plymouth. Their success has driven developers to convert existing downtown buildings into office condominiums. Bloomington-based United Properties recently announced that it will turn two buildings in the Minneapolis Warehouse District into condos, and Commonwealth Properties of St. Paul will convert four buildings into office condos in St. Paul.

Office condominiums appeal to small business owners in stable professions, such as lawyers, accountants, and dentists, who snap them up as they come on the market. They are attractive because they provide a vehicle for companies to invest in real estate on a small scale, build equity in a property instead of shelling out capital for a lease, and have more control over their space planning needs. With most of the new condos being built in the suburbs, the properties offer business owners the opportunity to work near home.

"[Condos] are best for smaller, established, and stable businesses. They are attractive much the same as buying a house is more attractive than renting. It's an opportunity to build equity," says Tina Hoye, principal at Nelson, Tietz and Hoye, a corporate real estate consulting firm in Minneapolis. "[Purchasing is attractive to] someone who has to make a

Until recently, smaller developers have found office condominiums to be appealing projects. But this year, Carlson Real Estate Company in Minnetonka jumped into the game. President Matt Van Slooten says the company had planned to use its land in Plymouth at Highway 55 and Vicksburg Lane for a standard office building, but decided that high vacancy rates across the metro area didn't provide the necessary demand for the space. With Plymouth developing rapidly, Carlson saw more demand for small office spaces from professionals such as lawyers, chiropractors, and accountants. Carlson's Town Center Office Plaza features 36 units starting at 1,560 square feet and costing $280,000, or roughly $180 a square foot. That 1,560 square feet will provide room for about five offices, a work space, and a reception area. Alternatively, a business could create a cubicle set-up that comfortably seats seven employees.

In general, office condominiums in the Twin Cities range in price from $160 to $200 a square foot. Van Slooten cautions business owners to make sure the prices they are quoted include interior im- provements such as walls, car- pet, doors, and sinks. Units sold as unfinished shells should cost $120 to $150 a square foot, he says. Demand has been steady for the Town Center project. As it neared completion last fall, Carlson had sold five units, had secured reservations on lots for four, and had 12 serious buyers consider- ing units. "We're finding the highest percentage of buyers have been finan- cia! planners. To me,.that reinforces that (condos are] a good investment,'; says Van Slooten.

Although office condominiums provide their owners with a range of benefits, they aren't for everyone. Business owners should consider several factors, such as future space needs and the potential resale value of an office condo, before plunking down a down payment on a condominium mortgage. Com- mercial real estate experts in the Twin Cities offer pros and cons of owning an office condominium and what to consider when searching for new office space.

"We're finding the hightest percentage of buyers have been financial planners, that reinforces that condos are a good investment."

Condo Benefits
For businesses, the main attractions of office con- dominiums are financial. That's why many of Mc- Carthy's clients ask him about trading leased of- fice space for an office condo. "Right now, be- cause interest rates are low, the occupancy costs for owning a condo and leasing favor owning office condos," he says. "In addi- tion, companies may benefit from principal reduction, tax write offs, and appreciation. " McCarthy gives the example of a medical practice, which might pay $25-$30 a square foot in rent, taxes, and utilities on a leased office. If the same practice purchased an office condo for $450,000, put 10 percent down, and borrowed the rest on a 25-year loan at 6.75 percent, the buyer would ultimately be paying $20 a square foot, he says.

Office condos may offer more perks to small firms.

Another perk of owning a condo is that businesses don't need to renegotiate leases every five to 10 years. In addition rent increases when leases expire are no longer a concern. "[Buying] is a way for business owners to invest in real es- tate and control costs. It eliminates some of the uncertainty," notes Jim Freytag, a vice president at CB Richard Ellis in Bloomington, a fullservice commercial real es- tate firm that serves as the broker on Carlson's Town Center project. "It's attractive for those businesses that have been in the same space paying rent for the past five to 15 years. They are sick of shelling out rent and not having anything to show for it."

Condo owners like not having to meet build-out requirements and can generally structure space any way they please.

Condo owners like not having to meet build-out requirements set by a landlord, and they can gener- ally structure space any way they please. "You can build them like your home, put in fireplaces, and control your own destiny. In an of. fice building you have to limit yourself to the landlord's rules," McCarthy says. "You can control heating and cooling and hire your own cleaning company. It's all up to you."

