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NREI Research Series

Part 2: The City or the Burbs?

Respondents were also asked about the outlook for CBD office properties in comparison to suburban complexes. Responses were similar for both property types and also mirrored overall sentiment for the sector. In both cases, about two-thirds of respondents expect cap rates to increase (67 percent for CBD, 70 percent for suburban), while less than one-fifth expect cap rates to decrease (19 percent for both CBD and suburban). A year ago, 54 percent expected an increase for CBD properties and 57 percent for suburban properties.

Respondents ranked CBD buildings and suburban properties as nearly equally attractive (51.1 percent for CBD and 48.9 percent for suburban).

When it came to projecting which type of investment offers higher long-term yields, sentiment was also evenly split (50.8 percent for CBD properties and 49.2 percent for suburban properties). Last year, CBD office buildings edged suburban properties by a wide margin (60 percent to 40 percent).

Employers, including technology companies, are luring young talent to the suburbs with creative office campuses that provide lots of amenities, along with the greater housing affordability, industry insiders say.

“Movement to corporate office campuses is the biggest trend we’ve seen over the past few years, with tech firms consolidating or expanding into new campuses,” says Stephen Newbold, who heads national research for real estate services firm Colliers International.

Silicon Valley firms, including Google, Facebook and Apple, have headquarters at sprawling corporate campuses with gyms, chefs preparing organic food and massage services on-site. The rationale for everyone under one roof is the idea that it fosters positive employee morale, productivity and innovation, according to a Gensler study. While noting that it’s difficult to define creative space, Newbold adds that “there is a general trend by all occupants to use space more creatively. Part of that is to fit the work demographic to the space and consolidate or use space more efficiently.

Employers are attracted to suburban office markets because rents for class-A space there tend to be nearly half those of CBDs at $29.13 per sq. ft., compared to $45.90 per sq. ft., according to Colliers’s fourth quarter 2016 Office Market Outlook Report.

Meanwhile, continued rent growth in CBDs has slowed space absorption there, as tenants downsize to control costs. “The majority of transactions in CBDs are renewals,” Newbold says. As a result, suburban office markets now account for the greatest share of office absorption, according to the Colliers report.

The high cost of office space and housing in the San Francisco Bay Area and New York City markets is also driving smaller and early-stage tech companies into second-tier urban markets, including Portland, Ore., Austin, Texas and Charlotte, N.C., Newbold continues.

The fourth quarter 2016 office report from real estate services firm Cushman & Wakefield notes that more office space was put on the market in the Silicon Valley (-2.8 million sq. ft.), East Bay San Francisco (-927,000 sq. ft.) and Brooklyn, N.Y. (-847,600 sq. ft.), than was taken off.

But despite a flat vacancy rate, New York’s office market remained strong throughout 2016, with the second-highest annual leasing total in the past decade, according to Colliers. In addition, the San Francisco Bay Area remains the tightest of the top 10 office markets with a 5.6 percent overall vacancy rate, and vacancy as low as 2.0 percent in the Silicon Valley markets.

Early in this expansion cycle the strongest markets were technology- or energy-driven, but this “Tech and Texas” pattern shifted as oil prices fell and tech growth slowed, according to the Cushman & Wakefield report. Office markets with the most diversified economies enjoyed the greatest positive net demand and growth in occupancy during 2016, including: Phoenix (3.6 million sq. ft.), Chicago (3.5 million sq. ft.), Seattle (3.3 million sq. ft.), Dallas (2.9 million sq. ft.), Philadelphia (2.6 million sq. ft.) and Los Angeles (2.4 million sq. ft.).

Research Methodology:

The NREI research report on the office real estate sector was completed via online surveys distributed to readers in March. The survey yielded 274 responses. Recipients were asked what regions they operated in (and were allowed to select multiple regions). Overall, 48.5 percent said they operated in the South, followed by the East (40.2 percent), Midwest (35.4 percent) and West (34.3 percent). Half of respondents (52.2 percent) hold the titles of owner, partner, president, chairman, CEO or CFO. Approximately half of respondents are investors or developers. The results from the current research were compared against prior studies completed in early 2016 and late 2015. The 2015 survey yielded 216 responses and the 2016 survey yielded 371 responses.

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