Apply Efficient Frontier to Guide Property Returns

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Are you bringing spaces to market for re-let 1-3 months ahead of the lease expiration date?  Are you applying the same lead time for lease renewals?  (Even 6 months lead time puts your property cash flows [and relationship with tenants] at undue risk).  Do you know if market competitive lease terms, or transactional renewals and re-lets are good for property returns?    Consider viewing your multi-tenant property as a collection of investments (i.e. leases) that generate a portfolio return from the interaction of cash flows.

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Efficient Frontier

Apply Modern Portfolio Theory (MPT) and Efficient Frontier (EF) to your renewal and re-let efforts to curate preferred property returns consistently.  Investopedia.com defines EF as follows “The efficient frontier is the set of optimal portfolios that offer the highest expected return for a defined level of risk or the lowest risk for a given level of expected return.  Portfolios that lie below the efficient frontier are sub-optimal because they do not provide enough return for the level of risk.  The efficient frontier rates portfolios (investments) on a scale of return (y-axis) versus risk (x-axis). Compound Annual Growth Rate (CAGR) of an investment is commonly used as the return component while standard deviation (annualized) depicts the risk metric. The efficient frontier theory was introduced by Nobel Laureate Harry Markowitz in 1952 and is a cornerstone of modern portfolio theory.”

View the multi-tenant property of focus as one investment portfolio.  Identify the rate of return your organization would accept from alternative investments to earn on equity invested in the property (e.g. other properties, notes, equity or debt securities); that rate is the opportunity cost of capital (OCC) to discount cash flows of potential rents.  IRR is the annual return derived from the interaction of positive and negative cash flows, assuming profits are re-invested into the property.  As noted above, leases are individual investments whose cash flows generate a trend of IRRs that achieve EF for the property over a holding period.

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The EF can be realized from renewals and re-lets by determining the market value of: renewals, most likely uses of re-lets from basement to rooftop, optimal subdivisions of floors, and exterior signage on highly-visible exterior walls.  Give yourself enough lead time to evaluate whether to change tenants and lease terms to sharpen performance of the EF.  (The lead time enables social responsibility for the incumbent tenant to relocate within a reasonable period of time.)  Projecting the discounted cash flow (DCF) will enable you to identify the rent psf required from each lease over its term to achieve EF over a defined holding period.  The DCF is necessary to factor the rent roll, expense schedule, and debt service to identify equity returns, NPV, and IRR for each year of the investment’s holding period.  Discounting NPV annually at OCC will show EF trend per year from cash flows.

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If your organization is a long-term holder of property (i.e. up to 30 years), I suggest viewing EF in cycles of microeconomics that factor lease terms of your anchors.  Lock-in lease terms ahead of declining microeconomic conditions to ride out the cycle until rents begin rising and concessions decline.  For example, storage, retail, loft, office, healthcare, and multifamily spaces each have different market values with different needs from leases.  If your anchor leases are 20 years and microeconomic cycles are 7-10 years, cash flows from anchors are a hedge against market cycles, improved by cash flows from mid-range leases (e.g. 7-10 year terms), and improved from volatility of transient leases (e.g. 3-5 years).

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Ensure lease templates match the needs of use categories, yet are fine-tuned to economic and legal terms negotiated with each tenant.  The sum of lease templates per space category contributes to posture the property with inherent strengths and residual risk to support its market value.  This posture plus accurate financial reports showing EF can attract capital markets or buyers, extracting the most market value from the property (to finance or sell).

Prior Planning Guides Efficient Frontier

Re-letting space at favorable market terms may not perpetuate the EF.  IRR can be negatively impacted if space is brought to market within a few months of becoming vacant, causing lost cash flows from systematic (e.g. uncontrollable) forces of supply and demand.  Months may pass when no lease terms or property sale can recover all lost cash flows from vacancy; that state could also bring DSCR too close to NOI, upsetting your investors and lender(s).  In contrast, if renewals or re-lets are planned to factor lead time and market timing to complete them at preferred lease terms, EF is maintained, optimizing returns derived from cash flows (e.g. rent roll, expense schedule, debt service).  (Note that EF helps to improve tax benefits derived from depreciation and interest expense.)