Condos also offer perks not usually afforded to small firms in mul. ti.unit office buildings. They have their own front door and, often but not always, an opportunity to increase visibility by putting [the - business] name on the outside of a building. Plus there is pride of ownership. Condo own- ers have a more vested interest in keeping the property maintained well. "It protects their investment and the im- age they portray to cus- tomers and clients," Freytag says . Many small businesses don 't have a lot of leverage with land. lords who have multiple large ten- ants. For them, office condomini. urns are a nice option. Being a business in a big building can often result in getting moved aside for larger tenants. As condominium owners, small businesses don't have to worry about being pushed around and have more say over their real estate destiny, notes Boye. "The main attraction has been low interest rates," Freytag says. "But, a lot of people would like to own real estate in some capacity , either for their business or personal portfolios. But if you don't have the right vehicle, it's hard to make small investments in commercial real estate. For a lot of people, office condos give them that opportunity ."

Office condos provide investment opportunities >> to smaller companies.

Something To Think About
Office condos sound good, right? Not so fast. Commercial real estate experts point out several dis- advantages for businesses to think about before purchasing office space. The main concern is the unpredictable future. Office condos have been on the market en masse for less than seven years, mostly as items to buy new. Those working in commercial real estate haven't been able to gauge their resale value yet. Right now, interest rates are quite low, which continues to fuel demand for office condominiums. If interest rates climb and there is a surplus of new condos on the market, sellers might have trouble recouping what they paid for the property. Lower prices caused by rising interest rates is something McCarthy has seen in other markets.

"[Buying office space] isn't as risk-free as buying a house because the commercial market is more cyclical," says Hoye. "So when the space no longer works, you can't count on receiving what you paid. Right now people are buying not selling. It will be interesting to see what happens five years down the road. "Sometimes a lease can be more flexible," she adds. "But then if you sign a 10-year lease, you're locked into a 10- year lease." Another point to ponder is when owners go to sell the property, those that have

customized their space or have specific uses for the office might have trouble finding a buyer with exactly the same needs. Those owners might have to lower the price to entice a business that would have to pay for a major renovation. On the other hand, it might not matter as much that they're not getting their full price back on a sale, notes McCarthy. Over the years, [the business owners] will have saved mon. ey on taxes as a result of appreciation or depreciation and built up equity in the unit. That equity could make up for the lower selling price. << Tina Hoye, Nelson, Tietz & Hoye

Other Considerations
Businesses that have fluctuating space needs might also have problems owning office condominiums. When businesses have leased space and need to shrink or expand their offices, they typically can negotiate with their landlords to take over another office or give back some space. But condo owners are locked into the square footage that they own. They might have trouble finding an interested party located in their building that wants to buy the condo next door or some of their space. "Some people say, 'I'll buy more space than I need and sublet it. Then I'll have it when I need it.' But you're all of the sudden in the real estate business and not concentrating on your core business," says Hoye.

Office condominiums are attractive for small businesses that have changing space needs.

That's why office condominiums wouldn't be appropriate for start- up companies, which generally are pretty uncertain about their longterm space needs. The same goes for businesses undertaking rapid expansion. It would be better to continue to lease office space. It's easier to negotiate with the land- lord to give up or add space.

Finally, businesses that want to buy condominiums need a down payment, just as a buyer would on a residence. Lenders can require anything from 10 percent to 20 percent down, meaning $30,000 to $100,000 that could have been spent on equipment, salaries and benefits, or other items. Some small businesses just don't have that kind of money on hand. They're used to having enough cash flow to cover the rent and other operating expenses, and that's about it. << Jim Freytag, CB Richard Ellis

Hoye raises another point to consider. Business owners, especially those that jointly own a company, need to think about how to structure a condo purchase. Should the company buy the property, or should the owners buy it as individuals and lease it back to the business? She brings this up because different scenarios create different tax consequences. "You need a strategy for going in and a ness, that might not necessarily change the ownership of the building," says Hoye. "Go with your eyes wide open and have strategies for how to make changes. You just don't want to not have talked about all of this."

Office condominiums are attractive for many small businesses that have changing space needs and want more control over their places of businesses. The financial rewards that come from having a stable mortgage payment and from building equity in real estate may outweigh the potential risks of being a business property owner. It's important to look at the entire financial picture and compare leasing versus the longterm costs of owning property before signing a mortgage. •

Suzy Frisch of Champlain is a freelance writer.