By Cody Payne, senior vice president, Colliers International.
As strong job growth over the past decade has brought more and more investors to Texas, many of these buyers have looked to office product due to the appealing going-in returns that the property type offers. In addition, many cross-product owners look at office investing to make higher returns outside of their current portfolios.
As buyers look toward the office market, there are many factors that need to be considered before making an informed decision. Along with these basic considerations, the impacts of COVID-19 on real estate investing are also important to understand when looking at an office deal.
Cody Payne, Colliers International
The Dallas-Fort Worth (DFW) market in particular has experienced an influx of cross-product buyers from other asset types such as retail, multifamily and self-storage during this cycle. The higher rate of return is the primary catalyst behind their motivation to purchase office investments.
All asset classes are different and so are their opportunities, whether immediate or long-term. Understanding what sets office apart from other types of commercial investments is key to a successful operating strategy.
Hidden Costs of Ownership
One important factor to consider when buying office properties is that there are many hidden costs of ownership that can eat your income alive if not properly addressed.
There is a section within the financials when looking at an office building for sale that includes what many refer to as “below the line” items. These items can destroy an owner’s net operating income (NOI) and potentially make owning an office building an investor’s worst nightmare. These items generally consist of tenant improvements, commissions and other various capital expenditures that can be actual reoccurring costs annually.
There are also several common operating mistakes that buyers are prone to making when making an office investment. These include not understanding the time it will take to hit leasing projections, as well as having an inaccurate idea on how expensive renovation costs will be for a building.
The leasing aspect of an office investment is very methodical. Understanding tenant size requirements, which tend to vary from area to area, is important, and having a proper leasing strategy implemented for your building is equally key to success.
Time and time again, we have seen inexperienced leasing agents let an office building sit for years without achieving desired occupancy. While representation is important on the leasing side, it is also just as crucial for buying and selling as well.
Know Your Product
There is ample opportunity in DFW for experienced investment sales brokers in the office space to flip buildings that were previously listed by brokers who did not have an accurate understanding of how these properties run and operate.
Last year, Colliers International sold an office building in Las Colinas for half of a million dollars higher than its previously list price, simply due to the lack of understanding the previous broker had. We saw the true value of the building, articulated that to buyers and showed them how they would continue to increase this asset’s value and cash flow after its purchase.
In today’s market, it is equally important to understand how to create value in an office investment and to grasp where this value can come from. Value-add opportunities can be found in multiple aspects of an office investment.
Adding Value
One opportunity that is always considered is the question of whether rents are at or below market rates. If rents are low, there is an obvious opportunity to increase cash flow and therefore the overall value of the project.
There are several ways to help with the successful increase of rental rates, including exterior and common area renovations, as well as adding certain amenities. Features such as outdoor green space with seating, advanced conference facilities and upgraded food and beverage options can all go a long way in justifying higher rental rates.
Value-add opportunities in the office market can also stem from decreasing expenses wherever possible. The structure of a lease is one prominent way through which owners can find ways to cut expenses. For example, if tenants are paying triple net reimbursements, then they pay a prorated portion of real estate tax, insurance and common area maintenance.
Apart from decreasing expenses, more value-add opportunities can come from generating additional income on the property. Two examples of this practice involve utilizing cell tower income on the roofs of buildings and implementing paid parking.
COVID-19 Implications
While it is essential to understand the day-to-day aspects of office investments, we now face a unique time in which the rapid spread of COVID-19 has affected everyone in the United States and throughout the world.
The global economy has changed, and that includes the commercial real estate industry. While many people we talk with have told us that they are going to put their real estate purchasing on hold until COVID-19 concerns diminish, we have also had an equal amount of people reach out to us asking if they can buy more investments because of how low interest rates are.
We recently received a term sheet for a value-add office building with a 3.75 percent interest rate. Many local lenders are giving phenomenal deals for buyers in this market. Just last week, we closed a mid-rise office project in Dallas that had over 10 offers and great activity even with the economic concerns surrounding COVID-19.
All of that is to say that even if the most dire of macroeconomic situations, smart real estate plays can still be made in fundamentally sound markets like the DFW office sector. It just takes the right knowledge.
Cody Payne is a senior vice president in the Dallas-Fort Worth office of Colliers International focusing on capital markets advisory and disposition services of Class A and B office product.