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Tanner Montague came to town from Seattle having never owned his own music venue before. He’s a musician himself, so he has a pretty good sense of good music, but he also wandered into a crowded music scene filled with concert venues large and small.But the owner of Green Room thinks he found a void in the market. It’s lacking, he says, in places serving between 200 and 500 people, a sweet spot he thinks could be a draw for both some national acts not quite big enough yet for arena gigs and local acts looking for a launching pad.“I felt that size would do well in the city to offer more options,” he says. “My goal was to A, bring another option for national acts but then, B, have a great spot for local bands to start.”Right or wrong, something seems to be working, he says. He’s got a full calendar of concerts booked out several months. How did he, as a newcomer to the market in an industry filled with competition, get the attention of the local concertgoer?

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by Andrew Tellijohn
February 2004

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Time to buy?


Time to buy?

Some small companies are buying their space,
but risks are real

by Jim Martyka  

Sometimes, as a small-business owner, you just have to take advantage of the right circumstances, good timing and that gut feeling that tells you that you're doing the best thing. In these days of low real estate prices, that can apply to buying rather than leasing your office space.

"We were facing the end of a lease for our office space in Bloomington and we were in a situation where we were looking for something better," says Brian Dvorak, CFO for Minneapolis-based Metro Distribution, a newspaper and magazine delivery company that shares the same management team (and headquarters) as Digital Axis, a printing firm.

"We were actually looking for another lease. We weren't looking to buy our office space because we didn't think we would have the money for that type of move. But we soon realized that it could work out. We got a great deal and we decided to take a chance."

Metro Distribution is not alone. According to real estate and small-business experts, more and more small-business owners are at least exploring the option of buying office space for their business rather than leasing, a move that a decade ago would have been almost unheard of because of cost and the risks involved.

Now, however, stories of successful buys for small and mid-sized firms are popping up all over the Twin Cities in several different industries. Industry experts are torn on whether buying office space is a smart move. Those who support it say small businesses can get better deals because of lower interest rates while picking up a major investment and having the comfort of essentially renovating the space to fulfill company needs.

Those who warn against it say buying office space means locking a firm into that space and taking on a large financial risk that could be used more on building the business. Plus, they say, purchasing rates aren't that low.

But officials do agree on one thing. Interest is growing as more small businesses explore their options. "I don't think it's at the point where every small-business owner is going out and looking to buy rather than lease, but there is a lot of whispering going on around both cities and even the suburbs," says Rob Kost, a senior associate with Bloomington-based United Properties. "It's an interesting time in the office market and we could see more competition between landlords if buying becomes a more accepted practice."

The trend is happening within several industries, though there are some common traits in these businesses looking to buy. Buyers are typically smaller operations that are expecting zero to limited growth, such as independent law firms, insurance agents, dental offices and accountants to name a few, as well as smaller niche retailers.

The trend is popping up more in the suburbs than anywhere else. Real estate officials mentioned Inver Grove Heights, Oakdale, Maple Grove and Little Canada as prime examples. These are businesses that don't need much of a downtown presence, which works out well since there isn't much office space for sale in either of the two metropolitan centers.

"Most downtown office space is still a leasing situation and that probably won't change," says Dick Zehring, a principal at St. Paul-based MSP Commercial. "A small business might have to look a bit harder downtown and hope the right opportunity pops up."

Such was the case with Metro Distribution. While not downtown, the company can still claim its headquarters, which it now owns, in Minneapolis. The company, which boasts about $3 million to $4 million annually in sales, moved into its 54,000-square-foot building last February, taking 28,000 square feet and leasing out the rest.

For Metro, the strategy has worked out well. Dvorak says the firm was able to talk the sellers from $1.8 million to a $1.45 million sale price. Plus, the firm will receive tax breaks from the deal. Also, since the firm owned the space, executives were able to retrofit it to their needs, which meant making room for distribution facilities. Best of all, Dvorak says, the leasing of the extra space more than covers their costs.

"To be honest, it just worked out perfectly," Dvorak says. "I know it's not always that easy. But we did our homework and then we took a chance."

Price can attract
Real estate officials say the Metro deal is an ideal example of many of the benefits a small business could (with an emphasis on could) receive from buying.

