Buying a commercial condo can be a great move for a business, from the tax advantages, cost savings and predictability in expenses, it makes sense in many situations. Here are ten pitfalls to avoid when buying an office condominium space.
1. Not Understanding That 1 Square Foot Does NOT Always Equal 1 Square Foot
There are a host of square foot measurement techniques that are vastly different, the most common being rentable square feet, usable square feet and gross square feet. A company may be renting 1,500 square feet in an office building, enter into a contract to purchase a 2,000 square foot condominium unit, and end up with less usable square feet than when it was leasing only the 1,500 square feet. The square footage of many office condominiums already includes a “core factor” which is the pro rata share of the main lobby, elevator shafts, janitor’s closet, and other similar space. Some condominium buildings have a core factor more than 20% meaning that a 2,000 square foot office condominium unit may only result in 1,600 usable square feet.
2. Not Designing the New Space Prior to Purchase
Similar to not understanding the different measurement systems used, many buyers fail to have a space planner lay out their office or do a test-fit. In a buyer’s market, many sellers will allow a buyer to have the seller’s space planner design space on behalf of the buyer at the cost and expense of the seller, or will provide a $1,000 or $1,500 allowance for ensuring that the space will be sufficient for the buyer’s needs. Failing to properly design the space may cause a buyer to end up with a condominium unit that does not meet its company’s business needs.
3. Not Anticipating Future Growth
When a company leases space it is much easier to grow. In a large office building, the landlord can move tenants to alternative space, including different floors. If an individual purchased a house and needed more space for the family, additions could be added to the main house structure - this is rarely possible in an office condominium setting. My advice for growing businesses is to either consider purchasing a smaller additional condominium unit adjacent to the one that is being purchased or request a right of first refusal to purchase the adjacent unit at a later time from the developer. If a company is looking to purchase a 4,000 square foot condominium unit, then there may be an extra 1,000 square feet available adjacent to the 4,000 square foot unit. The 1,000 square foot unit could be leased until the extra space is needed. When designing the 4,000 square foot unit, plans for future growth should be included, along with a plan that would show how to incorporate the 1,000 square foot unit into the 4,000 square foot unit to make it all work together.
4. Not Understanding the Expenses
When leasing office space, there is typically a base or minimum rent which is based on a price per square foot, along with the responsibility for payment of a percentage of the operating expenses of the building which frequently include insurance, taxes, electricity, and maintenance costs. However, when leasing office space, the office lease may exclude certain items from being included in those operating expenses, such as capital items like replacing the roof of the building, replacing HVAC equipment, and structural repairs related to the building. Within an office condominium regime, the budget includes all of these items, both for repair and maintenance as well as capital expenditures. In addition, sufficient funds should be set aside on a monthly basis to ensure that there will be money available in 10 years when capital repairs, maintenance or replacements need to be done, such as repaving and restriping the parking lot and replacing the light poles in the parking lot.
In addition, the initial budget prepared by the developer is an estimate only. A prospective buyer should have a qualified third-party review this budget carefully to determine if it includes all applicable categories such as pest removal, maintenance of interior HVAC units which serve the common space, electricity expenses for common areas of the building, maintenance of exterior stairs and railings, repair and maintenance of exterior storm water management systems, etc. Furthermore, a prospective buyer should ask to see the capital repair and replacement schedule and estimate which would provide information on how much time is needed before the roof needs to be replaced, along with a budget for doing so. A prospective buyer should then review the budget to determine if sufficient funds have been set aside or are being set aside to pay for the replacement of said capital item. Some office condominium regimes do not set aside sufficient funds for capital items and this may cause the association to have a one-time special assessment in order to pay for the $150,000 roof replacement.
5. Not Understanding Restrictions or Not Anticipating the Lack Thereof
The condominium regime is governed by a declaration and by-laws. In addition, there are frequently additional restrictions in the granting deed or other title documents such as a master declaration. To the extent that the condominium building is located within an office park, there may be other restrictions imposed upon owners and their future use contained within the master declaration. During the due diligence period, the title company should provide a title commitment that lists all documents to which the condominium unit will be subject, as well as providing a complete copy of these documents. A prospective buyer should have a qualified professional carefully review these documents after gaining a thorough understanding of the nature of the company’s business. Frequently these documents may have use restrictions which may conflict with a company’s business. For example, in an office condominium, these documents may prohibit the sale of certain items and this may impact an optometrist’s ability to sell eyeglasses to his/her patients.
