March 5, 2009

By George Ratiu, Research Economist

Office market fundamentals are in decline-demand is down, vacancies are rising and rent growth is in negative territory. The situation is similar on the investment side, where investment in office properties is down 75 percent compared with 2007. The market maintained momentum during the first part of the year. However, the financial collapse that started in September precipitated an accelerated decline in the third and fourth quarters. A total transaction volume of just $54 billion was posted from January to the end of December 2008. This was in sharp contrast to the $208 billion volume in 2007.

The silver lining in the office sector is the fact that in 2008, the office market was the largest in terms of investment volume of the four core property types, accounting for 38 percent of all commercial investment. In spite of that however, the number of transaction was down 65 percent from 2007. In addition, average cap rates moved up 60 basis points, leading to a decline in prices.

Regionally, on a year-over-year basis, the greatest declines in office transactions were seen in the following markets:

• The West down 83 percent
• The Mid-Atlantic and the Midwest, both down 73 percent
• The Northeast down 71 percent
• The Southwest down 70 percent
• The Southeast down 62 percent

There were few individual bright spots in the gloomy market. Some of the markets experienced increases CBD office investment, including three in the Midwest. Detroit tops the list with an increase of 229 percent, but it only made the list due to General Motors acquiring Renaissance Plaza. The other Midwestern markets with positive changes in CBD investments were Kansas City (up 41%) and Cleveland (up 21%). The only other markets with increased CBD investment were Hartford (up 120%), East Bay (up 71%) and Miami (up 37%). Pricing for CBD office was down 22 percent in the fourth quarter of 2008 compared the fourth quarter of 2007. Cap rates were up 105 basis points over the same period. There is an underlying concern with determining prices, due to the low number of transactions toward the end of the year.

On the other hand, suburban market office investment declined across the board, with NYC Boroughs providing the only exception-a 34 percent increase. Pricing for suburban office is flat on a yearly basis, but cap rates are up 49 basis points.

 

TOP 5 OFFICE MARKETS BY VOLUME
CBD		Suburban
Manhattan	$13.1B	Los Angeles	$2.6B
DC	$2.4B	Atlanta	$1.5B
Chicago	$1.5B	Dallas	$1.4B
San Francisco	$1.0B	San Jose	$1.2B
Boston	$0.9B	Northern NJ	$1.2B

 

The ranking of the top office markets in 2008 changed from 2007. It was noticeable that only 15 markets recorded more than $1 billion in sales during 2008, compared with 35 in 2007. Manhattan continues to maintain the top spot with $13.1 billion in sales, followed by Los Angeles ($3.0 billion) and DC ($2.4 billion). The other markets rounding the top five were Chicago and Atlanta, with investment volumes of $2.2 billion and $1.9 billion, respectively.

Analyzing the buyer composition for office space, private investors gained market share in terms of office acquisitions, as other investors pulled out of the market. At the end of 2008, private investors accounted for 42 percent of acquisitions, up from 34 percent the previous year. Meanwhile, foreign investors recorded the largest decline in terms of office acquisitions. Foreign investments declined 100 percent in the fourth quarter 2008 from the fourth quarter of 2007. Equity funds and institutional investors also slashed their investment activity by 82 percent and 78 percent, respectively.

 

The top office deals of 2008 include:

• General Motors Building, New York, NY - $2,853 million
• Credit Lyonnais Building, New York, NY - $1,460 million
• Park Avenue Tower/850 Third, New York, NY - $990 million
• Chrysler Building, New York, NY - $888 million
• Macklowe/Boston Properties Deal, New York, NY - $705

Taking a glance at the data, 2008 will remain a year to remember. From a fairly resilient first half, the office market dropped in the wake of the financial markets crisis. In the ensuing roller-coaster ride, investor confidence plummeted, credit vaporized and deals dried-up. Looking ahead at 2009, the pace of investments is likely to remain muted. But, an increasing number of distressed sales are beginning to show up on the market, and they are likely to increase. With financing still scarce and the number of delinquent mortgages increasing, more properties are likely to come on the market in the months ahead.

This is one in a series of commentaries by the Research staff of the National Association of REALTORS®. Read more commentaries >

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