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The Potential of Office Assets in Real Estate Investments

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By Sonny Kalsi

As we navigate the current landscape of commercial real estate, it is clear that challenges lie ahead in 2024. However, I firmly believe that a rebound awaits us in 2025. Being a seasoned investor overseeing $80 billion in private funds at BentallGreenOak Group, I have witnessed the ups and downs of this market before, and I remain optimistic.

Recently, concerns about commercial real estate have been amplified due to New York Community Bancorp’s substantial reserve charge for losses on its real estate loans. Nevertheless, I choose not to panic. Instead, I see tremendous opportunities amidst the dislocations that dominate the headlines, especially in the office buildings segment.

Co-CEO of BGO, our firm was founded by myself and other veterans of Morgan Stanley’s real estate investment units in 2010. Following a merger in 2019, majority ownership of BGO was acquired by Canadian insurer Sun Life Financial.

With diverse interests spanning data centers, cold storage, apartments, and offices, BGO has become a prominent player in the industry. Our Manhattan office tower, located at 425 Park Avenue, houses esteemed tenants such as the hedge fund giant Citadel.

While individual investors may be more familiar with publicly traded real estate investment trusts (REITs), it is essential to recognize that the bulk of capital for commercial real estate comes from private entities like BGO. These entities, in turn, receive funding from insurers, pensions, endowments, and wealthy individuals. Compared to REITs, private funds have the advantage of utilizing more leverage, taking riskier bets, and swiftly seizing emerging opportunities.

Regarding the troubled office market, I firmly believe that it will eventually regain its strength. Admittedly, we have lost 20% to 25% of overall office demand as remote work becomes more prevalent. However, I do not think we have reached the bottom for office real estate. That being said, I estimate that we are approximately 70% through this downturn.

While it is true that the bottom quartile of office buildings, characterized by their age and lack of renovation, are struggling, I want to highlight that high-end buildings in the top quartile, exemplified by establishments like 425 Park Avenue, are thriving. These top-tier properties continue to attract tenants and command premium rents.

In summary, as we weather the challenges of the present commercial real estate landscape, it is crucial to maintain a forward-looking perspective. While setbacks are inevitable, I remain optimistic about the long-term potential and the opportunities that lie ahead. Let us seize these moments of disruption to reshape and revitalize the commercial real estate industry for a brighter future.

The Future of Office Assets and Real Estate Investments

BGO, a prominent real estate investment company, believes that the middle 50% of office assets hold great potential for profitability. Contrary to popular belief, this segment is not lost; it is where people will continue to make their purchases.

In addition to exploring opportunities in office assets, BGO is actively investing in Asian markets. Unlike many other regions, Asia does not face the challenge of remote work.

While multifamily dwellings, or apartments, have traditionally been considered a safe haven in the U.S. real estate market, Kalsi, the spokesperson of BGO, points out that rents are declining in certain markets like the Sunbelt. The Sunbelt region saw an oversupply of new construction due to aggressive bank lending. This oversupply has resulted in a decrease in rental rates.

Interestingly, Kalsi also highlights the potential stress faced by the multifamily sector. While office spaces are expected to face the most immediate challenges, multifamily properties follow closely behind. This knowledge shapes BGO’s investment strategy.

BGO has identified industrial property and data centers as the sectors with the most promising prospects. For several years, the company has been constructing cold-storage facilities. Previously, warehouse properties provided value for around 20 years. However, due to advancements in automation and the increasing need for electric power, they are becoming functionally obsolete after just 10 years.

The tightening lending policies of banks have created opportunities for private-credit suppliers like BGO to achieve equity-like returns on their investments. However, Kalsi emphasizes that this situation is temporary. Property owners cannot sustain the high interest rates charged by private-credit suppliers for an extended period. Additionally, the supply of private credit is significantly smaller compared to traditional bank lending capacities.

Kalsi predicts that banks will resume real estate lending when the Federal Reserve starts reducing interest rates later this year. Bid/ask spreads on properties are beginning to narrow, creating an environment conducive to increased transactions.

According to Kalsi, the gears of the real estate market will start moving again around 2025. This prediction indicates optimism for the future of the industry.

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