Core Commercial Real Estate Investing: Flattening the Depreciation Curve
So far so good, but what goes up can also go down and real estate is, by definition, a depreciating asset and particularly so as you get closer to the end of the lease. It therefore follows that to out-perform consistently over time an investor must not only collect and grow rents but also minimise the impact of depreciation over the longer term, either by owning assets with longer unexpired lease terms or through active management, or preferably, a combination of the two.
Depreciation, or obsolescence in commercial real estate takes many forms. The following graph illustrates the behaviour of an office asset over its useful economic life with the grey line indicating typical depreciation from new build to functional obsolescence beyond which redevelopment or re-purposing is the only option. The key to sustained capital value out-performance therefore comes from being able to flatten the depreciation curve during your ownership, often by extending a building’s economic life or “future proofing”. If successful, this can serve to generate alpha as illustrated by the green line below therefore saving the need for costly capital investment in order to plug this performance gap as per the blue line. Whilst the graph is somewhat simplistic the principles hold true for all commercial real estate assets.
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