Giving Tenants a Piece of the Action

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To help fill their buildings, developers offer ownership to those who move inWEST PATERSON – In the face of a slow leasing market, some local developers have started offering equity in their buildings as a deal sweetener for potential lessees.

Leasing activity in the New Jersey office market has been decelerating since the third quarter of 2005, making it more of a challenge to secure tenants, according to Stephen Jenco, client-services manager of Grubb & Ellis in Fairfield. That quarter saw nearly 1.6 million square feet of posi-tive net absorption of space. By contrast, the third quarter of 2006 showed a 127,000-square foot increase in vacancies, says Jenco.

He attributes the slow pace of leasing to factors such as company consolidations and the loss of high-paying jobs in the state. Net absorption refers to the change in overall vacancies from quarter to quarter, when both new leases and newly unoccupied square footage are taken into account. Negative net absorption refers to an overall increase in unleased space.

To help attract tenants, some developers have been trying out equity incentives as leasing incentives. Sheldon Gross Realty, for example, is offering an equity option for the first time with the Wall Professional Building, a 24,000-square-foot medical and office property that is currently under construction in Monmouth County and slated for occupancy in spring 2007.

At Wall Professional, tenants have the opportunity to own a piece of the property based largely on the size of the space they take, says Sheldon A. Gross, CEO of Sheldon Gross Realty in West Orange.

Because the mortgage loan is in the name of a separate entity, tenants who choose to invest in Wall Professional will not be held personally liable for the mortgage. In addition, tenants that leave the building can continue to own their interest in the property.

The arrangement is based on an equity model developed by Linden-based M. Gordon Construction. Gordon, which has partnered with Sheldon Gross Realty on projects for six years, has built 30 or 40 medical buildings with equity options around the state for the past decade, says Gross.

Under the Gordon model, occupants that choose to purchase equity in the building sign two agreements, a standard lease and an ownership agreement, according to Colliers Houston broker Tom March, who has worked with Gordon on several deals. Aside from rent, co-owners also pay for operating costs and debt service on the mortgage loan. In return, they receive a share of the building’s rental income and can depreciate the property for tax purposes. The developer maintains at least a 50 percent interest in the building and represents all of the co-owners in mortgage, financial and other matters.

“It’s a rather new model,” says March, who is based in Princeton. “They’re using that tool to accelerate leasing.”

Other developers are considering equity options for their buildings. Suzanne Macnow, vice president of brokerage services at CB Richard Ellis in East Brunswick, says she is in the early stages of a deal based on the Gordon model. In the proposed transaction, CBRE is representing a tenant seeking an equity position in a new building going up in Mercer County. The owner had not originally offered equity participation but is now in talks with CBRE on the percentage of equity he is willing to give up.

“We requested the option, given it’s a medical building and doctors are trending toward ownership,” says Macnow. “In markets where buildings are not available, this deal structure is a viable alternative.”

Meanwhile, the Passaic Valley Medical & Professional Center, a 187,000-square-foot medical and professional office facility in West Paterson, is offering another type of partial-ownership arrangement. The developer, a West Paterson-based group of private investors known as 1225 McBride Avenue LLC, is in the process of converting the former Kearfott Guidance & Navigation research facility into condominiums for a variety of medical users.

The office center was originally marketed to the medical community on a lease basis, says Stephen D’Amato, a CB Richard Ellis real estate consultant who is the broker for the property. But doctors and other professionals were more interested in owning office space.

The project, due for completion next spring, calls for 40 to 50 units of various sizes to be offered at $250 a square foot. While 1225 McBride Avenue LLC owns the entire building, it is poised to give up all of its equity as more users sign on as occupants, according to D’Amato. After a certain percentage of units have been sold, the users will take over the building as a condo association and will make all decisions regarding the property.

“The leasing market right now has slowed up,” Gross says. “But because of this equity interest, the people who are out there are very interested. We must be coming up with a new potential tenant two or three times a week now.” Tenants are already lined up for roughly half of Wall Professional, says Gross, who expects the facility to be fully leased by the time it is finished.

“We’ve had a very promising response from the people in the medical and professional community,” says D’Amato, who projects that the entire first floor of Passaic Valley Medical, an area of roughly 40,000 square feet, will be under contract within the next 60 days.

Equity participation benefits both the developer and the tenant, according to Gross. From a developer’s point of view, “It makes it easier to rent the space,” he says. “It also requires us to put less cash in, because other people are putting cash in. It gives everyone a better return, because by not having to borrow that much money, we can borrow for a smaller rate.”

As for tenants, “The person has more pride being in a building that they’re part owner. They take care of it better because they have an interest in it.”

D’Amato points out that partial ownership is only appropriate for “a select group of tenants … people who have a firmer grasp on their 10-year business plan and the way they’re going to grow.” Suitable tenants include doctors, lawyers and architects who have an established clientele. “If it’s going to be a company that can grow exponentially, then it wouldn’t work for them,” he says.

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