Many investors are drawn to core investments when considering adding to their portfolio.
It’s no wonder these prime properties are so popular; not only are they located in prime markets like New York, Los Angeles, and Chicago, but they are usually fully leased to investment-grade tenants and are in excellent locations.
Core markets, though difficult to get into, are considered the least risky, as properties are fully leased to investment grade tenants and are located in excellent locations.
However, although core properties might seem like the ideal investment due to their low risk and stable cash flow, they are often very difficult to find and offer little to no opportunity for appreciation.
Value-Add Investments Best For Appreciation
Investors who choose value-add properties plan on increasing cash flow through renovating or changing the best use of a property.
This might involve making improvements to the property by adding landscaping, tenant amenities, or upgrading technical systems. Improving the management of the property by collecting rent in arrears, evicting non-paying tenants, or filling vacancies is also an effective way to add value to a commercial office property.
Once these changes are made, investors can then reposition the space as a higher-end property, which allows them to raise the rent and attract higher quality tenants. Investors can then hold the property, sell it, or cash in on the appreciation and use the resulting cash for the purchase of another property.
Class B Assets Ripe With Opportunity
While REIT’s and other large investment groups still seek to acquire Class A properties, many investors are turning to Class B assets instead.
This strategy has been especially successful in markets where the spread between Class A and Class B properties is greater; combined with higher overall cap rates, investors willing to make capital improvements are reaping substantial profits.
Investors Tap Into Spillover Growth From Emerging Sub-Markets
Another area investors are turning to is the areas surrounding urban cores.
Rising rents and a desire for increased space for urban campuses has driven many businesses to these regions; this “spillover” growth has not only revitalized many urban areas, but it has also sparked a trend of moving even further to suburban areas in order to decrease rental prices.
Creative Office Build-outs Attracting Millennials
Business owners seeking to woo Millennials have begun re-evaluating office floor plans in an effort to create a more appealing company culture and environment.
For example, Millennials value office floor plans that foster creativity and allow for socialization between company teams. A host of amenities is also a must, with bike-sharing programs, fitness centers, and on-site cafes viewed as part of the company lifestyle rather than mere perks.
Adding these features not only attract higher-quality tenants, but they also help stabilize the tenant base by helping tenants increase employee retention and recruitment – which ultimately increases the property’s long-term value.
Long-Term Demand Drivers
Several factors are driving demand for value-add office properties.
One factor is the vast number of Millennials in the workplace. This demographic is, in fact, overtaking Baby Boomers, and as a segment, have attracted a lot of attention by business owners anxious to attract top young talent.
Another important factor for investors to watch out for is enough housing to support office market growth. The infrastructure necessary to support the growth of an area must already be in place in order to support future growth; otherwise, businesses may be forced to relocate to a more housing friendly area.
Decide Whether The Higher Risk Fits Your Investment Goals
Although investing in value-add properties does allow for higher profit due to appreciation and increased cash flow – more so than with core properties – they also present more risk.
There is always the chance that an investor will make an incorrect assumption about the profitability of the property, forcing them to sell the property and take a loss.
This can occur when construction takes longer than expected, or the cost of the construction itself is higher than anticipated. There is also the chance that the investor will be unable to find new tenants when re-tenanting, thereby decreasing the expected cash flow.
Despite the risk, many investors are willing to take a chance with value-add office properties, betting on the fact that value-add properties are comparable to newly constructed properties yet allow for greater appreciation and cash flow, as well as long-term rent growth.