Basis play / value-add office in high-growth markets - value trap or generational buy?
Is anyone seeing groups actually make money on buying well-located office at a steep discount to replacement cost in strong growth markets? Thinking value-add deals. What are your thoughts on long-term potential here?
Too soon because most investments were made in 2024-today and won't be realized for another several years. I don't think the value-add space is terribly interesting because so many of those buildings are 80s vintage, in so-so locations, functionally obsolete, and/or a CapEx sink. I think the more interesting trade is the core or core-plus stuff in the southeast. Can buy nice new stuff for $500 PSF and it costs $800+ PSF to build. And it's mostly full or will be in the next 12-18 months.
I took a look at some opportunities a few years ago and this was also my take-away.
You could buy brand new buildings in primary submarkets of secondary markets that had recently stabilized with a weighted average WALT of 7.00+ at 9.00% - 10.00%+ forward capitalization rates which was well below replacement costs. A Developer basically took all of the risks over 5 - 7 years and you could buy that product for 75 cents on the dollar.
Or you could pursue deep value opportunities that required a lot of capital expenditures, renovations, and tenant improvements / inducements in hopes to lease-up over a 5 year period. They were all horrible risk adjusted returns and many of those opportunities transacted so I am curious where they land.
The other thing I noticed that doesn't show up in the numbers is how horrible the floor plates / floor plans / layout designs were of many of these 80s / 90s vintage building. They were so inefficient and most likely obsolete without any real conversion opportunities.
Speaking of value-add office, an institutional player down the road from my house bought a campus two years ago and completely tore down hundreds of thousands of sq ft to put in last mile logistics. They are still in the demolition phase but interesting to see these Class A (quality) buildings get torn down because there's not enough demand for the space anymore.
An excellent point on the floorplates. WTF were architects doing in the 1980s? Nobody cares about your jigsaw puzzle shaped call center. Just give me a nice rectangle bro.
I think the really great buys of top of the top Class A office are behind us, although there are probably still good buys there. The Class A- or B stuff is still too early to tell. You are taking risk there, but obviously that's what they buyers of the Class A stuff were doing 18-24 months ago and it's worked out very well.
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