When you buy a piece of land with the intent to build on it, it is tempting to maximize every last bit of what the local planning and zoning department will allow you to do.
If you have a piece of ground that can house a 400,000 square foot building, it is tempting to build right up to that limit. But what if the largest building in the city is only 100,000 square feet? Would that give you pause? It should. Here are a few reasons why you should build real estate that is in keeping with the local market.
1. Market Depth in Sales. This reason is more obvious when it is presented using residential real estate as an example. Imagine you are looking for a 2,500 square foot single family home in a nice suburb. You agent shows you a neighborhood with several homes for sale that fit the bill. Because 2,500 square feet is a fairly common size, there are probably a few hundred of them on the market at any given time. Now, imagine that you are in the market for a 10,000 square foot home. How many of those are on the market? How many buyers are in the market looking for those kinds of homes? The point is that the depth of the market helps you in real estate. Real estate is a very illiquid asset. You have trouble getting your money out when you need it. One of the ways to help mitigate the liquidity risks involved in real estate is to build and own projects that are very similar to what is being built in the surrounding environment. There are many buyers who consider 100,000 square foot buildings in suburban office parks. But if you have a 500,000 square foot high rise that is 20 miles outside a major metropolitan area, you may have trouble moving it.
2. Market Depth in Construction. To illustrate this point, we will once again turn to residential homes for an example. Think about how many home builders are capable of building that 2,500 square foot home in an economical and timely fashion. Probably hundreds, if not thousands, or builders are capable of it. But how many of them can be trusted to build a 12,000 square foot mansion with state of the art systems and a complicated structure? Probably a lot fewer. The risk inherent in building something so different will cause your contractors to protect themselves by adding greater margins to their bids. The same is true in commercial construction. If you are building something very unique that is not done very often, contractors will not want to take huge risks in bidding on it. The result? High bids. Unless the market is very tight and contractors are really starving for work, your pricing will be on the high end of the scale.
3. Taxes. The simplest way to value something, whether it's for taxation or other purposes, is by looking at comparable structures and their history. If you build a building so unique and out of place that it has absolutely no comparables, how will a taxing authority view it? As an income producing property it can still be valued off the cash flows, but ultimately you are taking a big risk in terms of the taxation you may face.
4. Market Depth in Leasing. Another reason to build in keeping with the local market is the Tenant base in that market. You want to be able to compete with the surrounding buildings for tenants. One of the best ways to do that is to build what the Tenant's want. If most financial services and legal services tenants want small floor plates, and you are building downtown where most financial and legal firms are, you really want to look at having small floor plates. If you are building in a technology center where tenants love enormous floor plates, you should also plan accordingly. Doing this will allow you to compete for the existing Tenants in the market when their leases are up for renewal.