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How Investors Find Opportunity in a Cooling Office Market

Foster: “We are at the strongest point in the current cycle and, barring a major economic shock, the outlook remains stable over the short-to-medium term.”

NEW YORK—Office investor strategies continue to shift toward suburban and second-tier markets that provide higher yields, but there are still buyers—particularly from overseas—for trophy central-business-district assets, Colliers International’s president of office services for the US Cynthia Foster tells GlobeSt.com. According to a recent report from the firm, US office market fundamentals remain at their strongest point in the cycle, with peak occupancy and record rents; yet, there is little doubt that the market has been cooling.

The report shows that national office vacancy rate has been virtually static for more than a year. Rents are still rising but the pace of appreciation is modest and slowing. Likewise, absorption is still positive, but Q1 2017 was relatively quiet, and activity was concentrated in suburban markets. Office space under construction rose for the third successive quarter in Q1 2017, while investors continue to chase higher returns—leading to an increased focus on suburban and second-tier markets.

We spoke with Foster about the tailwinds that will fuel occupancy in office markets in the coming months and how investors’ strategies are shifting as the market changes.

GlobeSt.com: What will fuel occupancy in office markets over the next few quarters?

Foster: GDP growth—at 1.2%—was low in the first quarter, which is usually the weakest part of the year for the economy. As economic growth picks up, expect to see an uptick in demand and leasing activity. GDP growth for 2017 as a whole is expected to range between 2.0% and 2.2%. Second-quarter GDP could be as high as 2.5%. On a national basis, financial services and tech should continue to account for a large share of leasing activity, but drivers vary from market to market.

One trend expected to continue is the attraction of “cheaper” markets versus their expensive neighbors. Downtown Oakland, CA, is a good example, with class-A rents that are 30% lower than central San Francisco. In some markets—notably, Manhattan—demand has been restricted by limited large-block availability, which should ease as tenants move into new properties that they pre-leased in prior years and as new supply enters the market. However, there is one note of caution: real estate costs and the drive toward more-efficient space utilization are causing some tenants to downsize and consolidate when they take on a new lease. The reduction in footprint is typically in the range of 10% to 20%.

GlobeSt.com: How are investors’ strategies changing as the market cools? 

Foster: Investor strategies continue to shift toward suburban and second-tier markets that provide higher yields, but there are still buyers—particularly from overseas—for trophy central-business-district assets. As an example, a partial interest in Deutsche Bank’s headquarters at 60 Wall St. in Downtown Manhattan was recently acquired by Government of Singapore for $988 million. The US is still perceived as a safe haven by investors who take a long-term view. There is little upward pressure on cap rates at present, but rising bond yields and an increase in finance costs look set to have an impact. Expect some investors to be willing to take on some degree of risk as they chase higher returns.

GlobeSt.com: Which geographic areas will remain strong for the rest of the year?

Foster: On a regional basis, we expect the South to have the best performance, particularly in Florida’s Miami and Tampa Bay. There are also several mid-size tech-related markets in the South, such as Raleigh/Durham and Austin, that continue to perform well. Among the major cities, Manhattan—particularly Midtown South—and (Downtown) Chicago are also showing healthy performance that is expected to continue for the remainder of 2017.

GlobeSt.com: What else should our readers take away from the Collier’s office reports?

Foster: The US office market is cooling a bit, but remains strong. For instance, in two of the three major New York City submarkets, rents have reached new post-2008 highs. While national vacancy and rent growth continue to slow, we are at the strongest point in the current cycle and, barring a major economic shock, the outlook remains stable over the short-to-medium term. Construction activity remains elevated but is set to abate, with deliveries peaking this year and then declining in 2018. Although the major West Coast markets could be impacted by speculative deliveries, the majority of space underway across the US is pre-committed.

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