Commercial Real Estate Owners Alter What They Traditionally Invest In

For years, owners have recognized the importance of variety to reduce portfolio risks, but they’ve become increasingly dedicated to expanding their property types, while taking on more active roles in the buildings they cover. 

For example, Empire State Realty Trust, the owner of the Empire State Building, is a major player in Manhattan office. ESRT, however, has long dabbled in retail and multifamily, but recently increased its hold in these non-office projects in the outer boroughs of New York City, particularly in Williamsburg, Brooklyn. On the hospitality end, hotelier AKA made a name for itself with long-stay residences but has since acquired more traditional hotel buildings. Meanwhile, longtime conventional office owners that leaned on long-term leases such as The Durst Organization and Sage Realty have launched in-house flex office brands. 

Across commercial and residential real estate — not to mention the country — owners are expanding their reach in such ways, along with their roles. 

“Real estate is like a living organism,” said Scott Sherman, founder and principal of Torose Equities, a real estate investment firm. “So there’s always things changing, from market to macro trends to more kind of building-specific trends.”

Yet, many owners, Sherman included, are constantly anticipating — and reacting to — those changing trends. It’s always been part of the job to plan ahead and proactively assess not only what’s happening but also where things are heading, said Sherman. 

Across the board, the mission of real estate owners has remained relatively consistent, then, despite inconsistencies in the market. Independent of the pandemic, climate concerns and additional external factors, owners continue to strive for secure assets that make money and create cash flow. The difference is that they’re now taking fewer risks — and, frequently, a less passive approach — to get there. 

“Building owners always have to be concerned with the overall health of the properties,” said Francis Greenburger, founder, chairman and CEO of  Time Equities Inc. (TEI). “The concerns that are newer, or to some degree are more difficult in the last, let’s say, few years, are … the effects of climate change.”

He pinpointed the rise of natural disasters — whether floods, fires, tornadoes or other storms — as a major consideration within his strategy as an owner, which requires a careful lens to consider the risks of acquiring a property. While climate change is not a new phenomenon, “now we’re seeing it really play out, and we’re beginning to live with the extreme consequences of it, and it’s gonna get worse,” said Greenburger. 

The risks of climate change raise another, pivotal consideration for owners across the country, prompting owners to re-evaluate their portfolio strategies and reassess asset risks. Depending on a building’s location — though particularly for properties in South Florida — it’s increasingly difficult to get property insurance. Costs continue to go up anywhere from 10 to 40 percent a year, with an effect on lending and rents, said William Kramer, an attorney at South Florida-based Brinkley Morgan.

As costs increase, or insurance companies stop insuring properties, the insurance markets then dictate the choices of those properties’ owners. “Resilience is a topic of conversation in those markets, but that’s by necessity, not by choice,” said Cyrus Sanandaji, founder and managing principal of San Francisco’s Presidio Bay Ventures. 

Even if owners aren’t affected by natural disasters and corresponding insurance costs, they still have to grapple with the logistics and penalties of corresponding climate legislation designed to combat carbon emissions, such as New York’s Local Law 97 or Boston’s Building Emissions Reduction and Disclosure Ordinance. 

Consequently, owners today have to exercise sophisticated knowledge about various considerations in each of their properties’ markets. For TEI, the first step in acquiring any new property is to “put on extra sharp glasses to think about climate vulnerability,” said Greenburger. 

This need for sophistication underlies a major risk to the diversification and expansion of owners’ assets and markets, as different geographic regions — and building types — come with different requirements. Some owners, such as Sherman, have expressed more reticence in taking on new asset types, citing uncertainties and changes in the markets. 

“I’d rather be a specialist and focus on one or two asset classes and be good at those,” said Sherman, who said the evolution of owners’ assets depends on the market and the asset type. “I know what I know, I know what I don’t know. I’d rather stay in my lane and be good at what we know.”

The strategy — and challenges — for diversification therefore depend on the company in question. Allocators who rely on operating partners would likely fare better in owning all kinds of assets, as they can rely on the expertise of local operating partners, said Sherman.