"It does look attractive in a lot of ways, especially in price," Kost says. "That doesn't mean it's going to work out for everybody who tries it, but there could be some advantages."

The first is price. Most real estate officials agree that over the past few years, the cost of buying office space has dropped, though not as much as leasing. Interest rates have dropped significantly and landlords and sellers alike have felt the need to become more competitive in trying to land tenants and buyers, especially as vacancy rates continued to increase.

According to the most recent market report from United Properties, those vacancy rates and the price drops in office space appear close to bottoming out. But for now, tenants who want to lease can still get good office space for a few dollars a foot and those looking to buy can get good deals on buildings in the $2 million to $3 million range.

Cost is the main reason that Trudi Gorton decided to buy her space in Blaine rather than lease.

"It sounds pretty simple, but I just found a place that fit my needs and didn't charge as much per square foot," says the owner of Pretty In Ink, a retailer of rubber stamps. "Sometimes for a small business, it just comes down to cost."

Especially if that cost is fixed. Small businesses buy office space because it allows them to lock in a long-term commercial mortgage, giving them clear, fixed costs. Plus, small businesses tend to look at the move as more of an investment, providing an opportunity to build equity and diversify where they're putting their money.

"When it comes to investing, real estate hasn't taken the hit that the stock market or other types of investing have so it still has the reputation of a safe bet," Kost says. "Buying is an investment that many small businesses can feel good about, like there isn't as much risk."

Others look at it as a move to prepare for a possible exit strategy or retirement fund, assuming the property will appreciate over time and earn them money when they leave the business.

Also, in many cases, firms will buy a bigger building than they need and lease out the extra space, not only covering their personal costs, but sometimes even bringing in a profit, such as with Metro.

A final possible advantage is the tax deductions that owning and running an office space can provide in the form of mortgage interest, property taxes and other items. Because real estate is a depreciating asset, working with the right accountant can bring big tax breaks and money in pocket.

Risks are real
But, along with all of these advantages comes a fair amount of risk — so much so that many real estate and small-business officials warn against buying office space.

"I know it looks appealing, but to be honest it's really not a very good idea for a small-business owner," says Jim Vos, principal at Minneapolis-based CRESA Partners. "The main reason is that the prices aren't as low or appealing as people think. Also, there's really not that many perfect small office buildings that are going to provide everything a small business needs at a reasonable cost. They just don't really exist."

And the move means locking up a good chunk of capital in a fixed asset that may or may not appreciate over time. Vos says appreciation depends quite heavily on the maintenance of the building and the health of the market. Plus, there are a ton of upfront costs that need to go into buying a space, including property, appraisal and maintenance costs.

"For a small business, there are so many other places that this money could go," says Mike Ryan, director of the Small Business Development Center at the University of St. Thomas. "I'm not saying not to do it, but really assess whether you have the money to do it and if it's a deal that's worth the money."

Another risk is the lack of flexibility. Once a small business buys a space, it’s fairly committed to it. If a business suddenly experiences growth, selling that space can prove a lot more challenging than ending a lease. That's why most office space buyers are smaller firms that show little signs of growth. But be warned: Sometimes unexpected growth can occur.

"Well, we basically got stuck," says an attorney for a St. Paul-based law firm who asked that he and his company remain anonymous. "We bought a space a year ago not anticipating any type of growth and then, of course, there were two or three opportunities where we could have expanded the business. But we didn't because we simply didn't have the room. We've partnered with the other attorneys, but we could probably be bringing in more business had they been able to join."

Officials also argue the fact that buying is a good investment.

"You're really not diversifying your investments. Actually, you're doing just the opposite," Vos says. "You're compounding real estate risk with your business risk and that can be dangerous. Invest in the company and help that grow instead."

Whether in favor or against buying office space, all sources agree that small-business owners should seek the help of professionals if exploring this option. That means working with a broker as well as an accountant or a financial expert to help track down the best deals.

And there are some financial strategies out there, says John Thwing, vice president for the Minneapolis office of Wells Fargo SBA Lending. Beyond the conventional bank loans, there are SBA loans that may cost a bit more on the front end, but won't balloon over time like conventional loans.

"There's always going to be a debate as to whether buying office space is a good idea or not," Thwing says. "The best thing to do is educate yourself about the possibility and the options out there. Then, decide if you think it's worth the risk."