In addition, a prospective buyer should carefully review the restrictions as it relates to understanding that neighbors could adversely impact business operations. While the main purpose of the condominium regime may be for office use, it is possible, unless otherwise expressly restricted in the underlying documents, for a restaurant or bar to open in the building or for an abortion clinic, veterinarian or methadone treatment clinic to be operated in the condominium regime. If a prospective buyer is purchasing space in the building to run a sleep clinic, it may not want a restaurant or bar in the building.
6. Not Understanding the Finish Condition
With regard to existing condominium units that are being purchased from an existing user, the finish condition is very easy to understand as it is the existing condition of the space unless otherwise provided for in the contract of sale. However, many times the condominium unit is being purchased from the developer of the building in a raw condition or put under contract prior to the completion of the building. With regard to when the condominium unit is being purchased in a raw condition or prior to the completion of the building, then it is necessary to understand the following:
To the extent the purchaser is buying the condominium unit from the developer, then the developer frequently provides the purchaser with a tenant improvement allowance in order to fund the expense of the build-out.
7. Not Reviewing any Restrictions or Limitations with regard to the Parking
Not only is it important to review the current parking ratio for the building, but also assess whether there will be enough parking in five years and what type of parking space users may be in the building. The current parking ratio is determined simply by reviewing the total number of parking spaces not including any handicapped spaces and dividing this by the gross square footage of the building. While the marketing or sale flyers for the building will typically state the parking ratio as X spaces per thousand square feet, it is important to fully review the underlying documents to verify that the parking ratio is correct.
It is also important to understand whether there will be reserved parking spaces established by the developer or whether the condominium association has the right to establish a reserved parking regime at a later time.
To the extent that there are no restrictions on uses in the building, then it is possible that some heavy parking users (i.e. a telephone calling center, a large medical office or a sit-down restaurant) may purchase space in the building and there may not be sufficient parking spaces for all owners in the building.
8. Not Asking Questions about Signage
Be sure to ask questions and understand what signage is allowed and what signage will be prohibited. The condominium by-laws frequently have many restrictions on the size and type of signage that is allowed. Will there be any exterior building signage allowed? Will the developer be providing a marquee sign outside the building which will list the name of each company in the building? Or will the developer provide interior building signage on a central directory or through an electronic building display? Also, be sure to determine if there are any restrictions on a realtor’s ability to place for-sale signs at the property at the time of re-sale.
9. Not Reviewing the Zoning, Site Plan & Condo Plat
It is extremely important to review the permissible uses of the property according to the current zoning regulations. If the purchaser plans on fabricating and manufacturing computer cables at the condominium, does the underlying zoning allow the purchaser to do so?
Also, of equal importance is to review the site plan and the condominium plat. The site plan may have further limitations or restrictions as it relates to limiting the amount of retail use or the number of parking spaces that may be used by any one condominium unit. Furthermore, the condominium plat may designate reserved parking spaces and will frequently designate the perimetrical boundaries of the condominium unit. It is important to understand if the vertical boundaries of the condominium unit are the interior face of the demising walls, the mid-point of the demising walls, the exterior face of the exterior walls or some other boundary. Equally important is to understand where the bottom of the condominium unit begins and where the top of the condominium unit ends. These perimetrical boundaries not only impact how utilities are run, but also impact the condominium budget and tie into what needs to be insured under the condominium master insurance policy.
10. Failing to Hire the Right Professionals
All of these mistakes can be prevented by working with an attorney who really understands the legal issues that small businesses face when purchasing an office condominium. Although some business owners believe that they don’t need a real estate attorney because they already have a commercial real estate broker involved, this approach may often end up costing the business owner more because most real estate brokers are not trained as an attorney, to spot the issues and problems. Taking the time to find a lawyer who meets your needs is one of the best investments you will ever make in the growth of your business.
At the Law Offices of Kirk Halpin & Associates, P.A., our experienced lawyers are committed to providing each client with the personalized attention and counsel that is necessary to help a business owner purchase a condominium unit. In addition, our skilled attorneys are leaders in the Maryland legal community, and they stand ready to assist you with your real estate, construction, zoning and a myriad of other legal needs.