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Real Capital Markets Report: Office Investment Regains Consistency After Challenging End to 2018/Beginning of 2019

Real Capital Markets (RCM) Report explores impact of coworking trend, other market issues

Carlsbad CA— The office investment market is back on track and buoyed by significant sources of capital for deal-making, following some political and economic uncertainty over the past year, according to a Mid-Year Office Investor Sentiment Report by Real Capital Markets (RCM).

Among the key take ways is that a majority of investors (87 percent) who participated in the report view coworking as a moderate to high risk to investment values, with 37 percent of that group noting that the market could be saturated. Overall, investors are looking more closely at the investment value of co-working space, given its rapid expansion and potential exposure to any market downturn.

The report also notes that investors remain confident in the office market in general, given economic condition, population growth and other factors. “Conventional wisdom and years of experience tell us that we may be long in the cycle,” says Tina Lichens, COO of RCM. “At the same time, there is a broad sense of optimism, albeit somewhat cautious, that with the level of capital poised for investment, there are still allocations to be met and transactions to be completed.”

Key trends noted in the report include:

  • Coworking expansion continues but concerns about saturation emerge—The report shows that 50 percent of respondents see coworking as a moderate risk and 37% see it as a great potential risk and that the market could be oversaturated. Only four percent noted that it presents no risk at all.
  • Investors are cautiously confident—Economic expansion, population growth and low unemployment all bode well for the sector. There is caution, given the length of the cycle and concern about how a downturn would impact pricing.
  • Suburban office investment is seeing a resurgence—Select suburban markets with strong job and population growth are experiencing increased activity, which includes value-add transactions.
  • Top operational issue is increase cost of tenant improvement—TI costs are rising considerably faster than rents, an issue across the country and especially in markets with lower rents.
Coworking Creates Opportunities, Risks; Is Saturation Near?

Coworking accounted for nearly half of the U.S. office absorption in 2018, according to industry experts. Given this rapid expansion and its impact on building vacancy rates across the country, some investors are questioning whether this market segment is nearing a saturation point. How much is too much?

The top three ways coworking is impacting the market are:

  • Pushing vacancies down – adding value for landlords, stabilizing buildings and improving the health of some market areas.
  • Creating an Incubator mindset – for some larger owners and REITS that embrace the concept as a way to attract smaller tenants and manage those relationships as they grow. “Coworking is a way to incubate tenants in your own building, and work with them, once they get big enough, to keep them within your portfolio,” said William Prutting, Senior Managing Director, JLL Capital Markets in Washington, D.C.
  • Paving the way for more dramatic disruption to office leasing – the coworking lease process overall is less expensive, not as protracted or labor intensive as the standard lease and could be a harbinger of things to come.
Well Located Suburban & Emerging Markets Top Opportunity List

RCM survey participants noted that value-add suburban properties offer the greatest opportunities in today’s office market, along with well-located properties in emerging markets. Each of those market segments were noted by more than 37 percent of respondents. Markets with good fundamentals, including population and job growth, as well as a highly trained labor force, are making the grade with investors. Those include Charlotte, Chicago, Kansas City, Minneapolis, Phoenix and St. Louis, among others.

On the other end of the spectrum, the three property categories seen as less attractive, or having the least opportunity, are stabilized, well-located downtown buildings, trophy properties and stabilized, well-located suburban properties. These findings reflect the perceived lateness in this investment cycle and investors continued focus on growth, value and yield.

Expecting Consistency

Investors interviewed and surveyed by RCM suggest that the U.S. office investment market is back on track, following a slow down at the end of 2018 that lingered into early 2019. Political and economic forces—the government shutdown, uncertainty about interest rates and the real threat of tariffs and trade war escalation—raised questions, generated considerable uncertainty and slowed activity.

However, at the mid-point of 2019, property owners, investors, and brokers expressed confidence in the health of the market given the strength of the economy, continued job growth and population expansion in many markets. This is reinforced by the estimated $200 billion in dry powder allocated to the commercial real estate market.

Operational challenges are impacting value

In spite of its relative strength and consistency, the office sector is not without its share of challenges. In rank order the biggest challenges are the cost of tenant improvement allowances (63.7%), the ongoing trend of tenants taking less space (53.6%) and the cost of converting underperforming assets (42.0%).

Tenant improvements are a great underwriting challenge. Universally, tenant improvement costs are increasing considerably faster than rents. Increases in tenant improvements make it problematic, especially in markets with lower rents. While there can be greater disparity in rental rates from primary to secondary and tertiary markets, tenant improvement costs, from materials to labor, are more consistent, regardless of geography.

“We’ve reached a very interesting time in this current investment cycle,” says Steve Shanahan, Executive Managing Director, Real Capital Markets. “This is an investment cycle that despite its challenges, has been extended by robust levels of capital available for investment coupled with putting many lessons that have been learned from past cycles into practice.”

Click here to view the full Real Capital Markets report

About Real Capital Markets

Founded in 1999, Real Capital Markets (RCM) is the global marketplace for buying and selling CRE. RCM increases the speed, exposure, and security of CRE sales through its streamlined online platform. Solutions include integrated property marketing, transaction management, and business intelligence tools to unify broker-level and firm-level data and work flows. RCM has executed over 65,000 assignments with total consideration in excess of $2.3 trillion. Approximately 50% of all U.S. commercial assets sold, over $10 million, are brought to market using RCM’s online marketplace annually.

Real Capital Markets has published several Investor Sentiment Reports covering the Retail, Industrial and Multifamily sectors over the past two years. To view and/or download a copy of previous Real Capital Markets Investor Sentiment Reports, click here.