The foregoing considerations have shown that the efficient existence of a building must be measured and may be limited by its capability to make a reasonable return upon the original investment, and have indicated that the result should be accomplished in addition to maintaining or building up a fund sufficient for its own reconstruction at some future period. A building which, under these conditions, does not make a net return equal to current market rates for thoroughly sound investments cannot be considered a satisfactory equivalent for investment in other forms of security, and the extent of its failure in the return must be charged against any assuma-ble appreciation of the value of the site on which it stands, and may be regarded as an index of a shortened term for its existence.
In determining the extent of expenditure which is justifiable in the improvement of real estate, as has been done herein, use has been made of a percentage of the gross rentals as a basis for the financial return which commercial buildings may be expected to make in order to establish certain capitalized values in the site and a commensurate return upon their own cost.
This return is the result of two elements - the rentable value of a square foot of space prevailing in that locality for any specific class of occupancy, and the proportion of expenses for the operation of the building and for the payment of fixed charges thereon.
Rates of rentals do no doubt varv with locality and differ from those which at present prevail in New York City, as shown in table A. But the ratio of the expenses to the rentals may be expected to remain similar for any specific type of building and character of operation.
A prevailing rate is not always to be enhanced or beneficially affected by inducements such as elaborate ornamentation or imposing exterior appearances in new buildings, nor can a permanent dependence be placed on increased rentals obtainable by reason of novelty in construction or even by internal conveniences. Even the one definitely valuable asset or influence of the possession of ample light and air can only be permanently secured by the ownership of contiguous property or exceptional surrounding circumstances, or by the devotion of part of the site to this purpose.
It is unquestionable that certain beneficial effects result from dignified appearance in buildings, particularly as regards their entrances; and reasonable excess expenditures are justified in decorative effects which may be attractive to prospective tenants, but such matters need more than haphazard consideration. Imposing and elaborate cornice decoration accompanies gloomy recessed court entrances of some recent designs of apartment-houses, and these and other expenditures require to be directed with judgment.
There was recently published an account of a business building on the street front of which were erected solid columns of selected granite, the cost of each amounting to $7500, exclusive of their capitals and pedestals.
Interest upon the cost of these features would involve the entire earning capacity of one floor of the building, which may, therefore, be regarded as having been constructed solely for the purpose of justifying the investment upon the columns. As the cost of this additional floor added relatively to the total cost of the building, the whole building was also involved to some extent in the work of paying interest on the columns, the attractiveness of which to tenants would thus have to be very substantial to justify their existence. It is doubtful whether much dependence can be placed upon the future value of elaborate exterior decoration or expensive interior construction such as have accompanied the erection of a number of large business buildings.
In the case of office buildings it is to be noted that mortgage money may be obtainable thereon at rates considerably below those current for other classes of buildings, and that the interest return upon the equities may be acceptable at correspondingly moderate rates. If, however, the return upon the equity does not equal or exceed the rate upon which the mortgage is placed, the building could not be considered to be effectively productive, because the investor would naturally do better at equal rates by investment in a first mortgage or a bond upon the property, thereby obtaining a first lien upon its earnings, with entire freedom from all responsibilities and anxieties as to the details of operation.
Figures from a large office building of very successful character, twenty stories in height, may be taken as an illustration. With an invested value exceeding $6,000,000 in land and building, the gross rentals are 9.3% of the capital value, and the operating cost is (without provision for vacancies) 41.6% of the rentals. This cost does not include provision for depreciation of the building or of its equipment, so that the ostensible return of 5.5% upon the investment will be reduced by allowance for those elements to a rate of approximately 4%.
For so important a building, this is evidently a satisfactory result, and as a mortgage is placed upon the building at that rate of interest, the equity or remainder stands upon the same basis of interest as the mortgage. But it is to be noted that while the interest upon the mortgage would be secured as a prior lien upon the income, the remainder or equity would depend for the stability of its revenue upon the maintenance of the present rates of rentals, of taxation, and of other elements included in the cost of operation.
Another illustration may be taken from the results afforded by an office building of nearly equal size, but of only sixteen stories height, the appraised value of which, with its site, is $5,000,000. The rates of rental in this building are not nearly so high as in the foregoing instance, and so the proportion which the actual rentals bear to the gross value is only 7.7%.