With commercial real estate property values on the rise in the Denver metro area, investors and developers increasingly are seeking value-add opportunities to meet their targeted return thresholds. When evaluating a value-add opportunity, investors can select and utilize several different strategies to improve the current economics of the property based on pro forma assumptions. While technology has been available to the commercial real estate brokerage world, according to the Building Owners and Managers Association’s Commercial Real Estate Trends 2018 report, technology selection, integration and adoption still have their challenges.
When considering value-add investing opportunities, leveraging the latest technology should be at the forefront of the brokerage process with the following properties: high-vacancy properties; a Class A location with a Class C use; high-growth areas; and legacy-leased buildings. Following are reasons why being open to new methods and the latest technology will provide a significant competitive advantage for these four scenarios.
1. High-vacancy properties. Commercial real estate searching software enables investors to effectively identify opportunities in strong submarkets with high-vacancy properties. With the concept of reversion to the mean, it is important to identify vacancies due to ownership decisions or tenant problems, rather than specific location issues or unsolvable surrounding property deficiencies. For example, if the current submarket is operating at a vacancy rate of 4% with a specific building vacancy rate of 25%, a good value-add opportunity may exist. However, the buyer must always be aware in a value-add situation that some problems are difficult to solve, such as zoning, costly renovations or high vacancy due to minimal parking. Utilizing search software will quickly help identify key trends and solvable vacancy opportunities.
2. A Class A location with a Class C use. We all know the three rules of real estate: Location. Location. Location. There now are aerial identifiers and map overlays that allow value-add buyers the power to fully understand if target properties are more valuable vacant than with the current tenant occupying them. There are a lot of factors that could transform a building into an A location that has an outdated use. For example, properties that now sit at a signalized intersection, are located in a new opportunity zone overlay, have seen a change in zoning or are located in a shifting neighborhood. As locations change and improve, often tenants will stay in a location that may no longer be the best fit for the building. Finding a building where the tenant has outgrown the property’s best use through aerial growth identifiers and map overlays is key to uncovering the actual hidden value.
3. Population growth and new development. Denver was ranked the fifth-fastest growing large city in the U.S., along with Aurora, Loveland and Greeley being named the fastest-growing overall cities, according to WalletHub’s 2018 report. Commercial tenants that already are located in Denver are hungry to grow and are looking for additional locations in high-growth areas that they can operate from their Denver supply chain. Using similar map overlays for demographic growth trends, target areas can be identified for purchase where the commercial real estate rent tide will rise over the long term. This not only allows for potential rent growth upside, but also for additional value-add opportunities, such as proximity to a transportation-oriented hub (light rail) or working with the city council on a rezoning plan to change the use of the commercial building.
4. Building in rent-growth targets due to improving demographics. Commercial tenants were able to take advantage of the Great Recession by negotiating lease terms that they still are benefiting from due to five- to 10-year lease terms with renewal options. Investors and brokers should be using market change reports to understand when tenants signed their lease and how much term they might have remaining on legacy leases with low rental rates. By targeting properties with leases signed between 2009 and 2014, investors will experience greater upside on future leases as they are renegotiated to market terms with higher rental rates. In these situations, landlords will have the upper hand in lease negotiations and will be able to substantially increase rents and tenant reimbursements. We already are experiencing this in the Denver area with office landlord changing lease structures from gross leases to triple-net leases. This progression also is present in the retail market where investors who are able to acquire retail properties with low rents will be in a strong and profitable position to capitalize on future rental rate growth cycles in specific submarkets.
As the Denver commercial real estate acqusition landscape has become increasingly competitive and expensive, investors and brokers need to rely on emerging market signals and available demographic trends that will shape the real estate market over the next 10 years to remain market leaders. Multiple technology tools now are available to help deliver this information in order to locate specific opportunities and to provide a better understanding of the assumptions used to acquire value-add properties. The bigger question stands – what opportunities are you missing out on if you don’t embrace them?