Therefore, factor microeconomic forces of supply and demand to restore cash flows from new leases; add lead time for construction permits, construction, and rent concessions.  Each expiring lease should be evaluated with 6-8 months lead time from tenant’s move-in date.  Add time to secure construction permits, building materials and labor, for lease negotiations, space tours, and space marketing; the lead time could become 18-24 months ahead of a lease expiration date.  Any tenant should know whether they’ll remain in a space two years ahead of lease expiration.  Marketing to re-let spaces should occur when rents are full and robust; tours of units to become vacant are carried out per notice terms in the lease.  The goal of re-let is to optimize cash flows from a synergistic rent roll at lease terms approved to realize EF for the property.

Summation

Commercial real estate has evolved into market consciousness as an institutional investment grade option among equity and debt choices available from primary (investment bankers) or secondary (stock exchange) investment markets.  Therefore, factor investment objectives for your multi-tenant property over the holding period, approaching economic management from an asset manager’s perspective.  Realize objectives by determining most-likely uses of space, fair market rent, cost-effective operating costs, low financing and re-let costs.  Model these attributes into a DCF projection, add sensitivity analysis to test tuning attributes.  Optimize your rent roll through anchor, mid-range, and transient leases as outlined above.  Discount annual NPV at the OCC to determine rent needed to achieve EF from the interaction of positive and negative cash flows.  EF is achieved when the rent roll (IRR from cash flows on x-axis) equals risk (lease years on y-axis).  Hold mindshare meetings with senior staff to agree on lease terms the leasing team will secure to achieve EF.  Hand an abstract of the approved lease terms to the managing agent or agency leasing rep to guide them to secure from renewal and re-let deals.  This is a spiral process of steps as renewals and re-lets come due within 30 months.  Re-model terms of the abstract within 12 months of each new microeconomic cycle; the results will position your property to achieve EF from its next holding period of cash flows.

I trust the approach outlined above has been helpful to shaping economic performance of your multi-tenant property.  BREG prefers to take leasing assignments by applying Modern Portfolio Theory to achieve the Efficient Frontier from stabilized cash flows.  BREG can create the Efficient Frontier for your property by applying template spreadsheets in MS-Excel; we will prepare an asset management plan for you to review and edit or approve.  Please click “Request A Consultation” link in the upper right of the screen.  Enter “MPT: Efficient Frontier” in the subject line; please include the name, email address and telephone number of you or your executive assistant in the message body; I reply within 24 hours to arrange an exploratory conference call.  Thanks for reading and listening.###

Portfolio Management: Position Commercial Property for Sale

A natural goal of property sale is to leverage market conditions to optimize value from equity, operating cash flows and/or capital appreciation.  A high-level business analysis of objectives can position the price to attract your target buyers.  Stabilized long-term future cash flows are likely to attract low-cap core buyers.  Expiring leases totaling 25-40% of GRA are likely to attract value-add buyers.  Vacancy of 41% or more or sale of surplus land is likely to attract opportunistic buyers (e.g. property reposition or land development).  Feasibility analysis should factor stakeholder interests of property ownership (e.g. equity invested), portfolio management (e.g. return on investment), and asset management (e.g. value of cash flows).  Analysis should produce 3-4 sale paths that meet yield objectives of equity invested.  The holding period should be limited to the asset’s ability to generate preferred yields.

Sale to a core buyer can occur from stabilized cash flows of moderate to high credit tenants lasting 7-10 years forward.  A peak selling price is likely; future returns are likened to a low-risk bond.

Sale to a value-add buyer can occur from 60-75% stabilized cash flows lasting 5-7 years forward.  The sale price will be a risk premium [over the core cap rate] that factors re-lets to occur within 5 years, costs of deferred maintenance, and economic conditions of the submarket.  A value-add sale could tap capital appreciation to place into an attractive investment opportunity.

Sale to an opportunistic buyer can occur from 59% or more upcoming vacancy, extensive capital improvements to bring the property to modern standards, or to sell banked land for development.  The sale price will be a risk premium [over the value-add cap rate] to factor hard and soft development costs.

The success of each sale choice is dependent on a feasibility study aligned to stakeholder objectives.  Fine points of the listing will shape marketing and closing terms of sale.  BREG can prepare a detailed feasibility study to present to stakeholders; it can also provide asset management services to prepare the asset for sale.  This post outlines that service.

