Mixed Signals: Will Deal Volume Pick Up in the Second Half?

At the beginning of 2017, many forecasters predicted a robust performance for office investment, even in the face of political and economic uncertainty. Though industry veterans maintain an upbeat outlook, signs for the rest of the year are not all promising.

Image by Jordi Delgado/iStockphoto.com
Image by Jordi Delgado/iStockphoto.com

At the beginning of 2017, many forecasters predicted a robust performance for office investment, even in the face of political and economic uncertainty. Though industry veterans maintain an upbeat outlook, signs for the rest of the year are not all promising.

Despite solid gains by suburbs (up 11 percent year-over-year) and secondary metros (up 10 percent), volume slipped 2 percent to $64.6 billion during the first half, according to Real Capital Analytics Inc. Cap rates, meanwhile, have shown little movement over the past couple of years and averaged 6.7 percent at midyear.

“Trading volumes are down, and some product types are down more than others,” said Christopher Ludeman, global president of CBRE Capital Markets. “But pricing hasn’t really fallen off dramatically.” In large part, that’s because well-capitalized buyers are hunting for trophy properties, value-add plays and everything in between.

This year, office values are expected to rise at least 2 percent in 47 percent of the nation’s big-city central business districts, according to Integra Realty Resources’ survey of appraisers and consultants. In another telling finding, the IRR survey projects that values will rise 4 percent or more in seven markets: Dallas, Los Angeles, Miami, New York City, Philadelphia, Raleigh, N.C., and Las Vegas. On the minus side, declines may be in store for Baltimore, Houston and Dayton, Ohio.

Some attribute the drop in volume partly to seller skittishness. “There’s still so much uncertainty around the economic policy picture, and if investors sell, they need to have a redeployment strategy,” said David Bitner, senior director & Americas head of capital markets research at Cushman & Wakefield. “People need to be confident about making that next commitment.”

The resulting dearth of product on the market boosted prices 13.4 percent year-over-year through April, according to the Moody’s/RCA Commercial Property Price Index. Suburban assets gained a more modest 7.5 percent during the stretch.

Ready to launch?

Denver rail commuters 800x620As sellers adjust to a new political climate and observe how the economy reacts, deal volume should pick up over the next six to 12 months, Bitner predicted. “There is a ton of capital out there that wants to deploy,” he explained. Institutions, REITs, private equity and foreign players are all generating notable deals. 

David Steinbach, chief investment officer of Hines, ties investment strategy to a market’s place in the cycle. “You can’t put the entire U.S. office market into one bucket,” he said. For a market in a mature part of the cycle, like San Francisco, Steinbach said that he’d be sure to do some “pretty heavy scrutinizing.”

At least one Bay Area property has passed the Steinbach test this year. In March, Hines and an affiliate of Oaktree Capital Management bought Dublin Corporate Center, a 440,266-square-foot campus in Dublin, Calif. The partners cited the area’s high-quality office product, access to San Francisco and Silicon Valley, and rental pricing that compares favorably to other Bay Area cities.

Foreign buyers, meanwhile, are looking at “super-core trophy assets,” said Steve Pumper, executive managing partner for Transwestern’s capital markets group. “They’re investing in the best and most stable assets as wealth preservation versus wealth creation.” That explains why 21 of the 25 biggest deals reported by RCA
during the first half originated in just six high-barrier coastal markets: Boston, New York City, Washington, D.C., Seattle, San Francisco and Los Angeles.

In May, Ivanhoé Cambridge, the Montreal-based investment manager, teamed up with Callahan Capital Properties in a $650 million deal for 85 Broad St., a 1.1 million-square-foot downtown Manhattan tower. Meanwhile, foreign investors are also chasing $40 million to $60 million deals in markets like Seattle, Chicago and South Florida, reported Tim Lee, vice president of corporate development and legal affairs for Los Angeles-based Olive Hill Group. Another favorite: Silicon Beach, the high-tech L.A. hub.

Institutions seek out “amenity-rich, transportation-rich major metro opportunities,” said Alan Pontius, senior vice president & national director of Marcus & Millichap’s specialty divisions. “Some are more core in nature and want to buy well-leased, best-in-class opportunities, and some are value-add, still targeting the same areas but looking for some vacancy so they can come in and put their own mark on an asset,” he said.

New Directions

Notwithstanding the recent slowdown in sales, office assets continue to attract intense interest from buyers of all stripes. Demand in the most coveted markets often outstrips availability, however, so industry veterans suggest keeping an eye on less-heralded locations, many of which have been overlooked since the Great Recession.

  • Follow the sun: Many investors are chasing core assets in a handful of gateway cities, but aggressive pricing means that returns may be better elsewhere. For example, population and job growth in a variety of Sunbelt markets promise to translate into stepped-up demand for office space.
    Transit-oriented locations © The Regional Transportation District
    Transit-oriented locations © The Regional Transportation District
  • Transit-oriented locations: Capital is flowing to CBDs and suburbs that offerconvenient commutes. One example: theChicago suburbs, noted Christopher Ludeman, global president of CBRE Capital Markets.
  • Back to the ’burbs: Investors have often overlooked assets beyond core urban markets in recent years, but demographic trends call for a fresh look at the suburbs, contends Alan Pontius, senior vice president & national director of Marcus & Millichap’s specialty divisions. As city-loving Millennials start families, many will likely follow prior generations to suburban settings. 
    5 Houston Center cquired in January by Spear Street Capital for $272 million, Image courtesy of Business Wire
    5 Houston Center, acquired in January by Spear Street Capital for $272 million (Image courtesy of Business Wire)
  • Houston: Despite economic woes stemming from soft energy prices, the fourth-largest U.S. city may be a sleeper. “There are some green shoots happening there that make you feel like we’re somewhere at the bottom,” reported David Steinbach, Hines’ chief investment officer. “So we might get a bit more aggressive to acquire something.”
  • Capital ideas: Consider office assets in Northern Virginia and other parts of metro Washington, D.C., suggests Steve Pumper, executive managing partner with Transwestern’s capital markets group. “There’s a huge presence in the defense contracting industry, and given what’s going on with the new administration, most of the defense contractors will be busy,” he explained. 
  • Mixed-use and match: As urban areas and a growing number of suburbs encourage density, office properties integrated with multifamily and retail reflect live-work-play formats emerging in markets of all sizes.
  • Global goals: Hines’ Steinbach said he is closely monitoring the United Kingdom for opportunities emerging from Brexit. He’s also evaluating opportunities in Warsaw.

Originally appearing in the Mid-Year Update 2017.