Secondary Office Sector Attracts Investors

Analysts say that core office markets are so overheated that it’s driving new buyers into secondary markets for more reasonable deals. Real Capital Analytics reports that office sales …

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Analysts say that core office markets are so overheated that it’s driving new buyers into secondary markets for more reasonable deals. Real Capital Analytics reports that office sales were at $65 billion in October compared to a total of $81 billion for 2012 and there are still many new buyers flooding into the market while interest rates still remain comparatively low. Distressed properties are also catching investors’ attention due to availability constraints in popular locations with Class A properties. Things may look good in suburbia now, experts say, but continued activity in those fields will eventually lead to cap rate compression. For more on this continue reading the following article from National Real Estate Investor.

Office investment sales are gaining traction as a new wave of buyers have emerged, bidding up pricing for core assets and driving investors to second-tier markets in their search for higher yields.

Those were a few of the points made during the most recent episode of the “Commercial Real Estate Show”. Among other office sector issues we discussed investor demand, financing and cap rates.

Growing Demand

Through October 15th, office investment sales volume already totaled about $65 billion nationwide vs. $81 billion in 2012, said Dan Fasulo, managing director of Real Capital Analytics. Office sales should finish 10 percent to 20 percent greater year over year given that the fourth quarter is historically the most active quarter for office transactions, he added.

“In the past 12 months, we have seen about 700 new funds or buyers enter the market for $2.5 million-and-above office properties,” said Casey Keitchen, vice president, National Office Group, at Bull Realty. “The number of active buyers is approaching an all-time high.”

Active buyers are as diverse as they were at the height of the market, Fasulo added. “Everyone, from institutional investors to private investors, [is] back with a vengeance,” he said. Additionally, both public and private REITs have re-entered the market.

While interest rates are low and there are plenty of buyers in the market, many owners with stable occupied properties consider this to be a great time to sell. Because the market is so diverse, it’s important for sellers to broaden their offering, Keitchen said. “I see a lot of large brokerage companies convince a seller it’s okay to have a narrow marketing focus,” he said. “Sometimes the buyer that will pay the most isn’t the most obvious buyer.”

Financing transactions

“Debt is really fanning the fire in the investment arena, particularly CMBS loans that are readily available, even for suburban or value-add properties,” Keitchen said.

Financing is even available for secondary markets and transitional assets that were starved for capital during the last few years, Fasulo said. “We have to figure out how to keep the CMBS channel open because it is really helping the market be as healthy as it can be,” he added.

What buyers want

With so many buyers chasing office properties, some investors have been forced to move away from Class A assets or primary markets. “We are looking off the beaten path at some secondary markets and suburban markets,” said John Davidson, southeast regional director of Parmenter Realty Partners.

Distressed or value-add product has been popular with other buyers as well, Davidson said. It’s considered to offer the most upside at this point in the cycle. “I’m working on a number of deals for highly distressed assets that were purchased at the bottom of the market,” Keitchen added.

Places like Atlanta and cities in Texas, especially Houston and Dallas, remain hot for buyers, Fasulo said. San Francisco has also been strong because of the large tech presence there. “Supply in San Francisco is constrained, and rents are starting to spike in many submarkets,” Fasulo added.

Cap rate compression

On average, cap rates are around 5.8 percent, but can vary depending on the market and asset, Davidson said. “At the bottom of the market in 2010, cap rates were about 8.8 percent, so there’s been incredible movement,” he added. “However, there’s still room for compression and income growth.”

In prime locations, good properties are seeing cap rates as low as 4 percent, Fasulo said. “For prime, core assets, cap rates are at or near all-time lows again, and certain properties are trading at levels where the yields don’t appeal to the broad spectrum of the investment community,” he added.

For class-A products in core locations, cap rates are not anticipated to compress any further, Keitchen said. “However, cap rates for suburban and value-add properties may compress significantly because that’s where a lot of the activity is going,” he added.

The entire episode on the office investment market is available at www.CREshow.com.

Michael Bull, CCIM is the host of the nationally syndicated Commercial Real Estate Show and founder of Bull Realty, Inc., a U.S. commercial real estate sales and advisory firm headquartered in Atlanta. You’re invited to connect with Michael on Twitter and LinkedIn.

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