Portfolio Mgt: Commercial Real Estate

Investments in CRE  are Affected by Two Factors

One.  Equity.  As equity allocations [for investment] compete with commercial real estate, stock and bond markets, investors are evaluating the returns they could obtain from investing equity into opportunities of interest that receive a larger net amount in the future (a/k/a investment returns).  Investors will compare the returns they could receive from investing in real estate vs. stocks or bonds, and the tradeoffs made to invest in illiquid real estate vs. more liquid stock ownership.   Liquidity enables the investor to end the holding period of an investment to reallocate the principal plus capital appreciation into a more lucrative investment opportunity.

Two.  Basket of Leases.  A large percentage of property value is derived from the discounted value of the lease-up.  Investing in new development could be a 3-7yr hold pending the value of the lease-up or could be likened to a bond by investing in a long-term lease.  Leases within the commercial building are likened to individual investments within a portfolio (the building).  As leases expire, the space may re-let at a higher rental rate, or a lease renewal is made to maintain the stream of cash flows.  Renewals are often made at discount to market value to attract the tenant to remain operating from the building.

Larger cap investors tend to match investment opportunities with the returns they set for equity or equity funds.  Portfolio returns are the result of how equity is placed into the project in relation to NOI derived from dynamics of the basket of leases.  Thanks for reading; please comment or write “Portfolio Management” into the “Request a Consultation” form at the base of “About Us” page.  I will reply to your inquiry within 24 hours. ###

Portfolio Management: Commercial Multi-Tenant Portfolio

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Whether you’re an investor and/or developer of a local or mid-tier commercial multi-tenant property portfolio, portfolio management is a critical first step towards realizing return objectives for equity of the firm and for investors.  How will NOI, financing and depreciation contribute to generating preferred returns from the asset?  What holding period and reversion is needed to generate preferred IRR/MIRR?  These objectives will be factored into your Asset Management plan; your asset manager will advise your portfolio manager and owner how market conditions will impact portfolio management objectives.  Leases for each property are independent investments [with staggered lease expiration dates] that shape the cumulative IRR for the asset and shape the exit cap rate used for reversion.  The asset manager relies on the property management staff to maintain the integrity of the property, and a skilled agency leasing team to lease-up vacancies and renew leases consistent with the asset management plan.  Roles of key team members are as follows:

Owner.  Sets objectives for portfolio returns, secures locations, sources and secures the lead architect, construction manager, financing, and anchor tenants; evaluates leased properties to invest in.

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Portfolio Manager.  Is in-tune with investment philosophies and methods, has relationships with private equity investors and commercial lenders in capital markets, and is well-versed with returns generated from alternative investments.  Provides owner with advice about fair market value of assets considered for purchase, advises how equity placement can produce desired returns based upon internal competencies and market conditions.

Asset Manager.  Akin to a COO who creates an asset management plan to realize owner’s objectives, which may include how economic performance of the asset contributes to returns from the portfolio.  Some asset managers specialize at turning around troubled assets within a timed project.  Direct reports are from the Property Manager, portfolio controller, marketing director, leasing team, and property attorney; the Asset Manager manages scheduled audits of property economics by outside auditors.  The asset management plan is the result of extensive analysis of the current state of the property (e.g. physical, economic, and staffing), its SWOT analysis, and how market conditions influence shaping of the asset management plan.  The plan typically includes most-likely uses for vacancies, a capital improvement project, a marketing plan to lease-up the vacancies, a tenant improvement allowance, rent concessions, a tenant retention plan, costs for marketing and brokerage commissions.  The asset management plan is measured for performance at scheduled intervals to identify strengths to maintain or sharpen, and gaps to close.  The asset manager maintains a consistent relationship with the portfolio manager, yet as needed with the [busy] owner.

Property Manager. Manages all physical operating activities of the property to maintain the physical integrity of the property and its daily economics.  They follow the asset management plan to reach owner’s objectives for the property.  Is hired by and reports to the Asset Manager.

Marketing Director.  Responsible to create a marketing plan and materials to market vacancies, promote promotional lease transactions, and property messaging to retain tenants.  Assists the Asset Manager as internal service provider.

