The office market emerged as one of the leading sectors this past year. Driven by robust job growth and the rising demand for quality workspaces, the office sector posted strong gains as investors launched new development projects and owners repositioned their buildings into creative work environments. National vacancy rates declined and net absorption inched upward, indicating healthy market fundamentals in the office sector.
That said, strong tenant demand has fueled a construction boom across the U.S., which experts say could mark a record in new office deliveries, according to a CoStar report. This influx in new supply has raised concerns of a potential slowdown and softening in rent growth in the office sector. The question is: how are office owners and investors staying competitive in spite of these new deliveries?
As a real estate investment firm with a history in acquiring and repositioning value-add office properties, we’ve identified three key strategies for owners and investors to source attractive investment opportunities and stay competitive in the year ahead.
Target emerging gateway markets
Amidst rising office competition, investors are increasingly turning to emerging gateway markets with strong fundamentals in order to source attractive investment opportunities. By targeting emerging sub-markets surrounding urban cores, investors can capitalize on spillover growth and also benefit from the long-term stability that these regions afford.
Despite growing concerns regarding a potential oversupply in new office product, the development pipelines vary greatly from region to region, and strong tenant demand will continue to drive leasing activity in select markets.
For example, over 2.4 million sq. ft. of office space is slated for delivery in Los Angeles this year and next, according to JLL. This new supply pipeline is relatively small compared to other markets across the country. This is due to Los Angeles’ high barriers to entry and development restrictions that make it increasingly difficult to build a huge amount of new construction. As a result, Los Angeles is not experiencing the same type of oversupply that may potentially impact other markets throughout the United States.
Investors who target the emerging sub-markets of Los Angeles such as Culver City, downtown Los Angeles and the Arts District will have the most success over the next several years. Compared to other areas of Los Angeles, these markets still have plenty of runway left and are poised for long-term revitalization and growth.
Overall, by focusing on emerging sub-markets surrounding urban core areas with high barriers to entry, investors can find attractive investment opportunities that are less likely to be impacted by new construction and increased supply.
Invest in value-add and integrate high-quality amenities
The influx in new supply in many markets throughout the country is predominately in class A office product. Investors who target value-add opportunities and reposition their office assets in order to provide tenants with the best value-oriented alternative to new construction will have the most success in the year ahead.
For example, many office owners have been repositioning their buildings into creative, collaborative work environments in order to cater to tenants seeking to attract the next generation of talent. In doing so, office owners can provide tenants with the high quality workspaces Millennials are demanding at a discount to new construction.
Today’s business owners understand the value that Millennials place on a company’s culture and environment. As such, tenants are seeking greater flexibility, open floor plans for collaboration and environments that foster creativity and socialization. Landlords that offer these types of environments and creative office build-outs will be able to support businesses throughout their entire life cycles, resulting in strong tenant demand and high occupancies at their office assets.
In addition, integrating the latest lifestyle amenities can also add significant value to office assets. By providing a host of amenities, such as on-site cafes, gyms, art displays and bike-sharing programs, landlords can help drive employee retention and recruitment, which in turn boosts the overall stability of the asset and long-term value.
Looking ahead, the best investment opportunities lie not necessarily in brand new office buildings that command the highest rents, but rather in value-add assets that are comparable in quality to new construction and allow for long-term rent growth.
Focus on long-term demand drivers
Given the cyclical nature of commercial real estate, investors must focus on investment opportunities that are poised to deliver the most value over the long term.
There are a couple of key factors that office owners must consider when making an investment. First, they must evaluate demographic trends. Millennials have recently overtaken Baby Boomers as the largest segment of the workforce, making them a primary demographic to watch in the office sector. With the majority of Millennials preferring urban to suburban living, office investors are increasingly focusing on office buildings in urban settings with access to restaurants, transit options, and housing.
In addition, investors should focus on areas with a critical mass of housing development. There must be enough housing to sustain the growth of the office market. Otherwise, the lack of housing options may drive companies to move elsewhere. Investors must focus on areas where there is enough infrastructure in place to support future growth.
Ultimately, market fundamentals point to a healthy office sector in 2017. Office owners who target supply-constrained emerging sub-markets with long-term demand drivers, focus on value-add opportunities and integrate unique amenities will continue to find attractive investment opportunities and stay competitive in the year ahead.
Tim Lee is the vice president of corporate development and legal affairs at Olive Hill Group, a privately- owned investor, operator and developer of commercial real estate properties with a diverse portfolio of office, retail, hospitality and multifamily properties. Since 1996, the firm and its affiliates have invested in more than $2.4 billion in commercial assets. Lee can be contacted at [email protected].