–By Jeffrey Reder, CenterSquare Investment Management
A few weeks ago, my son declared that he wanted me to build a treehouse in our backyard. My daughter was in the car and quickly encouraged the idea as well. The rest of the drive home was filled with discussion about where this treehouse would be located, what features it should have, what color it would be, etc. I found it fascinating to listen to the two of them describe what was important to them and I just soaked in all the different demand drivers. My son wanted it to look like a castle and be lower to the ground so the dog could get in. He also wanted to have a gas line around it to create a ring of fire to keep his sister out. My daughter wanted it to look like a pink dollhouse and be as high up as possible with access via retractable rope ladder to keep both dog and little brother out. Being the passionate real estate investor that I am, I couldn’t help but find myself making parallels to what we all do for a living.
While many external capital market forces beyond an investor’s control impact commercial real estate values, the underlying fundamental value is ultimately driven by the ability to successfully match the product with the end user demand. What is the right product and what are the key demand drivers will vary market by market and even submarket by submarket. For example, something as simple as parking can have different value propositions depending on the building quality and location.
At one end of the range, we’ve made investments where the key value driver was the creation of well-above-standard parking ratios (over 7:1000) to accommodate a deeper pool of high density users in suburban office markets. At the other end of the range, we’ve invested in urban assets with limited parking that appeal to users seeking creative, amenity-rich space with multiple transportation options beyond the car. Lastly, we’ve made investments where the parking “differentiator” was as simple as being subterranean with direct access from under the building in a market where it gets well over 100 degrees every day during the summer. The key similarity is that all of these properties are in solid job growth markets (Dallas, Denver, Phoenix) and are physically well suited for a specific target tenant base and are in the right locations (amenities, access, etc.) relative to the respective tenant demand they are targeting.
While I referenced office buildings above, the same rationale applies to all asset classes. Commercial real estate is a real asset that is impacted at its most fundamental level by its physical characteristics (quality, location, amenities) and the depth and nature of the end user demand. It is not a set of cash flows to be commoditized in a financial model. Superior investment decisions can’t be made simply by reading research reports and making general market bets. Understanding what drives value in a specific asset at the local level and making investments that can be best positioned to capture the targeted demand from end users will lead to relative outperformance in the face of any external forces that investors can’t control.
In case you are wondering how things shook out with the tree house, after extensive due diligence, it was determined that a tree house was not the highest and best use for the available space. Further research showed that deepest and most universal demand existed for an oversized spa instead.
The author, Jeff Reder, is a guest writer/blogger of Metropolitan Capital Advisors. Mr. Reder serves as a Senior Vice President in the Private Real Estate Group of CenterSquare based in the firm’s Southern California office. Jeff is responsible for the sourcing, underwriting and closing of real estate acquisitions and investment transactions in the western region of the U.S. feel free to email Jeff at email@example.com.
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