At the end of 2017, the office sector continued to experience a slowdown. There was a 50 percent year-over-year decline in investment sales volume in November, though there was also a 4.1 percent year-over-year increase in pricing, according to a report from New York City-based research firm Real Capital Analytics (RCA). Some of the decline in activity may have been driven by the rising asset prices being out of sync with expectations for occupancy and rent increases going forward. Will these patterns continue into the New Year? NREI spoke with several industry insiders to get a sense of where this sector is heading in 2018.
- Vacancy rates will continue to tick up. Vacancy rates stabilized from 2016 to 2017, then began to rise slightly toward the end of last year, says Peter Muoio, chief economist at Ten-X, an online real estate marketplace. Although there is expected to be economic growth in 2018, supply is growing in the office sector, Muoio notes. This is particularly the case in stronger markets such as New York City and Houston, which saw stronger economic recovery than what Muoio describes as “left-behind” markets, which saw no substantial recovery and higher office vacancies. “It’s at a cyclical tipping point,” Muoio says.
- Rents will also increase. Many market signals point to a bump in office rental rates in 2018, such as increased employment rolls, says Bill Glazer, CEO of Philadelphia-based Keystone Property Group, a private real estate investment company that owns office and mixed-use properties along the East Coast. “When you take the sum total of those macro market impacts on the office sector, it does portend for a very strong 2018, and frankly 2019,” Glazer notes.
- Suburban offices will rebound. “We see accelerating strength in the suburban market,” says Alan Pontius, senior vice president, national director of specialty divisions at real estate services firm Marcus & Millichap. Part of the underlying reason for the improvement in the suburban office segment is demographics: older millennials are beginning to move to walkable suburbs. For office assets in these markets to compete strongly, they have to address the walkability factor and offer more than just a large lot to park cars, which are becoming less relevant with the proliferation of services like Lyft and Uber, Pontius adds. The communities on the edges of urban locales that work to rezone and entitle their land will be the most successful with this trend, Glazer adds.
- This year will see the highest level of speculative office construction as a percentage of the supply underway. There is 120 million sq. ft. of office space under construction in the market, and of that, 40 percent is still available—the highest level CoStar has recorded in the last 13 years, says Hans Nordby, managing director with research firm CoStar Portfolio Strategy. Factors underlying the increased speculative development include cyclically low vacancy, rising demand for only class-A space and rents above replacement costs in many of the best locations, Nordby notes.
- Investors will increasingly view office acquisitions as opportunities to diversify. While the multifamily and industrial segments are having more robust runs of late, investors may look at the office sector to counterbalance their portfolios, Pontius says. “I think the office market is also going to be viewed by investors with a greater degree of interest this year,” he notes.