Does anyone invest in value add office space? or is it really dead?

Question

I’m eyeballing a property in a B to C-area of town, built in the ’80s, and it looks like I could get it for under $50/sqft. It’s about half full (I’m choosing to be optimistic).

I know office is generally considered “dead” right now, but I can’t help but feel that there might still be an opportunity. Anyone else out there taking a second look at office properties in Texas? I’d love to hear if you’re seeing potential where others see risk, or if I’m just being dangerously hopeful.

What are CAP rates in secondary Texas markets these days?

Bruce Lynn · Answer

I don't know enough to comment on your specific market, but city seems pretty strong from what I could see a couple of times passing through.

A couple of things you should know:

Condition of all the components of the building HVAC, Roof, Plumbing/Sewer.  Know what capital improvements/replacements you will need and have the cash in reserves to do those.

I'd go talk to the PMs of other similar buildings and see how they are doing.  I'd pick at least 10 areas buildings that are competiting for space and look at their occupancy.  Look at their condition.  What will you need to do to compete if anything?  Know your plan to fill the building and keep your current tenants.  You should also talk to every single tenant and know your leases.  Are they NNN, NN, who is paying what expenses?  When do those leases end?  Do they plan to renew?

You can review CAP rates with your local broker.  There is not one CAP rate.  It can depend on the quality of your tenants, how long they have been there, lease type, lease length, size and quality of the building.  Is it a one tenant, national hight quality tenant (like a bank) or lower quality tenants with short leases or leases that are near end?  Does it have 25 tenants, or 1?

May be tough to get financing on a 50% occupied building or you will have to get lower leverage so make sure that works for you.  If you're set on buying and this is a good asset, what can you do to get a long closing date, so maybe you can get presigned leases to get it filled up before you close.  Any chance for owner financing?  Are you going to hustle to go find tenants to fill it up.  Rare I see any real hustlers you can hire to fill it up for you.  They'll put a sign out and put it on Crexi or LoopNet, but rare I see brokers that will hustle as hard as you might to get it leased up and at 50% you want to get it to 90%.

Don Konipol · Answer

Prices for office building nationally are lower by an average of 45%.Older buildings with obsolescence of layout, electrical systems, locations etc are valued 70% + lower than 5 years ago.  Some are virtually worthless. IMO this differs from previous large down times in that this appears to be a structural change in both the demand for office space in general and the obsolescence of old buildings.  We own a building in Memphis we are converting to event space / flex space due to office rents having dropped 50% + in the last 4 years. Office  Properties Investments (OPI) a publicly traded REIT was trading an about $30 per share 4 years ago.  However, because of 60% leverage (LTV) the equity for shareholder is essentially wiped out as its portfolio of office properties value dropped almost 50%.  Its shares recently traded at 18 cents.   And recently some inexperienced investor posting on BP told me that real estate prices had never fallen even 20% and I just didn’t know what I was talking about.  LOL.

Chris Clothier · Answer

I'm looking from a 30,000 foot view and I do not currently invest in the area.

From what I can find, I think a commercial investment there, depending on the specific property, might be a great opportunity.  The area itself is definitely in the path of progress. There appears to be a great deal of activity.  Looks like a little north of $100million in econ. development and a couple of city centers that are the focus of a lot of development over the past year.  I would anticipate an area like this to be popular in the next decade for job growth due to so many companies locating and relocating jobs to Texas from corporate offices to warehouses, logistics, and distribution.  It is located right in the middle of a free trade zone.

Again, I don't actively invest in SFR or commercial in the city, but I do love Texas for investments and specifically for the way they handle taxes and what those taxes are used for.  If you can find an opportunity that pencils out promisingly after your due diligence, then I would not have reservations about making a commercial investment there.  I think an investment allowing for a tenant service provider to the people of the area (think multi-tenant strip center, single-occupant medical) may be a great opportunity.  I can imagine there will be a lot of competition driving cap rates down, but that does not mean the investment or area is not strong.  Do your homework - but I do like the area.

Gregory Schwartz · Answer

@Don Konipol Sounds like that is a very well thought-out and long way of saying, "office in the classic sense is dead", haha. You said 'virtually worthless'. Would you consider $50/sqft virtually worthless, or do I need to reset my frame for how cheap we should be buying this?

Sonny Dhillon · Answer

IMO it really depends on how big of an office. Smaller spaces are still in demand , if you have one big space and can divide up somehow cheaply then that can work but remodling does come with price espcially in office space.  I own bunch of small 1000-2000sqft units in a big building and have no issues with demand, but i heard the larger you go the less demand is there beucae most people nowdays want flexbility of work and companies don't want to lease huge office space when only 30% of the workforce actaully shows up at a time.

Evan Polaski · Answer

@Gregory Schwartz

Office is not dead, but it is certainly a high-risk investment class right now.  Last reports I was reading in my market is suburban office leasing is actually up year over year.  Urban core is still dramatically down.  And within the "suburban" space, it is really area by area.  The newer properties that are still highly convenient to population densities and retail options tend the fair best.

And even then, it is a cash flow play.  I was talking with an operator that had a 100% leased suburban office property in Easton (outside of Columbus, OH).  When they took it to market, their only offer was at a 20% cap rate.  They were willing to sell at a 12% cap, but hadn't gotten it last I spoke to them.  Credit tenants, lots of life left on leases, one of the best trade areas in Columbus, OH.

Gregory Schwartz · Answer

How would you define Bryan / College Station TX?

Does anyone invest in value add office space? or is it really dead?

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