Market volatility in the fourth quarter of 2018 led to a sharp drop-off in investment sales in the office sector in January, according to the most recent report from research firm Real Capital Analytics (RCA). Office sales volume declined by 29 percent year-over-year, to $7.8 billion.
According to RCA researchers, “Investors became more cautious for a time, with the yield on corporate bonds growing faster than that for the 10-year U.S. Treasuries. Increased investor caution will lead to fewer deals being completed. Thankfully though, that turmoil and growing sense of investor caution has eased so far in first quarter 2019.”
Overall, investors continue to find office plays attractive, which is reflected in pricing.
In the fourth quarter of 2018, office prices per sq. ft. in the top six metros, including New York, Boston, San Francisco, Los Angeles, the District of Columbia and Chicago, were up 40 percent over their peak in 2007, according to a recent report from real estate services firm Colliers International.
The average cap rate on transactions involving office assets has stayed steady through 2018 at 6.6 percent, according to RCA. That’s about 10 basis points below 2017’s cap rate levels. In January, prices went up 5.2 percent.
Investors seem to be particularly drawn to office transactions in secondary cities, as these can offer higher yields than acquisitions in core markets.
According to Marcus & Millichap’s 2019 Office Investment Forecast, the Seattle-Tacoma market leads its National Office Index this year, followed by San Francisco, San Jose, Calif. and Raleigh, N.C. The Index ranks cities based on expected performance driven by supply and demand for space.
The movement of many employers into secondary cities is opening up more markets as attractive investment options, notes Alan Pontius, senior vice president/national director of specialty divisions with Marcus & Millichap. That includes cities like Raleigh, Nashville, Tenn., Dallas, Austin and Phoenix. Those markets can provide higher going-in returns for investors and a lower investment cost basis, Pontius says.
Raleigh is the perfect example of a secondary office market attractive to investors, as the economy is strong, with year-over-year growth outpacing the national average; the average cost for office properties averages between $150 and $199 per sq. ft.; absorption has exceeded new supply since 2012; and there is steady growth in employment and rents, says Pontius.
Marcus & Millichap’s forecasts that the average price per sq. ft. for office space in top secondary markets will range between $200 and $249 this year, compared to a range of $300 to $399 in primary markets including Boston, Oakland, Calif., Orange County, Calif., San Diego, Seattle-Tacoma and Washington, D.C. In Los Angeles, Miami-Dade, New York City, San Francisco and San Jose, price per sq. ft. for office assets ranges from $400 to $650 per sq. ft.