Then again, climate concerns, regulations and costs aren’t always or necessarily changing owners’ paths and missions. Many owners are still buying assets on the beach, said Sherman. “Values haven’t fallen off a cliff,” he said. “It hasn’t really changed people’s behavior.”

Regardless, the climate and its costs — when coupled with high insurance rates — feed into the already unsteady environment shaped by the pandemic. In turn, these factors have prompted many owners to take on more active roles within their portfolios. Some, like Presidio Bay, are therefore not only expanding the kinds of assets they hold, but are also increasing their level of activity within the properties they already own. 

After all, the pandemic posed a question of the unknown for owners, said Sanandaji. It’s an unknown that owners are still responding to and trying to decipher, especially in terms of their investments. 

Perhaps no asset type better encapsulates the changing mission of ownership than office. It’s no secret that office, as well as retail, struggled after 2020. But while some owners have turned away from corporate towers, others, like Sanandaji, have taken an opportunity to expand their role.

Case in point: Presidio Bay remains bullish on office, but with an “experiential hospitality mindset,” he said. “Real estate ownership in the past was certainly a lot more passive in the sense that you could get away with just providing space,” said Sanandaji, who believes proactive landlords differentiate themselves from their competitors and ensure a building’s success. 

“I don’t think real estate owners are purveyors of space anymore; we’re purveyors of experience,” he said.

That’s not to say owners aren’t focused on acquiring properties outside of their typical hold. Take TEI, which Greenburger said has “always been hands on” and diversified as an owner of all property types, with the exception of hotels. Within the last five or six years, however, TEI has added roughly five student housing assets to its real estate portfolio. 

The fundamentals of student housing prompted that decision, said Greenburger. “We saw some opportunities at good prices and we said, ‘OK, let’s try it.’ We tried it, and the first couple of assets we bought went well, so we bought three more — and we’ve got one that we’re under contract for right now.”

Similarly, Brinkley Morgan’s Kramer has seen an increase in clients seeking self-storage centers across Florida, as well as Puerto Rico. One of Kramer’s clients, for instance, was previously focused on multi-
family in South Florida, but now is also pursuing self-storage. 

As for why that pattern has cropped up? “It’s easy,” said Kramer, who noted a self-storage demand from young people in need of extra space. “It’s low maintenance.” 

Looking ahead, he anticipates that owners will try to diversify even further, though no one asset type seems to dominate owner demand across the board — nor is diversification the strategy for everyone. Expanding and evolving asset types may be a strategy to make a portfolio less risk averse, but it comes with its own financial risks.

It used to be that owners with financial wherewithal to buy into properties could do so and experiment with less risk, said Kramer. Now, higher prices and rising insurance and interest rates mean there’s more to lose. It’s a question of where the fine line is, so you have to be in a market with good demand for that given asset type, he said. 

The public often perceives real estate as a business with large margins, but owners play with tight ones, said Greenburger. That means there’s little room for error. 

Changes in owner behaviors have therefore surfaced to varying degrees, with some efforts more subtle than others. Sherman, for instance, said his strategy didn’t change much, as he’s always approached real estate by getting in the weeds with tenants and assets. However, he gave the caveat that those tenants, building uses and amenities are evolving, and can understand how responsibilities have followed suit.

Whatever the changes to an owner’s responsibilities and assets, reducing risk remains a priority. Owners own properties for a living, said Kramer, and, “at the end of the day, they’re in it to make money.” 

Survival ultimately informs the decisions made by owners. “I would assume that most owners are really just trying to keep their buildings afloat and keep their buildings filled,” said Presidio Bay’s Sanandaji, though he also highlighted the importance of the more intangible aspects of ownership. Those facets include ensuring occupants’ happiness and fulfillment, as well as actively partnering with tenants to help them achieve their business goals.  

This mission of cash flow may seem overly simple, but, in a way, it guarantees consistency and a road map for the future. No matter how natural disasters, insurance costs, high interest rates and other unknowns may materialize, “the sole purpose, I think, [of] anyone who invests in real estate is to generate a return,” said Sherman. “I don’t think that’s going to change.”

Anna Staropoli can be reached at astaropoli@commercialobserver.com.