On May 27th, Melissa Houston, Director of Sales at Juniper Square, hosted a conversation about the state of office assets with Brian Heafey, Partner at Pacific Coast Capital Partners (PCCP), and Darik Afshani, Senior Vice President at Stockbridge.
Despite significant challenges ahead, both Heafey and Afshani said their portfolios were holding up well and that they were bullish on the office sector and cities in general.
“We’ve been really pleased with the results from our portfolio,” Afshani said. “April collections came in the mid-90s. May is tracking well. We have already done a few renewals. We’re seeing an increase in concessions on things like tenant improvement, but not as much of an impact to rental rates – though admittedly it’s still early on that front.”
“We’re starting to open up again,” Heafey said. “We are seeing good liquidity coming in the corporate market, and that’s coming to the debt market. So I’m pretty optimistic.”
Navigating the current environment
As with other commercial real estate property types, some office tenants have asked for rent relief in the past two months.
“When warranted, we are applying security deposits,” Afshani said. “We’re entering into deferral agreements for several months of rent, and then having that replenished and repaid over a period of time, generally going into 2021.” Tenants with near-term lease expirations are receiving rent abatement in exchange for extension of their lease terms. “For tenants where we’re not able to provide relief, we’re letting them know that rent is still due, and some of that correspondence has been in the form of default letters,” he added.
Heafey provided perspective from the debt side of the equation, saying that PCCP remains active in the market underwriting a variety of loans, including for build-to-suit office and refinancings, especially in cases where the equity investor is willing to infuse some new cash into the deal. “An equity investor putting new capital in as a vote of confidence in their business plan is attractive.”
As PPP financing comes to its end, there could be additional requests from tenants.
“Depending on the tenant, they still may be having problems, but I think we’re at least moving in the right direction,” Afshani added. “I think there are a lot of things that are going to happen over the next couple months to hopefully make sure that tenants are heading in the right direction as well.”
The importance of transparency
Afshani and Heafey agreed that this period of high uncertainty has only underscored the importance of communicating with investors and stakeholders.
“We’re keeping them informed and updated on the financial metrics,” Afshani said. “We are getting a lot of questions on rent collections, how we’re handling non-payment, questions about valuations that are going to be upcoming, and operational metrics. I think they have appreciated the transparency and frequency of communication we are providing.”
The future of office buildings
Big questions facing the office sector are how to increase the number of people working in buildings safely and assessing what the balance of remote work and in-office work might look like in the months and years ahead.
Stockbridge and PCCP both own buildings in markets where “stay-at-home” orders have begun to be relaxed and workers are gradually coming into offices. Operating facilities safely has included changing HVAC filters, putting in new signage to encourage safe social distancing, limiting elevator occupancies and keeping some amenities like fitness centers and conference centers temporarily shut down. Tenants are also staggering schedules to have different people come in different days as well as allowing some workers to work remotely.
“I think people are adjusting pretty well,” Heafey noted. “I’m not as concerned about 8am when everyone is arriving at the office. I’m more concerned about 7am and people getting on public transit to get here. I don’t think getting into the office doors and up the elevator is going to be that big a problem.”
The creativity and flexibility owners and managers are applying to the physical environment will also need to be extended to lease negotiations. Co-working operators, for example, are struggling now with a decrease in renewals and low interest in new deals. Some need to make changes to their spaces to de-densify, but later on the short-term nature of their leases might be more attractive to tenants in an uncertain economic climate.
The resilience of cities
While there has been some talk that corporate tenants may start to shy away from urban environments in favor of less-dense suburban office parks, neither Heafey or Afshani are ready to write off cities.
“The drivers of what has brought so many people to the city will continue to keep attracting people. It’s access to restaurants, entertainment, nightlife, all the arts and cultural events, and then the walkability and the convenience that comes with all that. These have been the hallmarks of the urban experience. They’ve also been what has been taken away temporarily with this pandemic,” Afshani said. “But they will return, and I don’t think it changes the fundamental value proposition that causes many to make that urban living decision in the first place. History has proven cities are resilient.”
“People want to be together,” added Heafey. “You will see some temporary adjustments. But I think you’ll continue to see a very relevant and vibrant city life in the years to come. It may not be in the next 12 months, but if we’re doing this call 5 years from now I think it will be there.”
Juniper Square recently conducted its second survey of customers, which found 81 percent of respondents plan to fundraise in 2020 – something Heafey and Afshani saw as a strong sign that the pace of dealmaking will increase in the second half of the year.
“We talk about supply and demand which underpins real estate values, but also follow capital flows,” Heafey said. “Capital being raised in the real estate industry is a good marker for values. Like water, capital and real estate values find their level. Having that capital and liquidity helps people transact.”
Afshani noted that in April, Stockbridge held its first close for the fourth fund in its Value Fund Series for $225 million in commitments. “There’s still business going on and people are making plans for the future.”