Particularly in markets such as Denver, Phoenix, San Antonio and Las Vegas, many distressed and underperforming properties came to market with significant vacancy and low in-place rental rates. The lack of employment growth from 2001 to 2004 had taken its toll on owners who had grown tired of waiting for demand for office space and rental rates to improve. Such properties were offered for sale at attractive prices, sometimes less than half replacement cost.

Thanks to solid employment growth in 2005, there was a marked improvement in demand for office space as the year progressed. As a result, adding value through leasing was relatively easier to achieve. Rising construction costs made the fixing part of the value-add process more expensive but also served to postpone construction of new office buildings that would add to supply and depress rental rates. Overall, high occupancy and stabilized office properties were goals that were easier to achieve in 2005 than any time since 1999.

The icing on the cake for value-add investors is the continuing strong demand for investment real estate and low long-term interest rates that boost returns. In the current low cap-rate environment sales prices are high for properties that have been through the value-add process and are now stabilized, despite the fact that rental rates are well below highs set in 1999-2000.

For example, in December 2004, we acquired the Quad at Lowry for $92 per sf. Lowry is a well-located, class A office building in Denver that was built in 2000. The low price, approximately 50% of replacement cost, was due to low in-place rents (rental rates had fallen from $17 triple net in 2000 to $10 in 2004) and low occupancy (48%)--both soft-market factors. After nine months of aggressive leasing efforts, occupancy reached 100% and the property was sold for $168 per foot in January 2006 after a holding period of 13 months.

In the current investment environment, value-add office buyers can buy low, add value quickly through fixing and leasing and sell into a strong market once an asset had been stabilized. That's how 2006 should continue to shape up.

Chad Carpenter is co-founder and chief executive officer of La Jolla, CA-based Equastone, a privately held real estate investment firm.

Instant Insights /

Value-Add Office Looks Good in '06

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