Improving fundamentals attract investors to the office sector

Last Thursday, Howard Hughes Corp. sold an interest in a 1.5 million square foot. office tower at 11 Wacker Drive in Chicago. At $210 million, the deal price would bring the building’s valuation to more than $1 billion, the highest valuation for a Chicago office building since the Willis Tower was sold to Blackstone in 2015. The deal marks a continuation of a trend that began towards the end of 2021, when large investors began buying trophy office buildings at very healthy valuations.

Two years after the pandemic shuttered offices around the world, many workers have still not returned full-time. “Everyone has an opinion on what ‘returning to the office’ will look like, but no one really knows,” says Russell Ingrum, vice president of capital markets at Texas-based commercial real estate services firm CBRE. . “Still, most investors remain bullish on this asset class and have determined how they want to bet the desk.”

In February, the most recent month for which data is available, U.S. office investment sales totaled $6.6 billion, a 99% increase over the same period in 2021, according to real estate data company Real Capital Analytics (RCA). The average closing rate during the month was 6.3%, higher than those for multi-family and industrial assets, but significantly lower than the average for the hospitality trades.

In Ingrum’s view, nearly all U.S. markets should see higher transaction volumes for office properties in 2022 compared to 2021. But he notes that major market players have shifted from primarily institutional buyers to private capital and value-added funds.

Today, office investment is “very heavily biased towards private buyer groups as institutions have overweighted their top sector acquisition priorities towards industrial and multi-family,” says Al Pontius, vice president. -senior president and national director of the office and industrial division of commercial brokerage Marcus & Millichap. “For institutions, they will be very selectively looking at office properties that are modern, prime assets, which they expect to compete favorably with top companies in primary markets.”

Office REITs and offshore buyers, which have made a few acquisitions across the country in recent months, are also active, according to Ingrum. He adds, however, that they are picky about the types of assets they wish to pursue. Lauro Ferroni, senior research director, capital markets, at commercial real estate services firm JLL, says capital from Canadian, German, Singaporean and South Korean investors continues to target US office assets, in particularly well-praised trophy products in gateway markets. or the most dynamic secondary markets.

What types of agreements are concluded

Although CBRE investment sales data for the first quarter is not yet available, Ingrum says it has noticed an acceleration in trading volume. “The most active type of agreement has moved from single-tenant agreements to value-added agreements,” he adds. “As value-added funds seek to place capital, we are also seeing a large amount of private capital and high net worth (HNW) investors helping to build the market for this asset.”

Just looking at closed office investment sales in Texas, Ingrum says there have been more sales so far in 2022 than during the same period in 2021. JLL’s Ferroni agrees. , noting a significant increase in investment activity involving high-quality office properties, particularly among new developments that have completed their rental periods, with landlords now looking to sell.

In addition, investor interest in single-tenant and net-lease office assets continues to be strong, with such transactions representing a higher proportion of overall activity than before the pandemic, Ferroni notes. According to Ingrum, sales executions for older base buildings that require repositioning are much more difficult in a world that values ​​quality over price (although sometimes solid locations can still attract investor interest, even for older buildings).

Two years of waiting to monetize an asset has created more office sellers in 2022, he notes, and typically the greatest volume of sales occurs in markets where there are the most willing sellers. He notes that Houston, for example, is seeing a significant increase in investor demand as a large number of landlords are ready to monetize their office investments and move on.

“There were a number of owners who were preparing to sell in late 2019 and early 2020, but their plans were cut short by the Covid-19 lockdowns. Probably a lost rental that had to be backfilled and takes time,” he says. Now that tenants are signing leases again, investors can take out leases, bringing cash back to office buildings.

As real estate fundamentals improve, core diversified open-ended equity funds (OCDCs), which have been active on the sell side, are expected to begin making selective acquisitions in the coming months. , according to Ferroni. In addition, yield squeezes on industrial and multi-family acquisitions are increasingly positioning office assets as a higher-yielding alternative, she notes.

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