Inside Changing Pressures on Asset Managers

With tenants looking for shorter lease terms and tenant improvement costs rising, greater emphasis is being placed on the role of asset managers. ASB Real Estate’s managing director Jim Darcey talks about the value-add of asset managers today—and where the greatest pressures are being felt.

PrivcapRE: It’s a truism that asset managers operate ‘where the rubber meets the road’. How do asset managers add value?

Jim Darcey, ASB Real Estate: At ASB, we put a lot of emphasis on enhancing value after the buy. We always work hard to execute a solid transaction, but it’s what we do afterwards that makes us different. Our Capital Investment Group (CIG) is responsible for every property throughout its holding period. The CIG group manages all major real estate functions—sourcing, asset management, and the ultimate sale—creating ownership and accountability. Management teams are organized by asset, rather than by property type, geography or portfolio. They are constantly out in their markets and have a deep knowledge of local fundamentals.

Asset managers are responsible for each property’s budget. What kinds of budgetary stresses are you seeing today, compared to five years ago?

Darcey: Real estate taxes are a major issue today. Local jurisdictions face budgetary pressure and commercial property tax revenue is one way to bridge the gap.  Construction costs are another stress point. As the recovery gains traction, development is on the rise; as a result, material and labor costs are rising as well, affecting renovations and tenant improvement (TI) projects.   

What kinds of concessions and TI allowances are tenants demanding? 

Darcey: Tenants have always been demanding; they have every right to be demanding since after all, they are paying rent. But today, the demands are different. Demographic trends are changing the composition of the workforce, and millennials are playing a larger role in decision-making. In office buildings, the standard configuration of perimeter offices with internal cubicles, dropped ceilings and an interior kitchen are out of date. Now, open, collaborative spaces with interesting layouts, closely spaced work stations, and gathering places such as meeting spaces, entertainment areas and large kitchens are in demand. The search for interesting space is pushing tenants to less traditional markets in a search of live/work/play locations with high walkability and good public transportation. The aesthetics of place is as important as the aesthetics of space.

What changes are you seeing in lease terms? 

Darcey: Today, many tenants face uncertainty with respect to their long-term space needs. Small startups typically have a higher-than-average risk of failure, while more established businesses with strong growth prospects have to consider the possibility of running out of space. If a business does not have a long operating history, its future can be questionable and its growth in doubt. To mitigate uncertainty, a growing number of tenants are seeking leases structured for flexibility, with shorter terms and numerous renewal options as well as expansion rights to accommodate growth.

What concrete steps can the manager take to prevent assets from becoming problem assets?

Darcey: Every year the CIG group works through a formal process to rank all of ASB’s assets from top to bottom. An analysis of the bottom quartile explores why the asset is underperforming, how to fix it, and if a fix is not possible, an exit strategy is formulated. The active management approach is followed: “If you’re not a seller, you’re a buyer.”

Are holding periods shorter today? What triggers an exit?

Darcey: ASB’s philosophy is to build a strong portfolio positioned for growth across the cycles. In general, the strategy is to buy for the long term, but the firm is an active seller, redeploying capital where it can be put to better use.    

Are you seeing more pressure to improve the operating efficiency of your buildings, given the increased emphasis on sustainability?

Darcey: It’s just good business to operate responsibly. Some tenants are laser-focused on sustainability and this may influence their choice of space. The use of EnergyStar programs is almost a given. Achieving LEED Gold or Platinum designation can be hard, but it’s an important goal.