Going Contrarian: Why This Investor Bets on Offices

Denver-Based Confluent Looks for Deals Emerging for a Property Type in Low Demand

It's unusual to hear investors these days saying they're all in on office buildings.

Office sales across the United States have largely stalled as buyers respond to interest rates that have risen at an unprecedented clip, tenants that have offloaded more space than they take on and stagnant daily attendance that remains at a fraction of pre-pandemic levels. Yet despite hoopla over downtown "doom loops" — the narratives about how employees will never return to the office that is pushing some investors away — others are ready to dive in.

What makes their bet attractive? One reason, potential buyers say, is that the naysaying can help drive down prices, making it possible to score a deal.

One investor, Denver-based Confluent Development, may be a small player in the national office market, but its strategy can be seen as a litmus test for the types of deals buyers are willing to pursue.

"Not all office buildings will be warranted, but with a laser, rifle-shot approach, you can find some real quality assets that are valued at or below a significant discount," Cadie Crean, the development director for Confluent, told CoStar News. "We are taking a risk, and we understand there's risk involved, but you figure out how to mitigate it. For us, we know offices matter, and that won't ever change."

For Confluent, that ethos underpinned the firm's decision to kick off an investment strategy focused on acquiring office properties. A building has to meet certain criteria for Confluent to entertain a bid, Crean said. The firm is not interested in 50-story downtown towers or older properties that require far too much work and are unlikely to tip the cost-benefit scale.

"There are some buildings that just need a ton of capital to be able to rebound and remain offices," she said, adding that the firm is focused on properties built post-2000. "We won't be buying a giant office tower in Uptown Denver, but there are some strategic places that could be really interesting or a play with some vacancy that we believe would perform in a normalized market. There's a unique opportunity for us to get in at an attractive basis and generate outsized returns because of the timing."

With an eye on several deals across Colorado, California, Texas and Utah, Confluent set its game plan in motion with its late-December acquisition of a fully leased office building in Lone Tree, Colorado. The firm paid $23 million for the property that serves as the corporate headquarters for Cochlear Americas, a medical equipment maker that recently spent millions to finish out the space and still has seven years remaining on its lease.

That stable income stream, the building's good construction quality and the value of Cochlear's recent improvements all contributed to the makings of an ideal purchase, Crean said, adding that the seller was a motivated real estate investment trust looking for a speedy exit.

The seller in the Lone Tree deal was W.P. Carey, CoStar data shows, an investor that drew attention last fall when it moved forward with a plan to get out of the global office market quickly. The REIT, which serves as something of a bellwether for international workspace demand, set a goal to sell off its entire portfolio of 87 office properties by the end of 2023.

Confluent's circumstantial approach to investing points to an accelerating interest in buyers taking advantage of some firms' disposition sprees.

"Leasing demand is so specific deal by deal, and each market only has a handful of deals that fit our strategy," Crean said. "We're taking a multi-market approach, and while there will be winners and losers with each location, we're looking for where that path of growth is, and we're in a window of time where we're in the best position to get the best pricing on a deal."

All About Timing

A spectrum of investors small to large has acknowledged there's a window of time when they can scoop up attractive office properties at bargain basement prices. Yet for some, the benefits of positioning themselves for a potential office comeback have to outweigh the inherent risks that come with unpalatable factors such as higher interest rates.

"We are only interested in acquiring new assets at distressed prices," Vornado Realty Trust CEO Steven Roth told Wall Street analysts on a recent earnings call. "The markets are open and lenders are prepared to give you money, but only at 8%. That's not open to me because the cost of that capital is just too high. Now is not the time to be aggressively borrowing unless you absolutely need it."

It's a sentiment shared among institutional investors and REITs, a group that has historically been responsible for roughly 40% of all office transactions, according to CoStar analysis.

"There's definitely evidence in the math that the buyer mix is relatively more heavily weighted toward smaller buyers than what had been the 'normal' ones," said Phil Mobley, CoStar's national director of market analytics. "It probably has more to do with the larger ones being out of the market unless distress forces them to sell."

Sales for office properties across the country dropped to record-low levels last year, with activity falling nearly 60% below 2022, CoStar data shows. While those figures mirror the investment pullback that occurred through the Great Recession, today's office market faces a far different outlook than the one analysts were forecasting in 2010.

That has meant smaller or privately operated firms such as Confluent, San Francisco-based Presidio Bay Ventures and New York's RXR Realty have stepped in to fill the gap.

Each one is following its own playbook, but the guiding strategy is the same: Take advantage of a vulnerable market to score deals most otherwise wouldn't be able to afford.

"Smaller buyers tend to be lower leverage, so the interest rate environment hasn't been as dissuasive to them," Mobley said. What's more, "a lot of it is just smaller, leaner buyers can move when they want and there are enough of them willing to take the risk. They don't have to run everything by a 12-person investment committee."

Fast Action

The ability to move quickly and decisively has populated the national office market buying pool with investors that see the potential for future demand.

Presidio Bay, for example, last summer acquired a San Francisco office tower for $41 million, less than half the $107 million that seller Clarion Partners paid to acquire the building roughly a decade ago. Cyrus Sanandaji, Presidio's founder and managing partner, attributed the firm's decision to the momentum behind the return-to-office movement as well as the city's tech revival, a recovery that's been fueled by an influx of artificial intelligence startups leasing space in and around downtown San Francisco.

At RXR, a firm with a portfolio valued at nearly $20 billion of trophy office properties, CEO Scott Rechler is taking an "eyes wide open" approach to investing in high-quality buildings that are in some form of financial distress. The firm recently teamed with Los Angeles-based Ares Management to collectively invest $500 million to acquire challenged office properties across New York, a budget that could ultimately expand to $1 billion.

“Office gets painted with an overly broad negative brush,” Rechler recently told CoStar News. “We are still strong believers in the office market and we believe there is opportunity in this environment.”

With the right building and an attractive list of amenities, investors' pursuit of deals underscores their bet that — despite some short-term hurdles — the demand for office space won't disappear. Even more telling is that, despite all the conversations and pushes to convert office space into alternative uses, some of these investors want to preserve a component of their new purchases' original purpose.

Corporate giants such as UPS, IBM, Bank of America, Amazon and Kroger are gradually solidifying their return-to-office plans, eliminating the uncertainty that had previously been clouding their ability to gauge how much real estate they needed and where. These moves can make tenants more comfortable with longer-term commitments, a shift expected to translate into more deals throughout the next few years.

That means buyers such as Confluent want to be prepared.

"Flexible work isn't going away, but the amount of time companies mandate bodies in the office will go back to at least three or four days a week," Crean said. "We're seeing more companies that tether performance to office attendance, and for those that want to solidify their culture, the easiest way to do that is to get bodies back into the same room."

Article originally found on CoStar