The Power of a Balanced Portfolio: Q&A
- Apr 07, 2021
As landlords and tenants adjust to a new office environment reconfigured by the pandemic, KBS, one of the largest owners of office properties in the U.S., is applying long-standing principles tested throughout many cycles.
“The company takes a long-term approach to investing,” Robert Durand, executive vice president of finance at KBS, explained to Commercial Property Executive.
In the discussion below, Durand highlights the importance of relying on the right capital stack when it comes to building a balanced portfolio, and he shares his outlook for office investment market in 2021 and beyond.
What are the main factors for KBS when evaluating an investment opportunity today?
Durand: KBS has navigated through many market cycles, and the company takes a long-term approach to investing. We understand that unexpected events can and will likely occur, so we factor these risks into our investments and underwriting. While no one could have predicted the COVID-19 pandemic, our goal is to structure portfolios to limit downside exposure during times of uncertainty and this strategy serves us well today. The KBS portfolio has achieved rental collections in excess of 95 percent throughout the pandemic and leasing activity remains healthy across the portfolio.
With this in mind, we continue to evaluate investments with the same criteria we use in all economic climates. We look for markets and properties that closely align with our investment strategy. This includes markets with diversified economies, strong population and job growth and respected educational institutions, as well as properties that offer excellent amenities, walkability and access to public transportation and highways.
What is a typical KBS asset?
Durand: We place an emphasis on top-tier, Class A office assets with a diverse range of creditworthy tenants. We’ve seen pricing among these assets remain relatively stable throughout the pandemic. We also successfully leased and renewed more than 2 million square feet throughout the pandemic, demonstrating the continued demand for high-quality office space in core locations.
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What is KBS’ strategy for building a balanced portfolio?
Durand: KBS understands the importance of having diversification within its portfolio. This includes geographic, tenant and tenant industry diversification. Most of our assets are located in key business districts or prominent urban centers in top-performing markets in the U.S. We also strategically work to ensure that the tenant mix of each asset is diversified across a variety of industries. That way, no asset is significantly impacted by shifts in a single tenant or within a single industry. Each of our portfolio’s revenue streams are also diversified in that no single property contributes to more than approximately 13 percent of the portfolio’s rental income.
Beyond this, we have an asset management team that approaches markets and properties on a granular level. Real estate requires a local approach, and we incorporate this into our investment strategy. This enables us to study market data closely and have a solid understanding of both higher-level and local market trends. It also allows us to make important decisions about our investments, including acquisitions, dispositions, financings and opportunities for development and renovation where it is accretive to our investment strategy, at each property within each fund.
In late 2020, KBS completed three major refinancing deals totaling $527 million. What was the strategy behind such an elaborate deal?
Durand: The three major refinancing deals we completed in the fourth quarter of 2020 included a $375 million loan for Accenture Tower in Chicago; a $123 million loan for The Almaden in San Jose, Calif., and a $28.7 million loan for Crossroads Distribution Center in Charlotte, N.C. For each of these transactions, KBS leveraged the business expertise of our in-house finance team to understand a complex capital markets environment and identify refinancing opportunities that would be advantageous for our investor clients. We believe these transactions and their size show that lenders still have faith in high-quality, well-located assets in strong markets throughout the country, even in the face of a global pandemic.
U.S. Bank and Bank of America jointly led the Accenture Tower refinance—U.S. Bank served as the administrative agent, with Deutsche Pfandbriefbank joining the lender group at closing, and the National Bank of Kuwait joining in the first quarter of 2021. The loan floats over LIBOR and is structured with a three-year initial term and two one-year extension options. Twenty-five percent of the loan commitment is revolving, which provides KBS REIT III with the flexibility to draw capital as needed and to pay down the loan to better manage liquidity needs.
Refinancing The Almaden with Equitable Financial Life Insurance Co. allowed KBS REIT III to increase the loan amount and increase liquidity reserves while taking advantage of the historically low interest rate environment. This loan consists of a three-year initial fixed-rate term with two one-year floating-rate extension options.
Citizens was able to provide a new loan to refinance Crossroads Distribution Center. The loan included a three-year initial term with two, one-year extension options, all floating over LIBOR. This financing was custom-tailored to match the leasing activity at the property and provides additional liquidity for one of our sovereign wealth funds.
How does KBS approach potential financing transactions at this point in the economic cycle?
Durand: While the office market fared better than the retail and hospitality sectors last year, lenders remain cautious and are being very selective when it comes to making new office loans. KBS firmly believes that demand for office space is not going away. Many news sources have reported that office workers are becoming weary of working from home full time and many are eager to go to an office where they can collaborate with their team members, be more productive and take advantage of the resources and amenities offered in the modern office property.
You simply cannot duplicate the social experiences of the office environment in a remote setting. It is impossible to properly train, mentor and elevate employees and build a real company culture when working from home.
Overall, our outlook on the office sector remains positive. We believe that the sector will rebound once we emerge from the pandemic and the economy ramps back up again. As COVID-19 case numbers decrease and vaccinations increase across the country, we believe the office market is well-positioned for a solid recovery.
What are some steps that can be taken today to reduce future risk?
Durand: Developing property portfolios that are diversified across geographic markets and having asset managers that frequently travel to those markets to walk the streets and meet with tenants and users provides our teams with unique insight into the emerging trends in each area. Even though you can’t prepare for every scenario, maintaining this strategy helps reduce and prepare for future risks. That local knowledge and preparation are among the reasons our properties have performed over the long term, even through the pandemic.
From a big-picture perspective, what changes do you expect to be temporary for the office sector and what is here to stay?
Durand: We are seeing some reconfiguration of office space to allow for social distancing, mask-wearing and sanitizing protocols. Floor signage and wayfinding to help maintain social distancing has also become mainstream. We will likely see touchless and increasingly automated systems take hold in office properties to help prevent viral transmission. Increased focus on enhanced air filtration and a healthy work environment will likely survive the pandemic and will likely be tenant requirements going forward.
In 2020, KBS began working with Maptician—a cloud-based workplace management platform that utilizes technology and data to reconfigure office and community spaces—to facilitate a safety-conscious return to office for tenants. Technologies like this will help companies make the transition from remote work to working in an office again and help employees feel safe and comfortable in doing so.
We haven’t seen a major shift in the way office buildings are designed or developed as a result of COVID-19. While some developers and tenants are configuring more private offices, changing their furniture layout and creating more space between employees, we haven’t seen anyone completely alter their floor plans long term.
Going forward, how do you expect the office real estate investment market to perform?
Durand: We see great promise in the office real estate investment market. The current low interest rate environment is also a great tailwind for real estate investors who have an opportunity to refinance and take advantage of these historic low rates. KBS has been encouraged by the strong leasing activity we experienced from March through December of 2020.
As mentioned, we signed just over 2 million square feet in lease transactions during the COVID-19 pandemic in new leases, renewals and expansions that spanned across our $8 billion portfolio. This demonstrates just how much companies are longing to return to a physical office and their commitment to this return even in the face of a serious global crisis. That commitment is what we expect will drive office investment for the rest of 2021, into 2022 and beyond.