Leasing Team.  Responsible for sharp and current knowledge of the local space market, where to look for prospective tenants, and handles lease renewals.  The team leader is a public-facing, approachable personality, bridges owner’s objectives with tenant’s needs for space via lease negotiations, and coordinates space planning services with the building space planner.  Is hired by and reports to the Asset Manager.

 

Asset performance occurs by buying at a mid to high cap rate for the current 12 months of income, identify a plan to improve the property physically and economically, secure financing at terms favorable to the cash flow, upgrade and relet the property, choose to keep it, or sell in the future at a lower cap rate of NOI to realize yield goals.  (Stabilized income is reflected in a lower risk cap rate (e.g. exit cap rate).  Some developers sell a percentage of the accumulated equity in the project a few years after the cash flow is stabilized to re-start the process with a new project.

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The success of each asset is dependent upon aligning owner’s objectives with market conditions, interpreted by the portfolio manager and asset manager.  Mutual agreement about asset goals facilitates economic success.  Holding periods exceeding 7 years may require the asset management plan to be revised to re-align SWOT of the asset with market conditions.

Whether your investment house is considering acquiring new assets, upgrade owned assets, or exchange an asset for a different one, BREG can assist as portfolio manager, asset manager, investment sale agent, or team leader of your leasing team.  Please click “Request A Consultation” link in the upper right of the screen.  Enter “Portfolio Management” in the subject line; please include the name, email address and telephone number of your executive assistant in the message body; I reply within 24 hours to arrange an exploratory conference call.  Thanks for reading and listening.###

Multi-tenant Commercial Investment Portfolio

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Asset management of your multi-tenant property can be more than managing income and expenses for new leases, renewals and relets. Consider shifting your perspective to view each asset property as a portfolio of investments. (The economic performance of each property will contribute to the returns and profits of the collection of owned assets (your core portfolio)). This will shape asset management and improve IRR, annually and over the holding period. Take these simple eight steps to carry out this shift for you.

1 Establish Your Basis. A portfolio of equity investments needs its basis to calculate a return over the holding period, so should your real estate investment. Your basis includes all costs associated with buying the property and readying it for tenant use. Each block of capital improvements updates the basis to calculate returns from (e.g. upgrades to lobby, common areas, elevator, sprinkler system, air handling systems, etc). The completed updates have created a new building ready to accept new tenants.

return on investment2 Establish Expected Returns. What returns are expected from the property? I recommend using MIRR vs. IRR to get a truer perspective of returns on investment. (MIRR factors your borrowing costs and returns from alternative investments; IRR assumes profits are reinvested into the property, which is often unrealistic.) This step requires a discounted cash flow (DCF) analysis to drive the leasing and financing terms to realize expected returns. Keep projections in the DCF as close to signed lease terms as possible; it will guide and expedite your leasing effort.

3 Bid Financing Terms. With your DCF nearly complete, put your financing terms out for bid to source the terms you’re looking for. Sensitivity analysis of the DCF can be performed to select the loan terms that meet your financing needs.

xls-anal4 Rent Roll. View leases as investments contributing to the returns of your property. The rent roll within the completed DCF serves as guide for negotiations of each lease. Collaborate DCF analysis with your investment analyst and your leasing team to ensure leasing efforts are guided by expectations of ROI. Leasing results should produce deals that contribute to the property’s expected returns, yet flexible enough to meet field conditions of leasing.

5 Operating Expenses. Use your DCF to shape efficiencies of expenses during the holding period. Trimming expenses without an end goal will likely produce marginal economic benefit. For example, negotiating property management issues and reducing property taxes should be guided by the DCF.

6 Lower Taxable Income. Remember to factor how depreciation, loan interest, and SALT payments can lower the taxable income for the property, raising its investment returns.

pm-icon7 Property Repositioning. Building systems and equipment nearing functional obsolescence (i.e. air handling, windows, elevator cabs) could be cause to vacate a percentage of the property to install capital upgrades. This should be approached as a redevelopment project that is economically evaluated to justify the investment, carrying costs during construction, and new revenue. Follow steps to plan the project.

