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Investors Reducing Risk in Buys of High Vacancy Office Buildings

04/27/2015

Last month, a flood of high vacancy office purchases indicates that some investors willing to take risks have discovered ways for bets to be hedged. The upswing of vacancy offices was first noted during the third quarter of 2014 and it appears to still be on the upswing.

Investor Strategy

Throughout the first part of 2015, there appears to be a solid strategy among investors based on a pricing spread that since the 2006 level of 48 percent has now doubled. Of course, vacancy office buildings are just a small portion of overall investing that is currently taking place.

According to Gary Nussbaum, managing director of investment services with Transwestern, investors of office properties are excited that in certain urban markets the alternative strategy consists of aggressive searchers for higher returns.

Today, investors are dealing with premium pricing on core, but also core plus and value add assets and still willing to carry greater risk while paying higher prices for office buildings that are completely or near vacant.

Primarily, this trend is being seen in the largest office markets that have improving fundamentals but also markets that are being driven by lower returns on solid assets because of increased competition among buyers. In addition, there are more debt sources that are open to financing of acquisitions that provide opportunity.

In agreement is Patrick Fitzgerald, senior vice president of the commercial real estate lending group with BankUnited who said that strategies for value-add specific to office building investment are a big trend and that lenders are becoming more and more willing to ensure money is available to purchase high vacancy buildings.

Historically, real estate returns do not come from appreciation of assets but from property cash flow. Because in a large number of primary markets asset values are already at or above the peak valuation of 2007, alternatives are a major focus of investors. Therefore, analyzing a possible acquisition for the sake of improving NOI is critical.

As part of property evaluation, some buyers are willing to consider additional development rights and trapped value opportunities that include below market rent lease roll. In looking at a number of recent building sales, it is easy to see strategies that include value-add. For several of these deals, buyers were able to find innovative means to reduce lease-up risk when buying vacancy buildings to include:

  • Minimize Carrying Cost
  • Purchasing Buildings with Tenants Moving
  • In-Demand Work Environments
  • Buying What is Known
  • Taking a Small Piece of a Larger Portfolio
  • Targeting Strong Submarkets Near Home

The bottom line, investors are showing an increasing amount of interest in buying vacancy buildings and willing to take on greater risks. For many, this strategy is playing out better than imagined but in all cases, it is imperative for lenders to consider different options before locking into a deal. This consists of finding the right building and being relatively comfortable with the agreement but also considering options “outside the box”.

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