Real estate investors should consider adding exposure to prime-grade, central business district (CBD) office towers in the U.S., says Chip McKinley, senior vice-president and portfolio manager with Cohen & Steers in New York, and manager of the Renaissance Global Real Estate Fund.
This type of real estate, he explains, “has potential for strong, long-term growth at the property level, as well as at the total-return stock level.
“There are opportunities in major capital markets in the U.S., including New York, San Francisco, Miami and, to a slightly lesser extent, Los Angeles. There were also opportunities in Houston until the oil bust.”
There are two reasons to focus on these cities, says McKinley.
1. They tend to be more dynamic and cyclical. When demand comes back, he notes, builders will opt for the best locations first. And there’s excellent defense against new entrants in these regions because, typically, there are space constraints. As a result, “it’s hard to build new supply to compete in the [CBD office tower] space.”
So, if companies are already thriving in these major U.S. markets, they’ve got great earnings potential, given they’ll benefit from both occupancy and rent growth as supply shrinks.
2. Most CBD office tower companies “have been doing a good job of managing expenses over the last few years,” he adds. “As interest rates have dropped, they’ve been able to capture lower costs on their debt, which propels their cash flow growth.”