In the auction arena, most commercial real estate observers might think of multifamily and retail assets getting the most play. But office buildings are changing hands through this process as well. The second-largest office transaction in Orlando last year was done through Auction.com‘s platform, according to the Irvine, CA-based firm, which is a GlobeSt.com Thought Leader. Eric Paulsen, Auction.com’s co-chief executive officer, spoke to us recently about his thoughts on the office assets being auctioned and the direction in which the overall sector is headed.
GlobeSt.com: Office isn’t the hottest sector right now, but do you see any growth in transaction volume in the near future?
Eric Paulsen: I do think you are going to see more office transactions taking place. Whether a particular market recovers, or continues to remain stagnant, there is still pent up demand and office is still a desirable asset class for sophisticated investors. The key with distressed office is: 1) An office owner is usually more institutional in nature, whereas in the apartment sector or even in single tenants, you may have more of an individual, or one-off owner. Office owners usually underwrite more conservatively to allow for the potential for downside risk. They’re the ones who should be better prepared for downturns, especially given the risk and cost of tenant turnovers. That’s one of the reasons why I think there has not been as much office product, compared to other asset classes, available in today’s distressed market. However, we’re in an overall distressed market, so if you do see office today, it is either a solid investment opportunity, or there is a “story” behind it, tied to the fact that we are still in the 4th or 5th year of economic troubles and lack of job growth.
The flipside, is that in this current world, there are not a lot of good office opportunities. So for a good high-quality office building, basically a non-distressed seller with a non-distressed piece of real estate, you can almost name your price. Interest rates are extremely low, it’s still a very desirable product type and there is a lot of money chasing a little product. Today, there are more buyers than there are sellers.
GlobeSt.com: On the buy side are you seeing the same types of investors as on the sell side?
Paulsen: It’s across the board. They’re mostly “professional” or consistent real estate investors, and most likely institutional in nature. But there are opportunities, especially in secondary markets, that are appealing to “one-off” buyers. People are much more comfortable today with real estate as an investment alternative. But, you have to be comfortable owning something that has a lot of moving parts to it, as it’s also an expensive release/retrofit compared to a lot of other product types. An industrial building, if a tenant leaves, you get a big broom, sweep it out and put the next tenant in. With office, you’re probably going to have to knock down walls, put in new carpet, paint and cabling, all kinds of costs involved. You have a little bit more of a professional real estate owner that buys office buildings and that usually indicates someone that is as comfortable buying as selling office product.
GlobeSt.com: So office isn’t really getting bought up in secondary and tertiary markets?
Paulsen: Actually it is in the secondary markets, but not sure it has trickled down in a recognizable way to tertiary yet. With the amount of information available these days, investors are more comfortable with alternative markets. That and they may be forced into secondary markets in the ever present chase for yields. Investors are chasing yield in the secondary markets, and that in turn should have the waterfall effect of chasing buyers with higher yield requirements into the tertiary markets. But tertiary still is really tough right now, and I think there is still a more limited buyer pool playing there. Secondary, you are seeing more and more demand because of the higher pricing being achieved in the primaries.
GlobeSt.com: So is it all about employment? Is that what will make more transactions happen in the sector?
Paulsen: I think so. The smart office investors that are out there right now are looking for “First to recover, First to lease”. You look for a market that is going to recover first, where employment is going to grow first, and which building in that market will get tenants first. Solid buildings get the first choice of tenants. That’s the building that your office buyer hopes for. From there it goes down the food chain to good buildings in the first to recover markets, then to best building in the secondary recovering markets etcetera. So it is a trickling down effect for the national office investor that can buy in New York, California, Texas and anywhere in between. Where am I going to see the strongest employment growth soonest, and then trying to capture the best buildings in those markets. As yields go up in those markets, investors migrate down the food chain to the next level of opportunity.
GlobeSt.com: Do you have any predictions on how transactions will shape up this year compared to 2012?
Paulsen: We’ll see an increase in sales. It won’t be off the charts, but you are going to continue to see more sellers come to the market with either market recovery and taking some chips off the table, or markets/product lagging, the hope certificate expiring and the need to sell is there. The dollars are still there to buy real estate.
I think this is the perfect storm for real estate right now and even better for Auction.com. I have four thoughts on this. 1) There is still a lot of real estate you can describe as being in the “wrong hands” whether it is a financial institution that has taken property REO, or even an investor that acquired in the mid 2000′s and has too high of a basis. That real estate should be transferred into the hands of A) a true real estate operator (as owning real estate is not the financial institutions primary focus) and B) at the right basis to stimulate recovery and restore balance. 2) Where else are you putting your dollars right now? Real estate could be a high single-digit, low double-digit return, whereas what are your alternatives -the stock market? Bonds? Savings accounts? Tough to find a good return. 3) People are much more comfortable buying online today than they were as recently as three or four years ago, even for such items we traditionally thought you had to touch and feel, like shoes or cars, and finally 4) Technology today allows people to buy product online from any vendor anywhere in the world, from anyplace in the world. Using my laptop, iPad, or tablet, I can research, underwrite, contract, and close on a house, an office building, or any other real estate without ever leaving my house. So to me, it’s the perfect storm for real estate and an exceptional opportunity for us.