Office Market: National Cap Rate Trends
As illustrated in the chart below, the average office cap rate increased to 7.2% from 7.0% in the fourth quarter. This was below the ten-year average cap rate of 7.3% (shown by the dotted line). 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. The fact that office cap rates in 2018 were generally lower than rates seen in 2017 and 2016 is surprising given how interest rates have increased, but again, we caution that the data is subject to selection bias. It is also important to note that they have trended within a very narrow band of values, as shown on the vertical axis. Again, the lack of change since 2013 is in sharp contrast to apartment cap rates, which have steadily declined since then.
One could look at the numbers and conclude that these cap rates are in line with fundamental trends. Office rent growth increased just 0.7% in the fourth quarter, and the overall vacancy rate was unchanged at 16.7%. This is unusually high given how deep we are in the current expansion and how moderate construction has been compared to previous cycles. Tenants are leasing fewer square feet per added employee and investors have generally not preferred this asset.
National Office Market: Cap Rate Trends, 2013 Q4 – 2018 Q4
Source: REIS, Real Estate Solutions by Moody’s Analytics
Office Market: Average Price per Square Foot
The top 10 office metros for average price per square foot were New York City, Los Angeles, San Francisco, San Jose, Suburban Virginia, Seattle, Chicago, Boston, Atlanta, and Washington, DC in the fourth quarter. These metros account for 53% of the volume in the top 50. Average prices have not changed much in five years. However, while the average price was flat in the quarter for the top 10 metros, it increased noticeably in the top 50 metros. What this shows — in contrast to the apartment market — is that investors are perhaps seeking opportunity in non-gateway cities. Sure enough, metros that showed a three-year high in average price per square foot in the fourth quarter include San Diego, Palm Beach, Raleigh-Durham, Charlotte, Fort Lauderdale, and St. Louis — none of which are in the top 10 list. We caution, however, that in smaller metros, one significant office transaction can shift the average statistics significantly. The general trend is that the office market is still less preferred than the apartment market, but there are investors seeking opportunities in non-gateway cities.
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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