To say the office sector has recently experienced some challenges may seem like an understatement. Yet while pandemic shutdowns, political unrest, resultant hybrid and remote work policies and current economic uncertainty seem daunting, they are definitely not insurmountable.
As one of the largest owners and operators of premier office properties throughout the nation, KBS has experienced the highs and lows of this sector and is still thriving after more than 30 years. While some investors may be trying to liquidate their portfolios from office assets due to these ups and downs, established investment firms recognize that real estate is center on cyclical events see the value of holding on to well-performing and positioned-to-thrive office buildings, while strategically disposing of others.
Office real estate tends to be a solid investment option, even in times of market volatility. Businesses need physical spaces to work in and carry out operations. As such, investing in office real estate can provide a reliable source of rental income and the potential for significant returns over the long term.
We see office as a comparatively stable investment opportunity in uncertain times. Here are the areas where we see promise, the unique investment potential that office holds and which moves make sense for office investors going forward.
The office sector’s unique investment potential
All real estate sectors such as office, industrial, hospitality and multifamily depend on rent growth and upside on sale to boost ROI. Office investors have the unique characteristic of multi-tenant office properties that benefit from a diverse mix of industries that comprise our tenant base, thus preventing us from being subject to any one industry experiencing a downturn and long-term leases associated with the tenant base. This strategy can help office owners manage risk throughout the real estate cycle.
Also, despite the popularity of remote work, centralized office space remains essential for success in business. CEOs are recognizing that there is tremendous value in having teams together in the office, both for maintaining a supportive and cohesive culture and for training and mentoring younger team members. This means there will continue to be a demand for high quality office space that promotes collaboration and interaction.
Well-credited tenants will continue to be key, with businesses committed to creating and maintaining quality office environments that contribute to overall culture and employee attraction and retention being strong assets. At this point in the cycle, as tenants put up substantial capital to improve their own spaces and draw their teams back to the office, landlords can complement this through continually improving their buildings through investments in tenant lounge/reception areas, outdoor space, coffee bars, restrooms and other common areas. These improvements are not only attracting quality tenants, but also can potentially raise the value of office properties to the benefit of investors.
Despite sentiments expressed to the contrary, many diversified, fully-leased buildings can be a stable investment in a time of economic uncertainty, and office owners are still in the market to add these assets to their portfolios.
Office markets and features currently in-demand
Because the office sector is tremendously nuanced, the landscape looks different from market to market. For example, there are so many different factors at play in San Francisco vs. Miami, ranging from political and weather climate to industry clusters and more, which impact each region’s performance. And these differences help determine not only which markets are attractive, but also which features and amenities will work best for properties in those markets.
KBS continuously tracks fundamentals and specific office properties in key markets throughout the country and studies a broad array of information to determine the markets that make sense for us to invest in, which keeps us highly aware of areas where office properties are performing best. Based on this research, we are finding strong leasing activity in Bellevue, Wash., Salt Lake City, Austin, Texas, Dallas, Raleigh, N.C. and South Florida, to name a few.
As for specific amenities to consider, those that spark collaboration and creativity, such as a great tenant lounge and conference space that truly works for meetings, are the most impactful for owners and tenants right now. Also, activated outdoor space is proving highly desirable, as people are increasingly choosing to spend time outside and companies look to provide their teams with a change of scenery in their workday.
In addition, health and wellness amenities are in high demand and can truly make a difference for office stakeholders, like the state-of-the-art fitness center at Accenture Tower, one of our office properties located in Chicago, which is nearly fully leased. Along with touchless systems in common areas, buildings with UL Verified healthier indoor air are also faring well. KBS recently achieved the UL Verified Healthy Building Mark for Indoor Air for more than 14 million sq. ft. of our class-A office space as companies increasingly look to their landlords to ensure a healthy working environment.
Also, as ESG remains top of mind for many investors and tenants, features that focus on sustainability can increase a building’s desirability for investors and tenants. Our firm has established a Green team to help guide us in these efforts. Further, certifications such as LEED, Energy Star, and Wired demonstrate owners’ commitment to sustainability, which is why we have concentrated on these achievements at many office properties throughout our portfolio. Ultimately, attractive, functional workplaces that motivate people to return to the office and deliver choices in where and how they work are truly resonating with today’s office users.
In the current environment, many commercial real estate firms are meticulously reviewing their holdings to determine which office properties should remain in their portfolios.
Understanding each market and the factors that are impacting it now and in the future is a defensive strategy regardless of where we are in the real estate cycle. Ultimately, whether to hold, sell or acquire an asset is highly market-, property-, and even tenant-specific.
For example, certain markets have been disproportionately affected by the pandemic and other factors, including civil unrest and policy changes, over the past few years. Frankly, we do not see some of these office markets recovering in the immediate future. That said, given factors like the quality of the current tenant and terms and length of the leases in place, holding onto stable, cash-flowing assets for the time being and reevaluating in a few years could be the wiser investment decision over alternatives like, for instance, entitling and selling the assets for conversion into an in-demand product type for the area.
Other markets that investors may shy away from or consider getting out of are those currently experiencing challenges with the sense of security in their business districts. In these areas, investment in on-site amenities and formation of convenient, insular mixed-use environments can create in-demand environments at well-positioned properties within them.
Well-located, highly amenitized office properties are positioned to fare well for the long haul, especially when paired with a disciplined investment strategy. Using this approach will help office investors’ portfolios remain resilient and stable throughout 2023.
Marc DeLuca serves as CEO and Eastern regional president of KBS, a private equity real estate company and an SEC-registered investment adviser.