For the office market, the next few years should see a significant shift back to the private client marketplace and away from distressed commercial real estate.
In my 40 years of real estate and finance experience, I have identified several leading indicators that serve to predict changes in the market. These are:
- Compression of cap rates on single tenant net leased investments;
- The insatiable acquisition of “trophy projects” in all product verticals;
- An apartment market on fire with the fuel of cheap long-term money and many sources for it;
- Resurgence of demand for land, lots and subdivisions from the largest public home builders all the way down to some of the smaller in-fill local and regional players, also fueled by low interest rates.
It’s clear that the office market will benefit from these real estate and economic indicators. However, the office market does face some challenges, including a significant variance in the numbers being published on office vacancy and activity, and the varying pricing tiers based on quality and location. These challenges may spell an opportunity for the astute investor and commercial real estate advisor to provide added value.
Advisors should be careful with the sources they quote. For example, REIS reports the National Office Vacancy at 17.1% and .50 basis points below the recession high while CoStar reports National Office Vacancy at 11.9%, which would be 5.70% better than the recession high.
Following are some current statistics:
Vacancy levels for different classes of buildings:
- Class- A projects are at 13.3%
- Class-B projects are at 12.4%
- Class-C projects are at 8.8%
(Obviously the discounts and concessions in the better buildings are going away and rents are firming. Tenants still seek affordability, especially until their business and the economy improve)
- U.S. CBD vacancy is 10.9%
- U.S. Suburban vacancy is 12.2%
- There is still a lot of reported Class A sub-lease space at 27M s.f. or 58% of all sublease space. Still, a significant amount of excess and under-utilized space is not formally on the market.
- Suburban markets make up 33M s.f. of the sublease inventory or 71% of the total.
Lastly, a significant number of office property owners want to get off the vertical, based not only on the property’s age, but their own age and where they are in their personal investment cycle (they may be older, want more freedom, want to lower management issues, tired of tenant issues and demands, etc.). This situation creates a new frontier of adaptive re-use, space design and modification for today’s virtual or hoteling tenant and their employees along with a significant shift back into the vibrant American CBDs.
In my opinion, the product that represents the greatest opportunity is Class A suburban office, as long as it is properly priced.
Today, the most important part of advising clients is being aware of your local competitive landscape. Additionally, you must know what the new tenancy needs, wants and demands plus how the growing focus in space design on more “we” space instead of the “me” space of old (like law firms at 350 s.f. per person on average) will affect your client’s specific property.
As of Q2, I think the future is bright and the office market will continue to be at the core of commercial real estate.
Prepared by:
Council Chair of Office Properties
Sperry Van Ness Chicago Commercial
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