The scope for the wily user-investor

Posted On Thursday, 01 September 2011 02:00 Published by eProp Commercial Property News
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When you come across the term “distressed building” you might be forgiven for picturing a panicky cat in the middle of busy motorway. It’s actually more serious than that, depending on how you value cats of course

Michael SchirnigThe user investor market is beginning to raise its voice in the US; will SA follow suit?

When you come across the term “distressed building” you might be forgiven for picturing a panicky cat in the middle of busy motorway.  It’s actually more serious than that, depending on how you value cats of course.

Back in 2008 South African property investment company South Point Property Investments bought three “distressed” office buildings in the central business district of Port Elizabeth. The intention was part of what became a successful inner city rejuvenation plan, converting buildings that had been neglected by owners and ceased seeing paying occupants, into trendy student residences.  3D have done similar turn arounds in the Johannesburg CBD in recent years.

Putting aside for now the common ‘to lease or buy’ conundrum’: What about marketing distressed office buildings to corporate space occupiers, not just to the residential market or conventional investors? Well there has been no shortage of distressed and withered looking buildings in New Jersey, USA.
Newmark Knight Frank and London-based partner, Knight Frank, operate from over 200 offices in established and emerging property markets on six continents. Recently Newmark Knight Frank, known for it’s out-of-the-box approach, negotiated four intriguing transactions, resulting in the best returns available for the sellers of four distressed inner city buildings.

But to successfully sell to these hybrid user-investors, it is critical to appreciate how a space occupier’s motivation to buy, differs from a traditional investor. The hybrid user-investor is a wily creature, not to be underestimated. User-investors will consider locations that may not appeal to conventional investors, in part because a user is less concerned with the need to attract and retain tenants.
A significant reduction of occupancy costs is the most likely motivation by corporate uses in making these acquisitions.  Currently in the US the net cost of occupying such assets, purchased at today’s low prices, is far lower than the cost of leasing space, even if the buyer pays a premium for the asset!
Some recent transactions indicate that office user-investors have demonstrated a willingness to pay more for distressed assets than conventional investors are willing to pay.

Additionally, some user-buyers are willing to invest in facilities that exceed the buyer’s occupancy requirements, leasing out any unwanted space. So you could end up with scenarios where a conservative accounting firm buys Basil and Basil towers, occupies 70 percent of the building and leases out the rest to a combination of Hairpieces R Us and Habits and Vestments Inc.

One actual example of Newmark Knight Frank’s recent sales is that of a 130,000 m² office complex at 290 Davidson Ave. in Somerset, New .Jersey to SHI International Corporation, a software and hardware reseller.  SHI decided to occupy half of the complex and rent the balance to tenants, a move clearly fitting the profile of a user-investor.

Another recent example is that of the former North American headquarters of Samsung Electronics at 105 Challenger Road in Ridgefield Park, also in New .Jersey by Daekyo America. They plan to occupy several floors and lease the balance of the 50,000 m², nine-story building. The sale generated a premium of R4 per m² over the recent sale price of the next door office building, which sold to a traditional investor.

Recently the former Linens 'n Things headquarters in Clifton, New .Jersey, sold to user-investor The New Jersey Medical Practice Group. They plan 60% occupation leasing off the balance.

Despite the recent economic downturn, there is clearly a user-investor trend reflecting corporate profits at sufficiently high levels in some sectors. Many US companies have generated these profits by becoming more efficient, learning to utilize technology, reducing the number of employees, or transferring jobs to lower-cost regions. Not something to rush out and tell unions about!

Of course here in South Africa we are concerned about how such efficiency can potentially cause the unpleasant side effect of reducing job growth, with the knock-on result of reducing demand for office space, contributing to the currently high vacancy rates.

While many corporations in the US are now in a unique position to take advantage of the depressed office building values and vacancy rates they helped to create, in South Africa, and thinking like a tenant/owner Michael Schirnig, director of Alchemy Corporate Property Advisors comments, that property – whether leased or owned - is one of a company's most important assets and should be addressed as such.  “That’s why it’s critical that businesses have a specific, well-thought-out, strategic property plan,” says Schirnig.  What may be required is a direct link between overall business goals and the underlying property required to make those objectives a reality. A strategic plan meets financial and operational objectives and at the same time reflects the companies’ management style and unique corporate culture. (at this juncture we shan’t refer to the proposed SA Police Headquarters saga.)

Newmark Knight Frank Capital Group has modified its typical sales program to include corporate tenants. The opportunity for corporate users to reduce occupancy costs by buying a space makes a persuasive case.  Previously their team typically direct-marketed each investment property to more than 4,000 investors: by including corporate tenants, the buyer pool has now increased to more than 8,000 potential investors.
On the other side of the coin, considering the lease or buy argument,  in order for one  to remain competitive in the current tight economy, companies  need to maximize their asset utilization through consciously analyzing their leased and owned portfolios and then making the most of what they have.
In the light of this one may recommend that those companies with substantial growth projections secure appropriate advice from an independent consultant while the phrase ‘tenant’s market’ is being heard less and less in the US, there are still a number of ways to secure fair rentals and decent tenant installation allowances, and certainly this still applies for the time being in SA.

However in the US, corporations have seldom seen such favourable opportunities to buy commercial real estate. Current sales of vacant office buildings in suburban markets indicate values of approximately 15% to 25% of replacement cost.

For the flexible and well-capitalized users able to close a purchase, the opportunity to acquire a building for a little more than a year’s rent is very compelling.  One may conclude with little ‘distress’ that whilst the current market in the US and elsewhere is challenging for suburban real estate owners and their lenders, compelling opportunities await the perceptive, capitalized corporate user-investor.

Last modified on Wednesday, 21 May 2014 16:57

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