Investors Expect Deals Will Continue Spreading to Outlying and Secondary Markets and Risk Profiles
After surging sale prices caused them to fall a bit out of favor with investors, Class A office buildings may again set the pace for an improved outlook for investment sales through the end of the year.
The monthly sales volume of Class A office buildings began to edge down in November 2011 when the average price per square foot achieved a post Great Recession high of $263 per square foot. Monthly sales volume hit a nadir in May 2012, according to data from CoStar COMPs, as the robust price appreciation drove investors to seek out other property investment alternatives.
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More recently, monthly volumes of Class A office sales have rebounded after average-per-square-foot prices fell to about $248 per square foot.
According to analysis from Jones Lang LaSalle, renewed investor interest in Class A office property in the first half of 2013 was bolstered by overseas investors, who arrived on the scene to take out domestic buyers who had taken advantage of discounted prices following the recession. Capital from Germany, the Middle East and South Korea has been particularly evident in primary markets, according to JLL.
Overall sales activity was helped by large sales in the CBDs of Chicago, New York and Washington DC, with primary markets accounting for a 53% share of office sales in the first six months of tyhis year.
"With institutions, private equity, high-net-worth individuals and foreign investors all in aggressive pursuit of commercial real estate
, transaction activity in the United States should remain brisk and continue to grow,” said Jay Koster, Americas president for capital markets at Jones Lang LaSalle. “In particular, we expect office sales transactions to significantly boost volume in the second half of the year, with activity propelled by improving employment growth within the technology, health care and energy sectors.”
JLL expects to see a continued increase in activity for top-quality assets in secondary markets as investors, discouraged by the current low yields available on prime assets, begin to set their sights higher up the risk curve.
“Activity in Atlanta, Dallas, Houston and Minneapolis is keeping that share strong, and based on the heated investment competition in primary markets, there are very solid prospects for additional sales growth in these areas,” said Marisha Clinton, director of capital markets research at JLL.
Andrea Cross, national office research manager at Colliers International in San Francisco, is seeing much the same thing.
“We are seeing investor interest expand from core properties and markets due to a lack of available product in those areas and improving economic conditions in a greater number of markets,” Cross said. “There also is a lot of available capital, and office still offers attractive risk-adjusted returns compared to many other investments. With the low interest rate environment coming to an end, we expect demand to remain strong through the end of the year as buyers seek to lock in cheap debt.”
Colliers said it sees the greatest opportunities in the ‘intellectual capital,’ energy and education markets. These include technology and education hubs such as San Francisco, Silicon Valley, Austin, Boston and Raleigh-Durham as well as energy hubs like Houston and Denver.
Phoenix is another market benefitting from the aggressive pursuit of offices from institutional and private investors, according to Steven K. Lindley, senior managing director, capital markets at Cassidy Turley.
“Investors are looking across the entire risk profile: from our top Camelback and Scottsdale markets to suburbs in the Southeast and West, from stabilized occupancy to 100% vacant, from trophy assets to older, challenged properties,” Lindley said. “Investor demand exceeds the supply of available investments, resulting in increasing values; prices for the highest quality, stabilized investments are approaching replacement cost and peak market values. Many owners are considering selling into the market improvement, although we expect the investment supply to continue to be limited.”
As competition from institutional investors in core markets continues to drive up prices, analysts believe investors with a higher cost of capital will either be priced out of the market or look elsewhere for investment opportunities.
“Their options are, overpay in a primary market or explore other markets where the risk adjusted return justifies gravitating to those markets,” said Steven L. Timmel, brokerage senior vice president at Colliers International in Cincinnati.
“For the right assets, we believe investors are willing to take on more risk. For the last three years the deals have been at either one end of the spectrum or the other - core or value add. We are seeing investors now wading into that area in between where the deal is not just a straight cap rate acquisition and not a true price per pound buy. The investors are now starting to move into the partially leased arena in search of yield but they are doing so very cautiously.”
That too is what CoStar is seeing in this month's CoStar Commercial Repeat Sale Indices. Monthly gains in the value-weighted index have averaged nearly 1% over the last three months, and in July 2013 the index rose just 0.1%. This slowdown in pricing gains likely reflects the fact that pricing for core assets, particularly five-star office properties, Class A apartments and well-leased malls in primary markets, has already reached its prior peak.
Meanwhile, pricing gains in the equal weighted index, which is dominated by smaller transactions, has continued to accelerate. The equal-weighted index has risen by a stronger 2.7% per month from May - July 2013, indicating that investors’ risk tolerance is growing.