Commercial Investment Real Estate March/April 2019 | Page 28

Investment strategies run the full spectrum, with capital
available for more stable core and core-plus assets to riskier
value-add and opportunistic properties in both urban and
suburban markets. Some investors, however, are tweaking
acquisition criteria to account for slowing growth. The office
market has struggled with a tepid post-recession recovery
over the past several years and is bracing for a further slow-
down. Office vacancies are expected to tick slightly higher
to 13.2 percent in 2019 and 13.6 percent in 2020, accord-
ing to the ULI Fall 2018 Real Estate and Economic Fore-
cast, while rent growth will slow to 2 percent this year and
1 percent in 2020.
Middleton Partners is one investment group that is
adopting a more conservative strategy to fit changing
market conditions. “As the market cycle has matured, we
have become focused less on lease rollover risk and more
on predictable income stream,” says Mark Cypert, CCIM,
a partner at Middleton Partners, a Chicago-based private
equity investment group. The firm has shifted from value-
add investing several years ago to focusing on acquiring
INVESTORS TACKLE NEW
UNDERWRITING CHALLENGES
Investors are acquiring office assets even as they face
a flurry of challenges forcing them to sharpen their
underwriting skills, such as soaring construction costs,
disruptive technologies, and expansion of coworking.
Explosive growth in coworking and flexible workspace
is front and center for office investors. For the past three
years, the U.S. has added more than 5 million square
feet of coworking space annually, according to Cushman
& Wakefield. The firm estimates that the flexible space
market currently represents 1 percent of the total
multitenant market, with the potential to grow to between
5 and 10 percent in the future.
“I believe the coworking trend will be transformative
for the office market,” says Rebecca Wells, CCIM, senior
vice president of investment sales at Lee & Associates
in Indianapolis. The metro area is home to 14 different
coworking providers that are leasing space, or in the
case of Novel Coworking, purchasing their own buildings.
The office is where people spend most of their time,
and people want to make that part of their day more
interactive. Coworking also allows for greater flexibility
on the part of the tenants who might be unsure of their
expansion or contraction needs in the short term.
Nationally, landlords and real estate service firms also
are moving into coworking. Brookfield and RXR Realty
have partnered with Convene to design and service
flexible workspace at properties, with initial projects up
and running in Los Angeles and New York City. CBRE
also launched its own flexible workspace subsidiary,
Hana, in early 2019 to provide flexible workspace
consulting services to both landlords and tenants.
“Coworking and flexible space is clearly a trend that we
see continuing going forward,” says Mark Cypert, CCIM,
a partner at Chicago-based Middleton Partners, a private
equity investment group. Investors are keeping that trend in
mind with an aim to build out spaces that are coworking-
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March | April 2019
friendly with open, flexible floor plans and building ameni-
ties that will help to attract tenants — whether that is
employers or coworking space providers. In addition, the
general trend is to pack in more people per square foot,
which affects everything from parking density and floor
plans to capacity for elevators and restrooms. “When we
do forecasting for future demand, we take those funda-
mental changes into account,” Cypert says.
Upgrading Class B Properties
Another challenge for investors is the transformation
occurring within the Class B office market. Some Class B
property owners are spending more money to attract big
tenants, which in some cases, is resulting in retrofitted B
buildings that are on par with some Class A towers, says
Paul Waters, CCIM, chief operations officer at Integra
Realty Resources in New York City. High-profile examples
of that include General Electric in Boston and Google and
Amazon in New York City. Those upgrades are creating
new underwriting challenges for investors looking to buy
those upgraded Class B assets. “The variance between
some A Class and B Class space is really making investors
sharpen their pencils quite a bit,” he says.
For example, is a Class B retrofitted building in
Manhattan now a better return on investment than a
Class A tower? It might be, and that certainly wasn’t the
case 10 years ago, Waters says. In addition, investors
buying Class B buildings are, in some cases, looking at
spending the same money on fit-out of tenant spaces
that is more typical of a Class A building. Investors must
carefully analyze whether they can achieve the rents
necessary to justify those higher investments in building
improvements — especially amid soaring construction
costs. “It is very challenging for some investors because
the increased fit-up dollars are changing the profile of
everything,” Waters says.
COMMERCIAL INVESTMENT REAL ESTATE