R. Scott Martin serves as Executive Vice President with NAI Capital in Pasadena. He has 29 years of experience in office leasing and sales and has a career transaction volume in excess of $1.2 billion. He can be reached at (626) 564-4800 X 1504 or email@example.com.
On January 5, 2018 the Dow Jones industrial hit 25,000. On Squawk on the Street that morning, the conjecture was that stocks were going through a "repricing" and that led to the surge in the Dow. There are many things that influence corporate stock values: cash, management and perhaps the latest tax bill. The term “repricing” got me thinking how real estate has gone through its own revalue. Below will look into the influence of Wall Street, global comparison and sociological changes that have affected real estate values. These pressures have started a “repricing” for commercial office prices and rents beyond traditional economics.
In my opinion, “repricing” has been a trickle-down effect in real estate, starting with private equity and institutional monies, which can be seen in recent purchases of major commercial offices properties. Many of these acquisitions were financed with percentage blends of equity and debt. Through the process, additional capital has been used for building upgrades, modifications, renovations and or additions to the properties. As an example, the former ATT building at 177 E Colorado in Pasadena completed a renovation of its lobby and common areas; building Wi-Fi service; building security; restrooms; fitness area; and added a Fleming’s restaurant in a freestanding structure. Of recent, many institutional owners made such improvements to their office holdings and then significantly increased rental rates. I find this an interesting dynamic as both neighboring Glendale and Pasadena office markets have had negative office space absorption with nearly 300,000 square feet returned to the marketplace. This has dramatically increased both cities' vacancy percentages. Yet the rents grew by at least 3%. This is contrary to supply and demand economics. Is this a form of “repricing”?
When viewing the repricing trend from a sociological perspective, companies owned by non- Boomers, known as Generation X, and in some cases the Millennials, have been lured into similar opportunities of buying older designed buildings and renovating them. Those companies owned by the Boomer generation and older have primarily stayed with the more traditional type of office space. For companies owned by the younger generations, I believe this phenomenon of change in design and amenities are partially being driven for reasons of safety, cyber security, to attract talent, open collaborative environments and fun amenities that are attractive to that generation. Boomers appear to be staying in the older designed spaces with traditional private offices with some cubicle areas and may be too comfortable in their own ways. For the Boomers this has brought either a reluctance to move and or a motivation to purchase.
With the rise in the rental rates, rates have set a bar to value against those businesses seeking to purchase their own buildings. The cost of ownership is now going through a “repricing”. What are the values of a building? The industry standard measurement is on a price per square foot basis. These per square foot values differ from area to area, but there is a tie back to the rental rates in the marketplace. Globally, when reviewing London office rents for example, office rents are $10 per square foot per month and the buildings sell at over $1,000 per square foot. Going back to institutional owners, their global outlook gives perspective to higher values, which is why we are seeing the recapitalization to our office buildings.
For business users looking to purchase a building, the cost of ownership is the primary factor. Class A rental rates set the bar. A business user will compare the cost of owning a building and compare it to the rents on a per square foot basis. As an example, Class A office rents in Pasadena are $3.25 a square foot on a monthly basis. A potential user might pay a premium up to 10% more for the ability to own his own property, with thoughts of locking in long- term stability to rising cost, tax incentives and principal reduction. Additionally, with interest rates at all-time lows and money so abundant in the marketplace, we have seen a "repricing" of buildings. Those looking for owner-use buildings are now having to pay a higher price per square foot. Local building values that were at $300 to $400 per square foot a few years ago are now seeing $500 to $600 per square foot.
Within Southern California, values differ based upon rents. In West LA or in Beverly Hills prices are $1,000 to $1.500 per square foot. We have been experiencing this “repricing” for a while and this begs the question, How long will it go? That will be my next newsletter, but I can tell you that in my opinion, 2018 looks better than 2017.
-R. Scott Martin, SIOR, Executive Vice President