Connect Media sat down with KBS CEO Chuck Schreiber to gather insights on the market, managing risk and real estate investment. An edited transcript of the discussion follows below.
Q: There are a number of headlines today suggesting that the commercial real estate market may start to soften. What’s your take?
Chuck Schreiber: There’s been talk of a softening for five years now. We always seek to be prepared for changes in the market which can happen rapidly. We focus on 16 markets and businesses are doing well in those markets. For us it is important to be sensitive to the needs of our tenants so that our properties can compete at the top of those markets.
Q: What types of properties, and markets, does KBS focus on?
Schreiber: We are strong believers in Class-A high-quality multitenant office properties. It costs more to operate multi-tenant properties on a quarterly basis, but when you look at it over a 10-year hold period there’s generally much lower risk for the investor. If we realize something is going on in a specific market that will change the demand from tenants, we will modify our involvement in that market. Having a national portfolio allows us to modify our presence in one market – it gives us a lot of flexibility.
Q: Where do you see growth companies migrating today with respect to office space, especially when gateway markets can be overpriced not just for space, but for employees who need an affordable place to live?
Schreiber: Urban markets with the right mix of amenities and public transportation are high on our radar, as are markets that are home to major universities with an abundance of tech, engineering and science talent. Today we are seeing tenants make moves into existing KBS buildings or extending their leases. These growth companies are making decisions and a key member of that committee making the decision is the director of human resources. For most growth companies today, selecting a property and a location that will attract the right kind of talent is critical to their success.
We are strong believers in Class-A high-quality multitenant office properties. It costs more to operate multitenant properties on a quarterly basis, but when you look at it over a 10-year hold period there’s generally much lower risk for the investor.
Q: What other factors do tenants consider?
Schreiber: Decisions are being made with flexibility in mind. Many tenants want the ability to grow or contract. If they are on four floors and sign a seven-to 10-year lease, there is a good probability the demand for their space will change—growing smaller or bigger—during that time. This is why we find that the hard work involved in buying and operating multi-tenant properties usually pays off in the long run from a risk perspective for KBS and our valued investors.
Q: Does the amount of debt that you deploy in your acquisitions factor into how you operate your properties?
Schreiber: We run conservative levels of leverage anywhere from 40% to 50% on our portfolios. We are focused on longer-term debt of five to seven years or longer. We do an analysis once a year to confirm we will have the funds to consistently improve our buildings. We may buy an $80-million building and we could allocate $1 to $2 million in strategic improvements to make it compete at the top of its peer set in terms of rents we can earn and the amenities and modern finishes we can offer to our tenants. We may anticipate that in five years we need to spend another $1 million to keep it competitive. It’s an ongoing demand and not over-leveraging our properties allows us to do that.
Q: What is the outlook like for developers today who want to build a new office building in a great market? What challenges do they face?
Schreiber: For the majority of the developers — and I am speaking of commercial office, retail and even industrial — if they are not substantially pre-leased it is very difficult to get a construction loan today. It’s hard to get dollars for speculative projects. They may have great land but if they do not have a tenant lined up for 80% of the space in a $100-million build, they will have a tough time getting a $50-million construction loan. Fifteen years ago, there was 75% to 85% leverage, but today they need twice as much equity. This means that the market is a lot healthier because we don’t have that risk of overbuilding.
We believe the biggest risk to assets in our portfolios is over-development. Tenants may be in an eight- to 15-year-old building and if a market is overdeveloped, that’s a big risk. This is why we are keenly aware of what is happening in every market we target for investment. We are blessed to have the portfolio that we built during the past six years, it’s a great time to own high quality Class A office space in the right markets.
Chuck Schreiber is the CEO of KBS, one of the largest office owners in the United States..
Pictured: The renovated lobby at the KBS-owned Meier & Frank building in downtown Portland.