Prospering in Office Property During COVID

In December of 2019 the managing partners of Selective Financial Capital moved forward with an investment in a value-add office building with a high vacancy rate. Unbeknownst to us at that time the COVID pandemic had begun. Starting in 2020 government mandated lockdowns would force many office staff to work from home with a deleterious effect on office real estate.

At the end of 2022 we exited our Washington Square investment. Given the once in a lifetime negative impact of COVID, many might expect negative results. But our investment in a high vacancy office building had a different ending than the headlines suggest. We met or exceeded our financial model. For instance an A2 investor of $100,000 or more, realized a return on investment of 26.5% versus our original projection of 23.6% in less than three years. This represented a gain of almost $77,000 on a $100,000 investment.

The reason we were able to deliver such strong results was largely because we focused on and got the real estate investing basics right. Our Washington Square investment is a story in what really matters when it comes to commercial real estate investing.

Details Matter

When it comes to real estate investing it’s the boring details, rather than the exciting headlines that often matter most. Our Washington Square investment in an office property was certainly impacted by the big negative headlines. Keeping and gaining tenants, collecting rents and even simply managing the property all became more difficult in the midst of the COVID pandemic. But the investing details mattered more.

For instance, our financial model was stress tested. Even though no one could have predicted COVID, we did anticipate the possibility of a recession. So, we modeled the details of a possible economic downturn. Our robust financial model factored in the possibility of a negative environment. Ultimately, we performed inline with those expectations delivering income performance within our modeling at its lower recessionary modeled range.

However, in terms of sales price we actually exceeded our modeling. There is a saying in real estate that the three most important factors are location, location and location. Based on several factors including positive demographics, local office supply versus demand and a business friendly climate we purchased in a Miami Florida submarket.

As much as COVID was a negative for office occupancy, it was a positive for Florida real estate. Florida was rewarded for its business friendly climate, as positive demographic trends were supercharged. We were able to more easily manage an office building in Miami than in other urban centers, and we took full advantage of the rising real estate prices to execute a sale at a strong price at the end of 2022.

Details, Dollars & Diligence

More than the headlines it was the details, dollars and diligence that mattered. We bought the property at a low price. We sold it for much more than we purchased. The low purchase price allowed us to model a robust financial model, where we could withstand an economic downturn and some negative financial headwinds and still deliver strong results. Dollars matter. What you buy, sell and can reasonably expect to earn on a property are key. And details, like those, as well as details like the location’s supply and demand dynamics, demographic patterns and business environment matter.

Just as important is diligence. A big part of our investment thesis on Washington Square was that prior owners had not been diligent enough. The property had been mismanaged. The vacancy rate was well above the local market. We believed diligent hard work could realize untapped value. But believing isn’t enough. You need to then do the hard work.

Of course the truth is we would have preferred an easier test of our investment thesis than a global pandemic. And we had to work harder than we anticipated to manage and lease-up the property. Ultimately, we did prove that the details, dollars and a lot of diligent hard work mattered more than the headlines.

Micro More than Macro

Certainly if you are buying an index of publicly traded real estate investment securities (REITs) owning a vast multitude of properties the headlines and big picture macros really matter. For example over the last three years the Dow Jones U.S. real estate index (IYR) has been flat. It’s been a tough market lately for a lot of investors, whether in stocks, bonds or commercial real estate.

But when it comes to an individual property the micro details often matter more than macro factors. We simply intended to make a good investment when it came to Washington Square. But then COVID came along. In realizing good investment returns, we also ended up proving the point that micro details, typically matter more than big picture, macro headlines.

Certainly, the headlines matter. In a more benign environment, we think our Washington Square returns would have been even better. But when it comes to an individual property it’s the details around an individual property investment that often matter most. So, don’t ignore the macros. But don’t forget to pay as much or more attention to a property’s pricing, local supply and demand dynamics, financial modeling, the management team and all the other little details often more critical to performance than the exciting headlines that get all the attention.