Trophy office properties located in major coastal cities like Washington, D.C., New York, and San Francisco have been a favored target for investors in the wake of the Great Recession.

But with heightened tensions in the Middle East, foreign capital pouring into the United States and prices reaching pre-recession levels, institutional investors are hoping to achieve higher returns by exploring opportunities in America’s heartland.

In February, Dallas-based Invesco Real Estate purchased 1800 Larimer, the first new office tower built in downtown Denver in 25 years, for an estimated $213 million. That price equals $430 per sq. ft. for the 495,518 sq. ft. building, and set a new record price for a Denver office property.

Right now, institutions are flush with money to put to work. According to a recent survey by Kingsley Associates and Institutional Real Estate Inc. (IREI), North America’s largest tax-exempt institutional investors will plow some $30 billion into commercial real estate in 2011.

The annual survey also notes that after a two-year hiatus, real estate has resumed its place atop the list of asset classes in terms of delivering the highest expected risk-adjusted returns, compared with U.S. stocks, foreign stocks, fixed-income, and venture capital and private equity investments.

But many observers believe that institutions are finally realizing they can achieve higher returns by moving inland away from the high-priced major coastal markets.

According to New York-based researcher Real Capital Analytics, the average capitalization rate on office buildings purchased from September 2010 to March 2011 in Washington, D.C. was 5.9%, while the cap rate for the same period was 9.1% in Denver.

“Institutions are definitely getting the message that trophy assets in major markets are getting overpriced,” says Patrick Duncan, chairman and CEO of San Antonio-based USAA Real Estate Company, which has more than $6 billion in assets.

Many agree with that observation. “Pent-up demand created by strong capital raising by pension fund advisors, non-traded REITs, sovereign wealth funds and traded REITs is driving trophy asset prices back to previous highs and above,” says David Steinwedell, managing partner with Austin-based investment firm Stoneforge Advisors LLC.

“Office buyers are justifying their pricing by concentrating their purchases in Class-A properties with stable rent rolls in high-demand, major markets with better than average real estate fundamentals.  It will be interesting to watch if the pricing overflows into other, less healthy markets.”

There is already movement afoot in that direction, as institutions are exploring opportunities in America’s heartland.

In March, Boston-based pension fund advisor Cornerstone Real Estate Advisors LLC purchased two trophy office buildings in Chicagoland and in Dallas. Cornerstone, a subsidiary of Massachusetts Mutual Life Insurance Co., has $22.8 billion in real estate assets under management. It was recently ranked as the ninth largest real estate investment management firm for 2010 by Pensions & Investments magazine.

Cornerstone’s first big purchase was a 251,235 sq. ft. office building known as Highland Landmark V in suburban Chicago’s Downers Grove for an estimated $69.6 million from Opus Development Corp. The building was completed in 2008 and is fully leased as the corporate headquarters for both DeVry Inc. and Dover Corp.

In March, Cornerstone also purchased the Northpark Central office tower in Dallas for $64.4 million from AREA Property Partners’ Value Enhancement Fund II. The 491,083 sq. ft. building is 91% leased. AREA paid Connecticut General Life $53.8 million for the building in 1996.

Also in March, Wakefield, Mass.-based Franklin Street Properties paid $53.6 million for the eight-story One Legacy Circle office building in Plano, Texas, just north of Dallas from a partnership set up by developer Trammell Crow Co. and Principal Financial. Franklin Street is a real estate investment trust (REIT) that owns 35 buildings with more than 6.8 million sq. ft. of space.

This marked Franklin Street’s third major purchase in the area in March alone, after it paid $37 million for two office buildings at 5100 and 5160 Tennyson Parkway.

One wild card that could have a major impact on the institutions’ moves is the sovereign wealth funds. Given the heightened levels of insecurity in the Middle East and Arab world, USAA’s Duncan expects to see more sovereign wealth funds, in particular, stepping up their activity.

These funds typically acquire trophy assets worth a minimum of $100 million on both U.S. coasts. That move could further pump up prices to stratospheric levels.

Institutional investors also are beginning to explore investment in so-called “value add” deals, which include buildings or developments that need a fresh injection of capital to turn around their fortunes.

USAA Real Estate Co., for example, has more than $1 billion in new developments underway and is launching a new $1 billion investment fund targeting investment in value-add opportunities.

“We’ve really seen a lot more interest lately,” says Duncan. “Just in the last three months, we are getting more calls to joint venture on value-add deals.”