Flex Product Takes Center Stage in the South Bay

SAN JOSE—Kennedy Wilson Fund VI, a commingled fund managed by Kennedy Wilson, recently acquired five single-story R&D buildings and a two-story office building totaling 257,000 square feet in South San Jose for $53.5 million. The institutional-quality commercial buildings expand Kennedy Wilson’s presence in Silicon Valley and its growing portfolio of flex office assets across a global footprint.

“We are confident in the long-term prospects of the greater South Bay market where Kennedy Wilson Fund VI currently owns investments in excess of 660,000 square feet of commercial space. We were eager to move on an opportunity to acquire a high-quality portfolio with such a strong tenant base at a discount to replacement cost,” said Nick Colonna, president of commercial investments and fund management at Kennedy Wilson. “With return-to-work arrangements in flux, these six buildings are perfectly suited to adapt to the needs of a range of tenants long into the future.”

The portfolio feeds off the strong local technology, manufacturing, education and healthcare markets in the South Bay. The portfolio is currently 100% occupied by 15 tenants.

“There are many reasons for the renewed investor and tenant interest in flex industrial space, but I believe the most recent uptick is a direct response to evolving tenant needs as the result of the pandemic,” Colonna tells GlobeSt.com. “With flex industrial commercial properties, you are most often looking at one or two-story buildings with low density layouts, where tenants have their own separate entrances and the work environments naturally lend themselves to social distancing. We experienced growing interest before the onset of the pandemic too, as contract manufacturing has returned to the US across many industries including military, proprietary technology and medical. From an investor standpoint, we saw the opportunity on the horizon several years ago, and the potential for significant rent growth, lower vacancies and downside protection.”

As far as the benefits of individual entrances and lower TI costs attracting investors, Colonna says as the name suggests, this asset class lends itself to flexibility and a lower intensity usage.

“It also enables tenants to operate a variety of functions within the same space,” Colonna tells GlobeSt.com. “Many of our tenants are highly specialized in the products and services they provide, and will often have more traditional office space and customer service-oriented functions towards the entrance along with their accounting and finance teams, and then in the open back-area space, you’ll find the machinery necessary for manufacturing processing, assembly and staging. Tenant improvement costs in these spaces are typically lower on the front end and tenants tend to stay in their spaces for longer amounts of time, which further reduces operating costs.”

Beyond the recent deal in San Jose, other opportunities align with this trend, he says. Kennedy Wilson has an 11% interest in Fund VI, which targets value-add real estate opportunities in high-growth markets across the Western United States and focuses on underperforming real estate that should benefit from a significant repositioning or renovation through its asset management program. The Fund VI portfolio includes 13 multifamily, office, retail and other commercial assets in markets including San Jose and Los Angeles, Salt Lake City, Denver and Seattle regions with an aggregate purchase price of $1.1 billion.

“Kennedy Wilson has been active in purchasing flex industrial for the past three to four years, with our assets focused in high-growth STEM markets including suburban Seattle, the greater Denver region and Silicon Valley,” Colonna tells GlobeSt.com. “Prior to our most recent acquisition of the R&D portfolio in San Jose, we bought a 661,000-square-foot Denver area commercial portfolio with office and flex industrial space within Kennedy Wilson VI that is feeding off of the strong local technology, healthcare and aerospace markets with a line-up of well-capitalized investment-grade tenants.”

Finally, market demands have shifted with regard to flex industrial/office spaces. This has led to increased competition and leasing rates for those spaces, he says.

“We have seen the biggest demand shift and the most growth potential in the STEM markets that we target. We are generally interested in the technology-driven flex industrial space with sophisticated layouts that cater to a wide variety of tenants who can adapt quickly to the changing market environment,” Colonna tells GlobeSt.com. “We are also seeing more tenants moving into flex industrial spaces that could easily be housed in traditional office environments, but are gravitating towards the open layouts, extra space, flexibility and low-density layout that the flex industrial product provides. From a development standpoint, you have not seen a lot of this product newly built in recent years, as land is expensive and the rents have not warranted the development costs. I believe new construction of flex industrial property will begin to make more sense as rents continue to rise to meet the incredible tenant demand we are encountering.”