Investors’ faith that leasing activity will improve is offsetting concerns that rising interest rates will dampen investment activity, reports a new study on the office investment market. The study, "Rationalizing High Prices: Is The Office Market Ready To Implode?", was conducted by Grubb & Ellis, PNC Real Estate Finance and Real Capital Analytics, and is based on an analysis of leasing and capital markets data along with formal interviews of leading real estate investors and brokers.

"Many were surprised that when interest rates rose earlier this year and investment activity remained very strong," says Bob Bach, national research director at Grubb & Ellis. "The investment market has been characterized by a back log of buyer demand for quite some time. Rising interest rates have convinced owners that if they plan to sell in the next two years, now is the time to do it. Supply is starting to catch up with demand."

Nearly $15 billion of office properties changed hands during the second quarter of 2004, according to Bob White, president of Real Capital Analytics. And at $18.3 billion, the level of new offerings for the second quarter was $7 billion higher than any other quarter on record.

The spike in new offerings, combined with the interest rate hike should have put upward pressure on cap rates, says Nicholas Buss, group manager of market research for PNC Real Estate Finance. "But the opposite appears to have happened — cap rates continued to trend lower," he explains.

Other findings from the report:

o 40% of the 83 Grubb & Ellis office sales brokers polled believed that the improved leasing market is prompting buyers to be more aggressive in their bidding, while 22.5% of them thought that rising interest rates are making buyers more conservative

o The real estate debt market remains as liquid as for equity. If anything, over the past six months, competition among lenders has increased. Loan spreads have narrowed and other loan terms are also improving.

o The first 50 to 100 basis point increase in long-term interest rates may exert little or not pressure on cap rates.