The Skin in the Game mailbox is rammed. Last week I asked readers if there were any commercial property funds they liked with exposure to the crappier end of the office market. Thanks for all the ideas*.
It was also amusing to receive so many tales of woe, having admitted in the column that I turned down an investment of a lifetime by not buying an apartment in Miami at the depths of the financial crisis.
Well, you’ve definitely made me feel better. I can’t tell you how many readers decided that Tesla was a no-hoper in its early days. Me too. We should form a therapy group. The wannabe analyst who once explained in a job interview why Dell was superior to Apple (at 30 cents) can join us too.
There was also a consultant who opted to be paid in cash upon completing a project for Amazon, rejecting the offer of stock instead, when it was trading at 5 cents. And I giggled when reading about a great grandmother who never forgave her husband for turning down a large plot of land on what is now the Vegas strip.
I’m sure this column will add more to the list. Which is fine — we don’t want to be greedy. But will missing out on a massive rebound in office prices be on it? I received hundreds of comments in support of my hypothesis that down-and-out buildings were worth a look. Mostly from those with a vested interest, to be fair.
But many of you thought the idea was absolutely cracker-nuts. Worryingly, these came from people who sounded like they knew what they were talking about. Therefore, forgive me for writing about the same topic again — but we’re in this together and I wanted to share the feedback.
To summarise, I am pondering if it’s time to buy commercial property, in particular offices, given a big fall in prices and some eye-watering yields. I questioned the universal gloom around the future for nonprime buildings — or at least asked whether the risks were now discounted.
The hundreds of responses which said my thinking is wrong fall into three main arguments. I would urge you to read the comments under the last column as there is a wealth of useful experience there to draw on (and I cop some fun abuse as well).
First is that I grossly underestimate the effect of the pandemic on changing work patterns. Many in the industry simply don’t think we’re going to show up to an office ever again — period. Or certainly not for five days in a row. A paper last year by NYU is frequently quoted.
Those who make this argument believe that the lure of refurbishing is small compared with this epochal shift in behaviour. Upgrade an old building all you like, make it sustainable, add pool tables and shiny coffee hubs. We’re not coming back.
I don’t buy this view, but it may prove correct. One owner of a suburban office wrote in with an interesting counterpoint, however. He accepts that workers may be done with long commutes into city offices — no matter how new the bean bags. But those with short drives to a local building with car spaces are returning.
And it is these second-tier offices in regional areas which have seen the worst price declines — hence the jumbo yields. Which leads to the second big criticism of my hypothesis: that it’s not the location that renders buildings obsolete, but rather the huge capex bill required to upgrade them.
I never considered this to be much of an issue. Buildings have been constructed, refurbed, and demolished since we gave up caves. Initial yields and cap rates simply decline to the point where upgrades become viable.
Or you just attract a different kind of tenant — ones who care less about old tiles or draughty windows. Wrong again, I’m told. Office owners are being forced by green legislation to upgrade regardless. In the UK, for example, the government wants all buildings with new tenancies to have an EPC rating of B or higher by 2030. Barely a fifth of them currently do.
I was sent loads of examples from around the world of half-empty buildings which fail to meet ever-stricter sustainability rules, and where landlords cannot raise rental incomes enough to fund a refurb. This is surely the definition of a stranded asset, many of you said.
Is it though? Environmental standards are in the public domain. We know what’s coming. Clever property investors can work out the cost of an upgrade, or even a demolition if the potential returns are better. Capital values just have to fall enough to make funding these viable.
But they haven’t, lots of you reckon. Which is the third main criticism of my retirement plan to buy secondary offices while they’re cheap. Another 20 per cent drop in prices is a common forecast, with some readers refusing to get out of bed until yields reach a similar number and defaults abound.
Sadists! And yet another property guru who is also a qualified accountant emailed to say the attractive yields on offer are nonsense anyway. The denominator is hard enough to estimate, with assets trading infrequently even in good times. Now volumes are down another 50 per cent year on year, current valuations are guesswork. Initial prices often exclude buying costs.
As for the numerator when calculating yields, our guru said the industry is notorious for the numerous fiddles employed to flatter incomes. Owners sometimes show market rents even when new tenants start on discounted rates. Unlet spaces or rent-free periods are conveniently ignored.
To conclude, I hear the risks in offices but believe in efficient markets, even illiquid ones. Much should be discounted. Add a premium if you’re really nervous about prices. And don’t take advertised yields as a given. Outsiders may never know the real figures, so another premium still. Happy hunting!
* In no order and for information purposes only, here are some funds which seem popular with readers. They are not recommendations. Regional Reit Limited, Schroder European Real Estate Investment Trust, Highwoods Properties, Boston Properties, Growthpoint Properties Australia, Emira Property Fund
The author is a former portfolio manager. Email: stuart.kirk@ft.com; Twitter: @stuartkirk__
