Show Buttons
Share On Facebook
Share On Twitter
Share On Google Plus
Share On Linkdin
Share On Pinterest
Share On Youtube
Share On Reddit
Share On Stumbleupon
Contact us
Hide Buttons
Commercial Property

Investing in Office Property


Investing in office property requires an understanding of how office markets operate and behave, as well as the various dimensions affecting office property investment performance.

According to historical data on the performance of institutional investor property holdings, office property returns have been the most volatile among the four major property types (office, retail, industrial and apartments). This high volatility of office property investment performance is due to a number of reasons, including the lumpiness and large size of office investments and the inability of supply to quickly adjust to negative demand shocks due to lengthy development process.

Due to the high volatility and cyclical nature of the office market timing a well-thought strategy in terms of the timing of market entry and exit, location and quality of product to be targeted it is critically important for achieving targeted returns. Furthermore, other dimensions, such as property attributes and location selection need to be carefully defined for successful investing in office property.

The Cyclical Nature of Office Returns

Intelligent investing in office property needs to take into account the cyclical behavior of the office market. Office returns are cyclical because the supply-demand conditions of the office rental market follow a cyclical behavior. This cyclicality is due primarily to the cyclicality of the demand side, which is driven by the business cycle. Demand for office space comes primarily from businesses offering financial and business services. These employment sectors are an important part of the overall economy. Thus, as the economy expands or contracts, so does the demand for office space. When the economy grows rapidly, office demand grows rapidly as well, pushing vacancy rates down, and rents, cap rates and property prices up. These conditions create the upward rising path of the office cycle.

The strong spike in rents and property values triggers many development projects and creates a large pipeline of projects. However, office development is a lengthy process, and this pipeline takes 2-5 years to materialize. Historically, the downward path of the cycle in the office property market has occurred, because just when this large pipeline started coming out in the market, demand was weakening, thus creating oversupply conditions, with vacancies rising, and rents, cap rates and values declining. Within this context, the office market is likely to remain cyclical, and this behavior needs to be duly incorporated when devising a strategy for investing in office property.

Characteristics of Office Investments

When investing in office property it is important to have in mind the following characteristics and have them appropriately incorporated and taken into account in the overall investment strategy:- Multi-tenancy, which is especially the case for downtown multi-storey buildings. Multi-tenancy is not bad because it reduces the risk of loss of income when a tenant does not renew its lease and the space is vacated. Special attention needs to be given in the case of large tenants that occupy significant percentage of the total square footage of the building, especially when lease expiration approaches in order to proactively manage the risk of experiencing a large vacancy and loss of income.

– Relatively high fixed operating costs, as percent of rental income; although, a significant portion of operating expenses is usually reimbursed by tenants, office investors bear the risk of having to pay a greater portion of a building’s operating costs and property taxes when market vacancy goes up and the market softens.

– Significant capital costs, which are required from time to time to cover leasing commissions, tenant improvements upon the signing of new leases, and improvements and upgrades to the building (including but not limited to lobbies, security systems, and building services) in order to maintain or improve the competitive position of the property.

– Reduced cash flow risk, and rental income stability and growth, even when market rents are declining, due to long-term leases

– Inability to take advantage of market rent increases due to long-term leases

– Time consuming disposition process due to the large capital that a potential buyer needs to commit

– Property disposition not only needs to be timed so that it occurs close to the peak of the upward leg of the office market cycle when property values are higher, but also so that the lease roll of the building is favorable with most of the leases, and especially the largest ones, expiring many years ahead

Selecting Timing of Market Entry

Given the cyclical nature of the office market, the investor needs to have a pretty good assessment at which part of the cycle the market is and how close it is to a potential downturn or upturn before making decision regarding the timing of market entry. Such an assessment needs to be derived based on reliable forecasts for the path of the economy and the supply coming out in the market in the years ahead.

If the office market is very close to entering a downturn the investor may think twice before investing in office property within that market at that particular time. If market entry is decided, a specific strategy needs to be outlined in terms of what assets will be acquired, at what price, occupancy status, lease roll structure, etc., in order to counter the risk of declining market rents and values. It also matters whether the investor’s strategy focuses on cash-flow, capital appreciation or both.

In terms of taking full advantage of the office property cycle when investing in office property, the ideal strategy would be to enter at the bottom of the cycle when values and investment cost would be the lowest and exit at the top of the cycle when income and property value would be the highest.

In determining optimal timing of market entry , the volatility of local employment base and, especially, the sectors that are primarily relevant to office demand (financial and business services) needs to be assessed through historical data. However, the current state of the economy and its dynamics at the time of the contemplated investment need to be equally taken into account in order to assess how volatile the market is more likely to be over the planned future investment period.

Selecting Types and Attributes of Office Buildings

Building attributes represent another important dimension of a well thought strategy, when investing in office property. An office building’s attributes and quality have a significant bearing on its attractiveness to tenants, as well as the rent it can command, and the capitalization rate that an investor may apply to its income in order to determine the price he is willing to pay. For this reason, a well-thought strategy for investing in office property, needs to define the preferred physical attributes and qualities of office building targeted for investment. Such attributes may be defined in terms of the maximum age of building (for example buildings completed no later than 10 years ago), wiring and configurations that can accommodate the latest technologies typically sought by creditworthy tenants, floor plate size, quality and adequacy of vertical transportation, lobby efficiencies and appeal, architectural design features, construction materials, water views, proximity to transportation nodes prime residential areas, business services, quality restaurants and shopping facilities.

Identification of new and growing office-using sectors within the local economy may also provide clues as to what types of office buildings would be most suitable to invest in, in order to capture the demand of new and upcoming segments in local office markets.

Selection of optimal property attributes will also depend on the timing of entry with respect to the local market cycle. In case of an anticipated downturn in the local economy, the investor may target properties of top-quality and location, high occupancy, quality tenants, and a staggered lease expiration schedule, in order to shield property income from such a downturn. If the assessment of the prospects of the market points strongly to rising occupancies and rents, then the investor may decide to take leasing risk by buying quality properties with high vacancy, with the objective of realizing significant capital gains by bringing the property to full occupancy and increasing its income considerably.

Selecting Location

Location selection at both the city/market level and the intra-city level is very important when investing in office property. An important criterion for institutional investors, when selecting cities for office property investments is market size, which is usually defined in terms of total office stock in a particular market and the level of transactional activity. Sizable office space stock secures that few new developments will not overwhelm the demand-supply balance of the market. Furthermore, high level of transactional activity, which is a proxy for the appeal of a market to institutional investors, reduces exit risk, as the likelihood of finding an institutional investor that would be interested in buying, when the investor wants to exit a market, is greater.

Volatility of the local economy and the office using sectors is another criterion, often used by institutional investors, in selecting markets when investing in office property. Cities/ markets with lower economic volatility reduce the risk of negative demand shocks that may lead to rising vacancy rates and declining office rents.

In terms of selecting locations within cities, the investor needs to select between established and emerging office employment nodes. The two choices entail different risk levels. Established nodes entail obviously less risk than emerging nodes. The latter often have substantial land for development and consequently can be overwhelmed by new supply; furthermore tenants maybe skeptical in renting space at emerging locations, as they may have more doubts as to how attractive those locations will be to potential clients, compared to established locations.

Another important parameter in selecting within city locations when investing in office property, is the presence of support services typically required by office employees, such as banking and other business services, good restaurants, and shopping facilities

Be Sociable, Share!

Basic Analysis of Stocks

Previous article

For Sale By Owner Property

Next article


Leave a reply

Your email address will not be published. Required fields are marked *

Popular Posts

Login/Sign up