The January 5th New York Times Business Section contained an interesting article reporting resurgence in office building transaction activity. The article pointed out that the activity was pretty much confined to primary markets like New York and Washington D C and involved not only well leased properties but also those with substantial vacancy. At the same time, the article indicated that rates of return (capitalization rates) were dipping below 6.0% while overall office vacancy was above 16% nationwide. Finally, the article suggested that investors were “betting” on increased rates of return as the office market improves while noting that the key to increased occupancy was improvement in the job market.
Does all of this mean that the office sector is climbing out of the doldrums of recession? Probably not! What it most probably shows is that there is a substantial excess of investment capital searching for opportunity in an opportunity thin environment. It also probably shows that REITs and investment funds have been able to raise large amounts of capital at relatively low interest rates that permit returns below 6% to produce positive cash flow. On the other hand, the office sector is still fraught with vacancy, mortgage delinquency, foreclosure and falling rent problems. So, is the optimism rational or is it wishful thinking?
In certain select markets the optimism may be rational but in the majority of markets it is wishful thinking. There is no question that occupancy rates will not begin to improve to a point where vacancy is below 10% (the level where recovery is most probable) and that should not be expected to happen until the employment statistics show sustained improvement indicating hiring resurgence. However, there are other factors besides employment levels to consider. It must be expected that the number of employees working from their homes either full time or at least part time will continue to expand. This portends a change in the amount of space needed per employee. With employees working from home, a dedicated private office or cubicle for each employee may no longer be part of space planning. Rather, off-site workers may spur an increase in the use of “guest offices” as the probability of the entire staff being on-site at the same time diminishes to a percentage approaching zero. If these things come to pass, new demand may not push rentals upward as quickly as anticipated. Another problem that could impact office demand in some markets is the lack of affordable housing and efficient municipal transportation. These factors could induce management to relocate clerical staffs to secondary communities where there is affordable housing and where transportation (parking) is not problems.
One final observation may be valid. The money flowing into office building investments represents “managed funds”. When managers, working with other people’s money (OPM), dominate market activity does it necessarily mean that they purchase decisions are sound? Not always! Experience indicates that when money managers have substantial cash or access to substantial cash, they are competitively induced to find an investment outlet for that cash as was evident pre-crash. In the boom leading up to the financial collapse, major, sophisticated REITs and investment funds made catastrophic errors and lost billions of dollars with the lenders taking most of the losses. There is an appearance of a “herd mentality” and that could lead to the same kind of excess that led up to the recent market fall.
It is, therefore, concluded that in the current economic environment, commitment of major funds to office building investments may be premature

This entry was posted in Property Ownership, Real Estate Economy, Real Estate Appraisal, Real Estate Investment. Bookmark the permalink.

Leave a Reply

Your email address will not be published. Required fields are marked *