Office Capital Market Update, Q1 2019

National Cap Rate Trends


National Office Market: Cap Rate Trends, 2014 Q1 – 2019 Q1

Source: REIS, Real Estate Solutions by Moody’s Analytics


The average office cap rate increased to 7.3% from 6.7% in the fourth quarter. This recent increase puts the average cap rate at or very close to the 10-year average. Office cap rates have seen far more volatility than apartment cap rates and – as this chart clearly shows – very little overall change over the last five years. The 12-month rolling average increased to 7.1% from 6.9% last quarter. Note that these rates have trended within a very narrow band of values as shown on the vertical axis. Again, the lack of change since 2014 is in sharp contrast to apartment cap rates, which have declined steadily in that period.

One could look at the numbers and conclude that these cap rates are in line with fundamental trends. Office rent growth increased just 0.5% in the first quarter, and the overall vacancy rate fell 0.1% to 16.6%, which is unusually high given how deep we are in the current expansion. Construction has been moderate compared to past cycles, yet tenants are leasing fewer square feet per employee and investors have been very conservative about investing in office properties.


Average Price per SF


National Office Market: Average Price per SF, 2014 – 2019 

Source: REIS, Real Estate Solutions by Moody’s Analytics


The chart above shows the average price per unit for the top 50 metros as well as the top 10. For the office market, the top 10 metros are New York City, Los Angeles, San Francisco, San Jose, Suburban Virginia, Seattle, Chicago, Boston, Atlanta, and Washington, DC. These metros account for 53% of the volume in the top 50. This chart mirrors the cap rate chart in that average prices have not changed much in five years. Note for the top 10 metros that the average price declined to $320 per square foot in the quarter after falling from a recent peak of $360 per square foot in the third quarter of 2018.  For the top 50 metros, the average price fell $20 per square foot to $280. What this shows, in contrast to the apartment market, is that investors are perhaps seeking opportunity in non-gateway cities. The premium that the top 10 metros fetch over the top 50 metros – represented by the distance between the two lines – has narrowed from an average of 25% in 2016 and 2017 to an average of only 18% starting in 2018. This contrasts the apartment market, where the gap between the average price for the top 10 metros and the top 50 metros has slightly widened. Sure enough, the only metros that show a three-year high in average price per square foot in the first quarter were San Francisco, Seattle, San Jose, Philadelphia, and Pittsburgh. Philadelphia’s average was weighed by the $451 million sale of 1735 Market Street for approximately $340 per square foot. This property is at the very “center” of Center City Philadelphia and has a number of amenities, including conference facilities and a few lounges.

At the other end of the country, the three major tech metros – San Francisco, Seattle, and San Jose – all saw healthy sales volume and prices. San Francisco closed four sales above $200 million in the quarter, including the former Gap headquarters on Terry Francois Boulevard in Mission Bay, which traded for more than $1,000 per square foot. In Seattle, 300 Boren Avenue sold for a record $740 million, or $921 per square foot. Not surprisingly, Amazon leases the property.

As these transactions show, investors prefer urban-core, amenity-laden properties near public transportation. Investors are also clearly drawn to tech markets. That said, the general trend in this chart is that the office market is still less preferred than the apartment market, but there are investors finding opportunities.


Sales Volume


National Office Market: Indexed Transaction Volume, 2014 Q1 – 2019 Q1

Source: REIS, Real Estate Solutions by Moody’s Analytics


The overall volume for office transactions fell in the first quarter after climbing in the third and fourth quarter. This pattern was consistent for the top 10 and top 50 metros.  The overall sales volume in the first quarter of 2019 was near a five-year low in both the top 10 group and the top 50 group.  This is consistent with the drop in apartment transaction volume. New York City saw the steepest drop in volume from an average of $3 billion or more per quarter to just under $1.5 billion in the first quarter.

The sharp drop in the stock market in the fourth quarter very likely drove investors to hit the pause button for a few months. The recent recovery of stock values could bring more optimism to the capital markets, which are undoubtedly very sensitive to any news that suggests that the end of this record-long expansion may be near. We do not suggest that this is the case; this is just a comment on how sensitive the market has become over the last few quarters.

As for individual markets, Seattle, San Francisco, San Jose, Nashville, Minneapolis, and Milwaukee all saw the highest transaction volume relative to recent quarters.

Analysis by Barbara Byrne Denham. Denham is a Senior Economist in the research and economics department at REIS, the team responsible for the firm’s market forecasting, valuation, and portfolio analytics services. Throughout her 20-year career, Barbara has written a number of white papers on the commercial real estate market.


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