8 Resale. Multi-tenant properties are bought based on income, expenses and sale projection; some more established landlord hold their properties for tens of years, improving returns from relets and capital improvements. A resale should be planned about 36 months before closing is needed to source a buyer at or very near to establishing expected returns. Use a copy of the completed old DCF to test it under project sale terms. That DCF will drive sourcing of a buyer to meet expected returns from re-sale.

Closing Comments. Ensure you have established all key points to making your multi-tenant property perform as a portfolio of investments; the return of each multi-tenant property contributes to the aggregate return of all properties your enterprise owns. Ensure your real estate analyst is nicely versed with Excel, Argus Enterprise, or PlanEASe to run the DCF, that includes running sensitivity analysis to test fine tuning of the DCF. Consider setting a company policy about handling each property this way, operationalizing the steps with your staff through a few test runs. Apply a project management framework to carry out the change in asset focus (Initiate, Plan, Execute, Monitor & Control, Close.)

If you agree that making this change is sensible for your asset portfolio, request a free 45 minute consultation with me by filling out the “Request a Consultation” form in the About Us web page. Please put “Asset Portfolio” in the subject line, paste the contact information of your executive assistant or COO into the message body. I will reply within 24 hours to schedule an exploratory call with your CEO or COO to assess your specific needs. Thanks for reading, perhaps I’ll hear from you soon. ###

Real Estate Investors, Tri-State Region $5M-$100M

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mhm-iconfinan-modelingReal Estate investors in the $5M-$100M range often have a skeletal staff and outsource select services. Deal analysis may be handled by a buyer’s broker (who is compensated in commission from a property sale).

Does your organization operate this way? Do your investment guidelines [consistently] need to be matched to the broker’s projections? (eg. scrub projections against your investment guidelines that includes core property type, financing sources, IRR/NPV/MIRR and holding period, splits or promotes to investors). If so, does that create “extra work” for your small staff?

Property financials and your investment guidelines are plugged into each suspect investment, and periodically, to assets within your portfolio. Such activities seek to identify how well a suspect or incumbent investment can contribute to your portfolio and enhance profits. Analysis reveals which assets need to be [financially] optimized or sold.

return on investmentxls-analI can perform these analyses for you on-demand or by project, free of HR expenses. Working with me gets you the projections you need to decide which property (ies) to buy, optimize or sell. I establish a working relationship with you, learn your investment criteria, equity relationships and financing tools to guide my work for you. Within a few completed projects, I will see properties from your perspective, expediting my work for you.

I was raised on real estate within the tristate region.  I leased or sold $30 million in transactions as commercial realtor [whether listed or not], most multi-tenant, some mixed-use, (eg. land, retail, industrial, flex, medical and office properties). I have a current, holistic view of the market and am adept at valuation. I am savvy to the makeup of micromarkets and the nuances of their communities. I understand how properties make money, to maximize rent and to divide floors efficiently. I am equally versed with how to build space that works efficiently. Extensive networking and transaction activities introduced me to key market players.  (Additionally, if you buy properties in the Atlanta MSA, I am savvy to that market, having worked it from Q403-Q407).

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segal 4x5pm-iconI am available by transaction or project; all compensation is reported annually via 1099, saving you HR expenses and benefits.  I approach work with a sensible, flexible, can-do attitude. (People I’ve met say a New York City attitude shines from me.) My efforts are complimented by knowledge and knowhow, with attention to detail.  If you’d like to discuss these “Quant with Project Management” services for your [real estate] investment portfolio, please ask your executive assistant to fill out “Request a Consultation” at the base of About Me in this website. Enter “Quant/PM” in the subject line, then paste their email signature in the message body. I reply within 24hrs to arrange an exploratory conference call within your calendar. ###

 

 

Project Management for Real Estate

Flex BldgActivating an initiative for real estate without carefully aligning it to your objectives and a cogent, time-sensitive strategic plan(s) will set your business up to clean up a big mess that’s expensive and time-consuming. Would you risk your cash (and resources) on an investment initiative without researching the likelihood of it performing? Of course not. A structured action plan that plans for success includes a business case, an impact analysis, activated by a project management framework. BREG’s 7-Point Service was designed to guide each real estate initiative along a tested business process to ensure each project’s success; see case studies in Mayer’s Blog for examples.

strategize-iconStrategic Planning

Executive planning includes strategic, tactical and operational plans. Strategy is a high-level view of a vision to achieve. Tactics are the means to realize the strategic plan. Operational plans are the goals for departmental managers to achieve from deliverables. Your real estate project (initiative) should be aligned to your organizational objectives, realized through tactical planning. A business case and a Business Impact Analysis (BIA) is recommended to determine how well the initiative is aligned to organizational objectives. Neglecting or passing-over this step could lead to an unplanned outcome or unwanted constraint, blocking the realization of objectives; fixing that problem creates excessive costs and downtime that materially impedes business operations.

