The year 1995 represented a clear turnaround for the office market, as investor interest has heightened. Solid increases in rents and declines in vacancies have elevated this asset type as a viable investment. Primary institutional interest is in the suburban markets where employment growth is focused, however, some attention is also directed toward Class "A" Central Business District (CBD) products where there is some opportunity for rent spikes. The "24 hour" CBDs are the investors' favorites. These CBD markets, with residential activity and retailing, have provided the vibrant environment necessary to maintain full city services and encourage investors to maintain enough faith in the core area to make a long term investment. With limitedplanned, most investors feel confident purchasing a top notch asset at prices significantly less than replacement cost. However, caution is advised, as corporate downsizing, bank mergers, and alternative working strategies may continue to limit demand for office space.
Suburban officehave outperformed CBD markets in most cities for many years, primarily due to the growth in population and employment in the suburban markets. This trend is expected to continue. Investors are taking the opportunity to purchase well located suburban office properties below replacement costs in anticipation of rent spikes and appreciation. Several markets report strong transaction activity, which in large part, is due to the fierce competition in other property assets, making office properties look more favorable. Clearly, the suburban office mayket has turned the corner, as some markets are experiencing limited speculative construction or build-to-suit opportunities. Suburban markets seem to be the preference of most investors for several reasons:
1. The suburban office parks provide offices closer to the employees' homes, thus, reducing commuting time.
2. Generally speaking, the suburbs provide higher quality public education per tax dollar paid. In other words, the newer, more functional schools are more efficient and perceived to be a better opportunity for the children of white collar workers.
3. Occupancy costs in the CBDs are higher due to additional parking costs, security costs, etc.
4. Older buildings in the CBD cannot accommodate newer power needs of today's computer networks without costly renovations. Additionally, the Americans With Disabilities Act has virtually made some buildings uneconomical to rehabilitate.
The CBD office market has enjoyed renewed investor interest for Class "A" properties only. Class "B" and "C" properties of little interest, due to the aforementioned reasons. Investors will continue to be very selective in their acquisitions in CBD's as banks, which are large CBD tenants, continue to merge, sending rippling effects through these markets. Our expectations are that space per employee will continue to shrink and that worthyin downtown markets will be hit and miss, and to a certain degree, uncontrollable by the investor. Caution is urged.
Of the cities surveyed by VIL members, the CBD vacancy rate of 17.1% remained relatively similar to last year's reported vacancy rate of 16.8%. In fact, a review of forecasted absorption, forecasted value changes and years to balance suggests little change. On the other hand, the suburban markets enjoyed a continued strengthening in vacancy rates down to 13.7% from 15.7% last year. Years to balance and forecast value change remain consistent with last year's expectations.
Capitalization rates also suggest renewedactivity in this product type. In both the suburban and CBD markets, capitalization rates have declined. Both markets report rates of 9.7%, compared to last year's rates for the CBD of 9.9% and 10% for the suburban markets. On the other hand, discount rates increased from 11% for both markets, to 11.6% and 11.9% for the CBD and suburban markets.
Top Office Markets
Fundamental office market factors which were quantitatively analyzed include: vacancy rates, forecast value changes, years to balance, FIRE and Services Employment growth by percentage and absolute change. The following cities were identified as the best markets for investor opportunities, based on these factors:
CBDSuburban 1.Seattle, WA1. Atlanta, GA 2.Columbus, OH2. Minneapolis, MN 3.Boston, MA 3. Las Vegas, NV 4.Minneapolis, MN 4. San Francisco, CA 5.Orlando, FL5. Denver, CO 6.Charlotte, NC 6. Portland, OR 7.Portland, OR7. Charlotte, NC 8.San Francisco, CA8. Richmond, VA 9.Las Vegas, NV 9. Phoenix, AZ 10. Washington DC10. Boston, MA
Seattle has taken the top spot in the CBD market primarily due to solid performances of all market factors considered. Seattle enjoys a strong vacancy rate of 8.5%, which ranks this MSA third of those surveyed. Orlando is a very strong growth prospect, as FIRE and Service employment is forecast to grow between 3.7% and 4.5% annually from 1996 to 2001, or 18,350 jobs annually.
The suburban market also reports two new MSAs. Miami and San Diego are replaced by Boston and Las Vegas. Miami enjoys a relatively strong vacancy rate of 11.1%, however, forecasted employment growth hinders investment opportunities in this market. Las Vegas, which finds itself on both the CBD and suburban top ten lists, enjoys strong vacancy rates, but benefits primarily by very strong forecasted employment growth. In fact, Las Vegas ranks sixth and eighth, respectively, based on FIRE and Services annual growth rates. It is interesting to note that seven of the top ten MSAS appear in both the CBD and suburban markets. This suggests that these communities have successfully maintained their CBD markets in light of significant growth and flight to the suburban markets.