Should you Acquire a Special Purpose Building?

Image Attribution: www.istockphoto.com

Commercial real estate assignments ebb and flow between buyer opportunities and seller representations. Occasionally, we’re asked to market a special purpose building or find ourselves considering one for our clients to purchase. These unicorns can portend great risk and must be evaluated carefully. But before I launch in to how I caution buyers against said beasts - allow me a bit of explanation.
 
A general purpose industrial building has broad appeal to the universe of buyers. Most structures fall into this category. Such things as power, warehouse clearance, loading doors, and single story office space will be found on a typical buyer’s wish list. If an address curries favor with a narrow slice of occupants - we call these special purpose buildings.
 
We witnessed a spate of these constructed in the mid eighties as our industrial market adapted to the surge of microelectronic manufacturing. Needed was a hybrid between a high rise office and a down and dirty place where stuff was made. Enter Research and Development or R&D locations. Sporting more parking and a higher percentage of office space where engineers could work bolted onto areas used for manufacturing - this product type was dramatically overbuilt. Unfortunately, as supply was increasing - demand was falling as more of this genre’s output was shipped overseas. Thus we found ourselves with a whole class of industrial construction with limited flexibility - special purpose. Many lay fallow for years. Those that secured residents prayed for their longevity lest they’d be stuck with a costly void.
 
Another one we see is a facility improved with food grade infrastructure as they are rarely morphed into anything else. Sure, the next guy might be able to use some cold or frozen space - but generally the floor drains, washable walls and the like end up in the scrap heap.
 
Buying a parcel with special purpose improvements becomes challenging for myriad reasons. Chances are the occupant uses the intricacies and so long as he’s in residence - you’re golden. If he bolts, you’re scrambling to replace his tenancy. You see, a substantial investment went in to the goodies - now you must pay to remove them. This assumes of course that what underpins is marketable. Frequently, it’s cheaper to scrape the whole thing and start new. We saw this on the countless aerospace campuses occupied by the lines of Boeing, McDonnel Douglas and Beckman. Built specifically for the use they housed - no one foresaw a time when a retool would be necessary. Why would they?
 
Rarely are sellers prepared to hear the downside and how this impacts the price a buyer may be willing to pay. In the case of the aforementioned campuses - owners had to realize the buildings had no value and all would be based upon the land underneath. A bitter pill indeed!
 
Now for the good news. If you’re fortunate to find one of these with a mammoth credit tenant and a long term lease - great upside is to be found. The bad news is if there’s a vacancy. However, because the location is so unique - there are no places to move. We refer to this as a “sticky” tenancy. The improvements cause the occupant to “stick” in place and not relocate.
 
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.blogspot.com.