Business Case. Any initiative needs cost-benefit analysis to justify how its implementation helps to meet organizational objectives. For real estate, it defines how an investment, expansion, or relocation effort would meet organizational objectives. Qualitative (judgement per criteria) and quantitative analysis (financial modeling) are performed with sensitivity analysis (what-if scenarios) to identify if the initiative is justified.

Business Impact Analysis. This assesses the risk associated with implementing the change. Is the risk worth the reward, or does the risk bring unwanted harm to the business?

Steering Committee. This group of thought leaders evaluates results of the business case and BIA, deliberating over the reports; an established commercial realtor can answer questions and offer advice. This group decides whether to return the research for more information, reject the initiative outright, or approve the initiative for implementation.

pm-iconProject Management Framework. The content below are the key points of project management.

Project Charter. An approved initiative is formally outlined in a project charter, to be signed by the project sponsor and BREG. The charter represents the goal of the project with which to create a Scope Of Work (the efforts performed to realize the goal), aligned with the scope of the project.

Scope Of Work (SOW). How your project will be conducted with the resources assigned to realize the deliverables. Roles of the steering committee, project manager and project team are outlined. A Work Breakdown Structure (WBS) outlines how work is distributed to project players with delivery dates of work completion. Project Procurement is a 5-Phase process to source services and materials for processing to produce deliverables. These two documents are critical to guide the project players along a path to completion, with deadline dates to realize deliverables on time. (Note: a scope statement may be needed for larger projects.)

Project implementation. Initiate, Plan, Execute, Monitor & Control, Close. These five core phases conduct the effort of the project. A certified and experienced project manager is versed with this process.

This framework can be abridged when the project scope allows for it, yet the framework guides project participants along a critical path to complete the project.

Project Close. Project participants may be inclined to part from the project after the deliverables have been met, yet this step ensures all parties agree the customer received their deliverables and have accepted the outcome. This brief formal process reviews deliverables with the customer, seeks acceptance of deliverables, and written consent to close the project. All project participants are informed when the project is formally closed. BREG extends the date of project closure several weeks after the go-live date to identify a punchlist items that ensure the customer realizes its objectives from the project. Then, the brief process of project closure is performed.

Centralized Management = Timely, Integrity, Reliable, Predictable:

  • CAPM BOK to assess project, prepare business case, seek consensus for project, prepare project charter, scope of work, WBS, assemble functional or matrix staff.
  • ITILv3 principles and processes include strategy, design, implementation, operations (support).
  • Daily and weekly monitor and control to fine tune processes to ensure project produces deliverables as envisioned.
  • Project is documented in cloud-based PM productivity app to ensure timely documentation of project progress.

    handshakeIf you’re considering to activate a real estate project for your business, the process outlined above works consistently. If you’d like to discuss your plans for a real estate project, please ask your CFO or COO to fill out “Request a Consultation” at the base of About Me at nytenantrep.com. Enter “Strategic Planning and PM” in the subject line, then paste the email signature of their executive assistant the message body. I reply within 24hrs to arrange an exploratory conference call within their calendar. ###

NYC Office Buildings Reposition

This is an excellent perspective how select Manhattan office buildings are repositioning themselves to match the needs of millennial tenants.  The article is found at this link.  (Note: the author is my co-worker). http://nyrej.com/75161

Investment Sale: Atlanta Community Office

Q3/2006 Facilitated sale of two-story community office property, 50% leased, to local business on behalf of private investor/owner. Property appraised and sold for initial list price that was +/-$25psf over market. Customized new contract of sale from Real Estate Trade Association and advised Seller to negotiate results of inspection period . 4000sf property sold for $700K.