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U.S. Office Sales Drop in First Half of 2018 With Fewer High-End Buildings for Sale

Supply Declines After Years of Torrid Sales as Fewer Buyers From China Emerge
July 31, 2018
In one of the largest deals of the second quarter, Crocker Partners and Rialto Holdings bought a 1.7 million-square-foot office campus in Boca Raton, Florida, for $179.3 million.

Total U.S. office property sales volume declined in the first half of the year as institutional owners opted to hold onto their properties following record sales in the past few years and buyers from China reduced their purchases.

Sales dropped 14 percent to $57.9 billion in the two quarters ended June 30, 2018, from the same time a year earlier, according to the latest CoStar Group data presented in its quarterly State of the Office Market webinar.

Investors from China have pulled back in recent quarters amid government capital controls while buildings have already sold in primary markets in the previous few years of record office sales, said Hans Nordby, managing director of CoStar Portfolio Strategy.

Sovereign wealth funds, real estate investment trusts and institutional investors that acquired office properties in recent years are likely to sit on their properties for a while, Nordby said.

"The average length of institutional ownership is five to seven years, so if they bought it four years ago, they’re just not ready to trade yet," Nordby said.

Like most REITs, Raleigh, North Carolina-based Highwoods Properties Inc. expects to purchase very few if any office properties this year.

"There just aren't a lot of institutional-quality assets available," Highwoods Chief Executive Ed Fritsch told analysts during the company’s second-quarter conference call last week. "For the few assets that we have seen in the market, pricing for the best located Class A office properties remains highly competitive."

Moreover, many U.S. pension funds are holding core office assets for longer periods in infinite life or separate-account funds where 10 years ago, pensions often invested in value-add vehicles that needed to buy, reposition and sell assets, Nordby said.

A few secondary markets like Minneapolis, San Diego, Denver and Phoenix have posted increased sales as local and regional investors capitalize on strong occupancy and job growth.

In Charlotte, North Carolina, for example, CBRE Global Investors Ltd. paid $222 million for 376,000-square-foot 615 South College St. in one of the largest deals of the second quarter.

However, sales have declined in the markets that rely heavily on foreign capital like San Francisco, New York, Boston and Miami.

In fact, office space was the only property sector to record a net decline in the primary markets of Boston, Los Angeles, New York City, San Francisco, Seattle and Washington, D.C., with sales sliding an average of 20 percent in those markets.

Only one deal prominently featured China-based capital in the second quarter, the $680 million purchase of the 2.3 million-square-foot Prudential Plaza office complex in downtown Chicago to a joint venture that included Chinese multinational investor Wanxiang Group Cos.

Canada and Europe have held steady as the top investors in United States office property over the past year, with small but growing allocations from investors in Japan and the Middle East.

For example, Sumitomo Corp. subsidiary Sumisho Realty Management Co. announced earlier this month the formation of its second closed-end fund totaling $245 million to allow Japanese institutions to invest in prime U.S. office properties. Sumitomo formed its first $315 million closed-end fund for U.S. office investments last year.

Despite the sales decrease, the office market remains mostly in balance between supply and demand, said CoStar Portfolio Strategy managing consultant Paul Leonard.

However, net absorption of office space was down 24 percent in the second quarter to 64 million square feet while rent growth pulled back to 1.9 percent in that quarter from 2.4 percent a year earlier.

"While the office market remains in equilibrium as evidenced by the 90 percent occupancy rate, unchanged from a year ago, there are signs the market is slowing," Leonard said.

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