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Is this the most damning chart we've ever made?
---- A common problem ----
Higher interest rates:
...cheapen returns.
...make investors need to get paid more for each risk profile.
...which puts downward pressure on values in the short run.
This dynamic has affected every commercial property over the last few years.
In this way, we're all in this together.
---- The way out ----
Values won't fall indefinitely.
Since real estate is relatively correlated to inflation, most properties will get back to those peak values. ...and if they do it quickly, they could even cover those peak debt loads.
But the only way to make progress in a rising rate environment is to grow NOI.
...and some property profiles are much more capable of growing income than others.
---- Office NOI growth ----
There's a growing consensus that inferior office properties are toast. Many believe these properties are functionally obsolete in a post-COVID world.
But what about higher-quality surviving properties?
Boston Properties (BXP) is a $10 billion office REIT. It's one of the oldest legacy REITs and owns some of the most favored U.S. office properties.
Seems like a decent benchmark for high-quality office properties.
Here are BXP's TI/LC expenditures (per square foot) over the last 11 years:
2013: $36.99
2014: $29.60
2015: $45.40
2016: $62.04
2017: $57.58
2018: $67.47
2019: $82.11
2020: $78.68
2021: $71.71
2022: $83.70
2023: $77.72
Overall, leasing CapEx is up by about 2x in 10 years. Ouch.
But you have to spend money to make money, right? Maybe these investments led to outsized income growth.
Nope.
BXP's NOI only grew by 42% over the same period between 2013 and 2023. And these don't seem like anomalous years. Here's a comparison of three years averages, then vs. now.
Scorecard: 2013-15 vs. 2021-23
Measure Then Now
------------------ ----------- -----------
Leases 4.3 msf 4.7 msf
Avg NOI $1.5 bil $1.9 bil
Avg TI/LC spend $162 mil $364 mil
Per SF $38.14/sf $78.19/sf
---- Takeaways ----
Some sponsors will make fortunes by buying and selling office buildings over the next few years.
But 80% (ish) of office investors are long-term, income-oriented investors. They're not fix-and-flippers.
TL;DR: Even high-quality office buildings seem shackled by high CapEx burdens, which will make it much harder to grow income and value.
Can buy-and-hold investors outperform other asset classes by buying office?
What are we missing?
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