With an estimated 500 million square feet (46.5 million sq m) of underperforming commercial property existing in the market and an influx of real estate capital on the horizon, the repositioning of urban office towers is poised to become a major market-mover in the commercial real estate industry.
But repositioning aging office towers is a complicated and hands-on game that takes tenacity and requires developers to take on risk, with costly surprises often lurking around every corner.
Even those who have had success in the repositioning game say it’s not for the masses.
“Everyone would do this if it were easy,” said Patricia Hauserman, senior vice president of Tishman Construction Corp., who moderated a panel called “More Than Skin Deep: High-Performance Models in Repositioning Urban Office Towers” at the 2015 ULI Spring Meeting in Houston. “Many of these buildings have unknown conditions, and you have to maintain the quality of life for the tenants during construction. But it creates a major opportunity to keep tenants and attract new ones, and the ROI [return on investment] can be huge.”
Hauserman said the recent push in building repositioning is being driven by the availability of capital, a growing trend in urban consolidation—with the next generation of employees expecting to work in energy-efficient buildings in major city cores—and increased competition with new buildings that are continuing to rise in downtown areas.
Sarah Queen, senior vice president of asset management at Brookfield Property Group, said that repositioning makes good financial sense in certain situations—one being when an older existing portfolio building has some major leases on the verge of expiration, or when an aging building can be acquired for a price that allows for upside potential with a repositioning.
Finding the right building with the potential for the greatest returns can take developers deep into the trenches.
Matt Field, chief investment officer at TMG Partners, said his firm looks for “big and ugly buildings” that are ripe for repositioning, and John Mooz, managing director at Hines, said his company searches for “hairy projects.”
“We look for properties that have taken a nosedive, ones that are almost dangerous to be occupying” said Field, who pointed to the intense repositioning of a building in San Francisco’s SoMa (South of Market) district that had formerly been occupied by the telephone company.
TMG Partners paid $60 per square foot ($646 per sq m) for the Folsom Street building, and had to put another $425 per square foot ($4,575 per sq m) into the property in order to fully bring it back to life. Field said that finding a willing capital partner in these risky deals can be the hardest piece of the development puzzle.
“On this deal, we basically had to tell people that if they needed to run the numbers on this deal, they probably weren’t the right partner,” said Field, whose company now points to the Folsom Street building as a major success story.
Mooz said the biggest hurdle in repositioning buildings is not finding the right property that is ripe for redevelopment or appeasing tenants through the construction process, but rather having the willingness to absorb the risk.
“What we’re looking for is stuff that other people wouldn’t try to do,” Mooz said, pointing to the examples of downtown Houston’s One Shell Plaza and 919 Milam as two of the company’s riskiest repositioning efforts, and also biggest success stories.
In the case of 919 Milam, Hines bought the building for $44 million, performed a “very tricky” $15 million renovation, and sold it 15 months later for $102 million.
But repositioning buildings does not always result in a sale. Because of the potential to bring in higher-rent tenants, it often makes sense to hold a repositioned structure for the long term. Such was the case with the Brookfield’s Brookfield Place building in New York City. The 8 million-square-foot (743,000 sq m) building, which was built during the 1980s, saw a 3 million-square-foot (279,000 sq m) tenant lease expire into nonrenewal, which caused the building to dip to 60 percent occupancy. Following a major redevelopment effort—including $250 million spent just on renovating the retail space into a collection of 14 chef-driven restaurants—the building is back up to 95 percent occupancy.
Mooz said as the building stock around the country continues to age, the trend toward repositioning is beginning to gain steam. But the process can be complicated and extremely costly, so it makes sense only in certain cases. Prime candidates include structures with good bones that were built before the 1980s, a location in a strong urban market, and a position close to major traffic arteries, all of which contribute to a potential upside for brisk leasing activity and higher rental rates.
“It’s all about return—and then figuring out where that return will take you,” Queen said.
