BBB Rating|A+

Resource Center

Everything you need to know about commercial real estate investing, real estate crowdfunding and more.
Office Buildings -- a Crowdfunding View
November 4 | 2013

Office Buildings

Real estate investment opportunities can cover many different market segments, and crowdfunding sites like RealtyMogul.com allow investors to take advantage of opportunities within most or all of the various property types.  One of the primary market sectors is that of office buildings, which constitutes a significant portion of the overall commercial property market.

Office buildings range from large multi-tenant structures in city business districts to single-tenant buildings that might be built to suit a specific lessee.   These buildings are, of course, subject to market forces affecting supply and demand just like other types of commercial space.  However, the economic drivers for office space are sometimes different than those for other real estate investments.

Rents and valuations for offices are primarily influenced not just by employment growth but also by a region’s economic focus.  That is to say, they are especially influenced by specific types of employment -- namely, sectors with very high proportions of office use.  These economic segments are generally those that utilize service and professional employees such as attorneys, accountants, engineers, insurance personnel, real estate brokers and related service providers (like title and escrow providers), and people working in banking, financial services, consulting, medical, dental, and pharmaceutical fields.

Office buildings are interesting indicators of how land-use patterns and submarkets develop within urban areas.  Like retailers, business firms utilizing office space look at the real estate and land from which they sell or market their services as just another input in the production of their client services that are sold from a location.  Business users view real estate as a factor that affects operating expenses and revenues; rent, space requirements, the number of employees, and revenues are viewed in the context of how various locations might maximize profit.  Does the building really contribute to their business, by (for example) allowing them to advertise openly? 

This viewpoint explains why the vast majority of real estate used by business firms is leased and not owned, even though many buildings may carry the name of a major corporation on their exteriors.  Most tenants find leasing to be more cost-effective than owning, especially when their space requirements are less than the quantity of space they would have to purchase in order to get a building in their desired location.  A large commitment of capital to purchase a large building takes away from the business’s ability to use those funds in its main area of focus and instead puts it in “the real estate business,” involving the know-how needed to collect rents, maintain, and insure the space.  Even if a business can occupy an entire building, it might still choose to lease because owning would reduce its operating flexibility; if the company decided to leave a metropolitan area and consolidate (or expand) in a different location, it might have to sell the entire property.  This could take a considerable amount of time and tie up personnel and capital, whereas a lease would have allowed it to move upon the lease expiration date -- or it could have simply negotiated a release from the landlord. 

Office space tends to be leased for three- to seven-year terms, with tenants often having the option to renew leases for additional terms.  Rents vary by locations within office properties, and owners may charge premium rents for higher floors (with unobstructed views), building corners, and spaces contiguous with elevator banks.  Tenants often demand special features in the leases, including rights of first refusal to rent contiguous space, signage rights, or even building purchase options.  Office properties often have longer-term leases that can lag current market lease rates, so that “step-ups” (or step-downs) of rental rates are not infrequent when leases expire.

Despite the longer lease periods, office buildings have their own set of risks.  Economic downturns can affect commercial real estate -- including office buildings -- more than residential buildings, and businesses can go bankrupt even while people continue to need housing.  (After the dot-com crash, for example, Silicon Valley rents dropped in some properties by more than 30%.)  For this reason, the credit quality of tenants is key; re-leases of office space can often require significant lead time to consummate.  Because of these issues, cash-flow oriented investors try to focus on office buildings with multiple tenants, so that no single tenant vacancy jeopardizes the entire property investment. 

Building owners must also stay abreast of competitive pressure.  A desirable office space is usually defined by whether it is “a good place to work” – which can encompass the convenience and other defining features of the surrounding neighborhood in addition to the state of the building itself.  Accessibility of public transport, nice design and interior finishings, the vitality of the neighborhood during working hours, and value-added services such as parking, wireless broadband infrastructure, and security all are increasingly important features of office properties.

Investments in office building properties can be profitable, but they have their own distinct risk/return profile.  Higher returns can be available, but these are offset by increased vacancy risks and competitive challenges.  Multi-tenant buildings offer a certain level of safety, and long-term leases with high-credit tenants are also attractive to investors.  Office buildings can fill a distinct place along the risk/return spectrum for commercial real estate, and for that reason should be considered by many investors seeking to diversify their real estate portfolio.

Did you find this article useful?
Please share your new knowledge.