Assessing / Analyzing Office RE
Office newbie here (main product focus is retail) and have been increasingly interested in learning about stressed / distressed office opportunities. A ton of office buildings are probably value traps and something you wouldn't touch with a 10-foot pole, but wanted to better understand the dynamics of office. Figured a lot of the headlines today are broad-brush and could lead to interesting buying opportunities a few years down the line for someone willing to sift through the rubble
With that said - can anybody opine on what you look for when you're assessing "viable" office? Asking primarily from the perspective of (1) office tenants and (2) an office operator
A few questions that come to mind:
- What type of floor plates / layouts are most attractive to the average tenant?
- Who are the most desirable tenants? Good credit is the obvious answer - but are some industries / types of tenants more sticky / desirable than others? How else do you assess tenant "stickiness"?
- What other important inputs for tenant demand? amenities? building vintage? ceiling heights? etc.
- Important capex items? e.g. for retail, particularly large power centers and grocery-anchored centers, roof and parking lot work make up a big % of your ongoing capex budget
- Nature of concessions? I'm guessing the name of the game today is buying term from your tenants by offering massive TI packages and large rent concessions, but just how bad is it today?
Any input is much appreciated!
When diving into the world of office real estate, especially when considering stressed or distressed opportunities, it's crucial to have a keen eye for certain characteristics that could make an office building a viable investment. Here's a breakdown based on insights from the Wall Street Oasis discussions:
Floor Plates/Layouts: The attractiveness of floor plates and layouts to tenants often hinges on flexibility and efficiency. Modern tenants typically favor open layouts that can be easily adapted to accommodate various work styles, including collaborative spaces, private offices, and areas for relaxation. Efficient floor plates with minimal columns can maximize usable space, making them more appealing.
Desirable Tenants: Beyond good credit, tenant desirability can depend on the industry's stability and growth prospects. Industries that have shown resilience and growth, such as technology, healthcare, and professional services, are often seen as more desirable. Tenant "stickiness" can be assessed by looking at the tenant's investment in the space, the cost and disruption of moving, and how specialized the space is to their operations.
Tenant Demand Inputs: Several factors can influence tenant demand beyond the basics of location and price. Amenities such as on-site fitness centers, cafes, and communal spaces can be significant draws. The building's vintage can affect appeal; however, older buildings with character that have been modernized can attract tenants looking for unique spaces. Ceiling heights and natural light can also play a role in tenant satisfaction and demand.
Important CapEx Items: For office buildings, significant capital expenditure items can include HVAC systems, elevators, and the building envelope (including the roof and facade). These systems are critical for the building's operation and tenant comfort, and maintaining or upgrading them can be a substantial part of the ongoing CapEx budget.
Nature of Concessions: In today's market, concessions are indeed a tool for attracting and retaining tenants. These can include tenant improvement (TI) allowances, which allow tenants to customize their spaces, and rent concessions, such as free rent periods. The extent of these concessions can vary widely based on market conditions, the building's position in the market, and the specific tenant's bargaining power.
Understanding these dynamics is essential for anyone looking to invest in office real estate, especially in a market that's currently experiencing significant shifts. While opportunities exist, thorough due diligence and a strategic approach to selecting and managing office properties are key to navigating potential value traps and capitalizing on distressed assets.
Sources: Value creation in different RE property types, Depth of market and renter pool analysis, Industrial Properties - What are the key things to know?, I'm long office properties, HOW DO YOU DETERMINE YOUR UNIT MIX?
^ find out what you think CapEx/ concessions are might be, then double it.
My firm owns and operates office buildings (but we're not buying anymore... not enough capital is backing it).
Office buildings are capital intensive, and the rates used to justify it but no longer do. The biggest CapEx items I see are HVAC and roof (PNW area). TI packages of carpet & paint are a given ($10-12 psf). Then additional asks like moving walls around and building breakrooms puts you at $18-20, which for a small 3,000 SF tenant is $60K. In some markets that I work in, $2.00 FSG rents are solid. OpEx might be $0.70-0.90 psf, you will probably have to give 1 month free per year, and tenant brokers are fleecing owners with increased LC's, so your net effective would be, say, $0.95. For a 3,000 SF user, that's $2,850/month (my 1,900 SF SFR makes more than this). Given all this, it will take you 21 months to recoup your TI cost; longer if you account for TVM or if the tenant's HVAC needs repairs. Most office deals right now are 2-3 years, rarely 4. So you're scraping by. Office is damn near zero-NPV deals right now.
The current play is a highly speculative one. Buy the Class A/A- office property at an incredibly low basis ($50-70 psf in my market), all equity. Sit on it vacant or do zero-/negative-NPV deals for the next 5 years while you wait for the office market to bounce back. You can hit a home run if you chose the right product, or you can waste years on a gamble that doesn't pay out; if you bought right you probably won't lose.
If I was buying right now, I'd either look at trophy assets in gateway/growing secondary markets or Class A-/B+, highly multi-tenanted (500-3,000 SF) buildings in high demographic/growing suburban cities. I'd pay cash and pick and choose the deals I do (only positive-NPV and accretive to the long-term value of the building). Maybe try the coworking model for a bit.
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