Coast. We’re building to core and we’re focused on strong-value-add acquisition opportunities, though we just can’t find enough of
those. We have less of an appetite for core acquisitions; we can’t
compete given where the yields are, and I don’t think we’re alone.
Looking at next year, we’ll all probably be looking at urban sites and
transit-oriented locations, but they won’t be in the core segment.
McANDREWS: The tendency, when one pictures millennials, is to
imagine them living in an urban area like Brooklyn. But in reality,
a bigger portion of that cohort is living in other cities like Raleigh
Durham, NC or San Antonio. They don’t all live in a brick walkup
in an urban gentrified neighborhood. They’re also living in older,
class B garden apartments outside of the city center.
I do think there’s a lot of attention being given to urban gentrification and the adaptive reuse of class B housing in urban areas. But
the challenge with urban rehabs is often costs. Once you get
through all the unit rehabs and property upgrades, the delta
between your class B rents is reaching the lower end of rents found
in the class A properties. That can place you in a very vulnerable
spot in a down market; you could lose your edge to class A properties as they lower rents to grab occupancy.
In other words, if you take a B property it ends up looking like
a bad class A property by the time you’re done converting it,
you’re at a bad place in the market. We like to be 20% to 25%
below the class A rents in the market, even after we reposition the
asset. It’s important that your price point is sensitive to that low
end of the class A spectrum.
HALLIWELL: In certain markets like Raleigh, Orlando, Atlanta
or Tampa, there’s probably five to ten times more office space in
the suburbs than in the urban areas. Accordingly, in these markets there are more jobs in the suburbs than downtown areas.
Generally, in these suburban locations, you typically will have a
greater percentage of garden rather than high-rise product. And,
the investment performance in garden apartments has been
superior to high rise. Intuitively, many think the urban, highrise
product should provide superior investment performance over
suburban garden apartments, although that has not been the
case over the last several years.
We have been doing some value-add investments in multifamily. The simple math used to be: your yield on cost after renovations would be 6% or above, and you can sell the asset at a 5% cap
rate. This 100-basis-point spread generated a mid to high teens
leveraged return. If we’re looking at it today, the spread may have
condensed to 50 basis points. If I’m taking on a lot of risk and I’m
only getting a 50-basis-point spread, a core investment may provide the better relative value.
DESIATO: You’re all targeting markets with high
employment growth. Are there any industries in
which you’re particularly interested, in terms of
JOHN CLARK: It’s tech, education and healthcare. We
like our investments to align with our capital source.
We like to stick with what we know, and be experts in
our markets and our property types so we can play
throughout the capital stack in order to find the best
relative value. We continue to target gateway markets
with a high quality of life and a highly educated work
force. Our focus remains on markets and locations
where we have a long track record and deep relationships. We are starting to look at secondary markets like
Raleigh, Denver and Portland where we can get a little
bit of yield premium.
SHAW: Suburban office is kind of like retail, it encom-passes a lot of different things and you can’t look at the whole group
as a single entity. Office and retail are two or more schizophrenic
asset classes because it’s a case of have and have nots in both.
CLARK: There’s definitely demand for assets in those inner-ring
locations that have residential and entertainment options. These are
not stand-alone commodity buildings, unless you’re going to be at
such a low basis that you can steal somebody’s tenant.
We’re involved in two assets in a strong suburban market. One is
an office park that’s adjacent to retail and entertainment. Tenant
demand is strong, and rents and occupancies are above market.
Two miles up the road, we have another office park that is more
isolated. Even though it’s two miles away, it’s a completely different
story in terms of tenant demand and rents.
PUMPER: What are your thoughts on what the next generation of office building will look like?
BONEHAM: Right now I’m serving as the point person for the consolidation of two Barings offices in Chicago into a new location, so
I’m looking at this from a tenant’s perspective, which I’d never had to
do before. There is a variety of things to take into account when looking at space; for instance, we want the floor plate that provides good
window line and open space. Building amenities are hugely important, particularly for our younger workers. Partly based on their
input, we are moving into a building that has a free fitness center, a
comfortable, expansive lounge with food service options, and a conference center. The idea of creating an office building environment
that helps to attract and retain your tenants’ employees for the long
term isn’t just lip service. We, as owners, need to pay attention to that,
if we want to have truly relevant, long-term investments.
CLARK: We’re doing creative office in some locations and it’s
going to be very operational. It’s almost like you have to provide
hotel-quality service and amenities.
SHAH: It’s tough to get comfortable with them initially. However,
there is clearly a paradigm shift in the way office space is being
used, and we can’t ignore it. We typically wouldn’t want co-working
to take up more than 10%-15% of your space. If there’s a downturn, we’d have real concerns on how they’ll pay the rent. That
being said, we need to understand it better as it is quickly becoming
more of a service-oriented business.
McANDREWS: We’re going through a paradigm shift in how people are approaching office space. Occupiers are living with less, putting people in smaller environments and making their space work
more intelligently for them. But the question for owners becomes,
will that result in both a physical and a cost structure change?
We’re buying class B and C
properties at a great price point
far below new construction costs,
and we can manufacture a solid
economic arbitrage for our
investors through rent increases
achieved through unit rehabs and
common area upgrades.
PHILIP J. MCANDREWS
AEGON ASSET MANAGEMENT