Class B Office: Capital Calls, a Anchor Renewal, and an Owner Distribution
You manage a 180,000 SF Class B office building constructed in 1986 for a private owner. Occupancy is 78%; NOI is $2.4 million; the $18 million loan matures in 18 months at 5.2%. The capital reserve holds $400,000; reserve policy targets $0.25/SF annually. An elevator modernization is quoted at $1.6 million, roof replacement at $700,000, and HVAC controls at $900,000. Two roof leaks have damaged tenant improvements, and elevator outages have averaged six hours monthly. The largest tenant, 45,000 SF, expires in nine months. In-place rent is $31/SF; market is $28/SF. Renewal would require $45/SF TI, six months free rent, and a 6% leasing commission; a new tenant would take 12 months to lease. The owner wants a $500,000 distribution this year.
1. Rank the three capital projects and recommend a funding plan. What should you tell the owner about the distribution?
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Priority and funding
- Roof, $700,000: active leaks are causing tenant damage and habitability risk. Do now.
- Elevator, $1.6 million: outages and safety exposure make this critical, but phase cab finishes and controls to reduce immediate cash.
- HVAC controls, $900,000: likely energy payback, but defer until reserve is rebuilt or refinancing closes.
Total need is $3.2 million against a $400,000 reserve. A $500,000 distribution would leave the asset unable to fund life-safety work and would weaken refinancing. Recommend suspending the distribution, using the $400,000 reserve, and arranging about $1.2 million of owner capital or a capex loan for roof and elevator. Do not drain operating cash if it pushes DSCR below the loan covenant. Put the plan in writing with triggers: release HVAC when reserve reaches $1.0 million or refinancing closes.
2. The 45,000 SF tenant asks for a five-year renewal at market. Show the economics and recommend a counter.
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Compare renewal with a speculative lease. At $28/SF over five years: base rent $6.30 million; TI $45/SF × 45,000 = $2.025 million; six months free = $630,000; commission 6% = $378,000. Net effective rent is about $14.5/SF/year. A new tenant adds roughly 12 months of downtime ($1.26 million) plus the same TI, free rent, and commission, dropping net effective to about $8.9/SF.
But $28 is below the $31 in place. Counter at $29.50/SF with $30/SF TI, three months free, and 5% commission. That produces net effective rent near $20.5/SF and preserves occupancy. Tie concessions to a seven-year term and credit approval. Avoid comparing face rent alone: downtime, lost rent, and leasing costs drive the real outcome. A 45,000 SF vacancy would materially cut NOI and refinancing proceeds.
3. Which metrics should you present to the owner when recommending hold versus sell?
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Present DSCR at current and refinanced debt, occupancy and lease-expiration schedule, capital reserve per SF, capex backlog, net effective rent for renewals, cash-on-cash return, and a hold-versus-sell scenario. Show the distribution's effect on DSCR and reserve. Recommend hold only if the owner funds roof and elevator and supports a renewal; otherwise a sale may be cleaner than undercapitalizing the asset.