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Seeing the upside...inside and out
Developers find hot market in repositioning outdated offices for modern times
NJBiz.com
February 16, 2015
Original Article

The three-story office building was built nearly 30 years ago, but Prism Capital Partners saw the upside in 2013 when it acquired 339 Jefferson Road in Parsippany.

And the firm is now taking steps to make prospective tenants see that potential: It's modernizing the lobby, adding a fitness center and right-sizing the existing cafeteria. It's also gutting most of the built-out space from the previous tenant, which was dominated by the types of private, heavy-walled offices that are becoming things of the past.

"So a new tenant, a smaller tenant who is going to come in now and look at the floor can actually see what it looks like and envision how they can lay themselves out," said Eugene Diaz, a principal of the Bloomfield-based firm. "It's very difficult for tenants to do that when they're staring at offices everywhere and unable to see from one end of the floor to the next."

It's a formula that has worked recently for Diaz and other savvy real estate firms in New Jersey — acquiring outdated office buildings and repositioning them through a series of key upgrades. And experts say it's a still-growing niche for investors and developers, especially in a state where most office properties are more than 30 years old.

Just last August, a venture led by Boston-based Marcus Partners paid $69 million to acquire 500 Plaza Drive in Secaucus, with plans to spend $15 million to upgrade the 450,000-square-foot building. In December, Rugby Realty Co. acquired Three Gateway Center in Newark for $42 million and said it will invest $20 on improvements.

Such opportunistic investors began flocking to distressed office buildings in the state early in the recession, said Charles Parmelli, a Chatham-based broker with DTZ. But he noted that "these were not necessarily really established landlords — they were either coming from other businesses or had been trying to get into commercial real estate."

"I think that we have seen more than a couple of those situations end up going back into distress before any sign of recovery," said Parmelli, a vice president with the firm. "And that's a matter of market timing, I guess, and not necessarily their fault. They thought it might recover quicker (and) they'd be in at a good price, but there was just not enough leasing velocity."

Not to mention that the improvements at the time were "all window dressing," Parmelli said — superficial upgrades such as new lobby furniture and paint.

Today, however, investors are putting in significantly more capital — more than $10 million, in several cases — to fund upgrades such as renovated lobbies, new mechanical systems and new or renovated amenities and common areas.

"It seems like they're really listening to what the tenant's needs and demands are, and they're accommodating it," said William O'Keefe, a senior vice president with DTZ.

He added that, in most cases, investors are buying the buildings at prices that allow them to offer rents that are attractive to prospective tenants, even after they spend significant dollars on renovations. And the upgrades often lead to what feels like a brand new building, helping the landlords stand out among the competition or even offer better value than a newer option with the same rents.

"There's clearly a flight to quality," O'Keefe said. "And if you can take an older building and renovate it to a Class A trophy product, you're going to see it pay off."

For developers, the projects are attractive alternatives in a state with little demand for new construction. Sam Morreale, managing partner of Vision Real Estate Partners, noted that "the older stock is typically in more of the primary locations than some of the newer stock" in secondary and tertiary locations, so the firm isn't afraid to go into markets "that aren't that healthy" and take on projects with high vacancy.

That also means the developer can act as a catalyst in a town whose longtime corporate tenants have moved on and left them with empty buildings.

"I think you have existing buildings that are nonperforming or low-performing in a community, so the ability to re-enhance that ratable is important to the community," Morreale said. "We're not cutting down cornfields to try to build new construction, which is more expensive, takes longer … and you have a lengthy and costly approval process to try to bring new construction out of the ground."

The Mountain Lakes-based firm last summer completed the redevelopment of a three-building office park in Hanover's Whippany section, which included major upgrades to a 150,000-square-foot building on the campus. It's now repositioning the first of two 100,000-square-foot office buildings in Montville last occupied by Bayer HealthCare, which it vacated in 2013 when it consolidated at a new headquarters built by Vision in Morris County.

Morreale said projects vary, but estimated the savings between repositioning an office building and building one from the ground up could be at least 25 percent. Aside from a shorter entitlement process, such a project benefits from already having utilities in place and being connected to existing roadways.

"There's a lot of speed to market that relates to cost-savings for everybody involved."