October 12, 2009

By George Ratiu, Research Economist

With the number of distressed properties rising and prices falling, there are signs of activity in the office sector. The number of transactions continues to be low, but buyers and sellers may be getting closer to finding common ground on market pricing.

Sales of major office properties dropped 29 percent in the second quarter of the year, compared with the first quarter. There were 116 properties that traded hands for a quarterly total of $2.5 billion. The decline was driven by a dearth of CBD investments, which declined by 74 percent. By comparison, suburban office deals actually rose 17 percent in the second quarter.

Based on transaction data collected to date, the third quarter is poised to post positive news. Through August, there were 86 properties traded for a total of $3.1 billion, a 24 percent increase from the second quarter. While the number of transactions is still relatively small, the other encouraging sign is the slight rebound in pricing. Based on Moody's/REAL Commercial Properties Price Index, prices for office properties declined 28.7 percent in the first quarter compared with the previous year. Meanwhile, during the second quarter, average office prices dropped to around $145 per square foot. However, based on preliminary data for the third quarter, prices are hovering around the $215 per square foot mark.

Weighing the data for the first half of 2009, the office market continues to face a large amount of unsold inventory. There were $9.5 billion of offices offered for sale versus $3.5 billion closed in the first six months. Cap rates have been rising slightly over this period-cap rates moved from 7.5 percent in the first quarter to 7.6 percent in the second quarter. However, the third quarter is experiencing average cap rates close to 8.5 percent.

 

Regionally, there were several markets that posted no sales activity in the first half of the year-Detroit, DC, Cleveland, St. Louis, Long Island, Hartford, Memphis, Salt Lake City, Charlotte, and Jacksonville. Based on the volume of transactions in the first half of 2009, the most active market has been Manhattan, with eight office transactions, totaling $1.0 billion. The other active markets, by sales volume, include Boston ($600 million), Orange County ($371 million), Northern New Jersey ($303 million), Chicago ($232 million) and Los Angeles ($224 million).

 

Office Transaction Activity
Closed H1 2009
Region	Volume ($M)	Average Cap Rate	Average P/SF
Mid-Atlantic	$474.6	8.1%	$184
Midwest	$660.4	7.8%	$146
Northeast	$2,072.8	7.7%	$319
Southeast	$278.5	7.4%	$102
Southwest	$530.6	8.4%	$101
West	$1,377.3	7.3%	$219
Source: Real Capital Analytics, July 2009

 

While sales activity improved in the first half of the year, the volume of distressed properties also rose. Lack of credit continues to plague commercial real estate refinancing. In turn, the volume of troubled properties jumped by 122 percent in the first half of the year to over 6,000 properties, worth $114.6 billion. Distressed office properties accounted for 670 properties totaling $17.4 billion. The office data represents a 99 percent increase in distress for 2009. Commercial mortgage backed securities (CMBS) have the highest concentration of distress this year, at over 50 percent.

Analyzing the regional distribution of office distress reveals that the Northeast has the largest volume of troubled assets-85 properties worth $7.9 billion-with Manhattan accounting for $5.1 billion of that volume. Meanwhile, there are several metro areas where the volume of distress is large and growing. After Manhattan, towards the top of this list are Los Angeles ($2.2B), Boston ($1.8B), Dallas ($0.8B), Detroit ($0.7B) and Chicago ($0.6B).

On a year-over-year basis, buyer composition has changed slightly. With smaller transaction volumes, private investors increased their share of acquisitions. As of the second quarter 2009, private investors accounted for about 58 percent of acquisitions, compared with 47 percent during the same period a year ago. Meanwhile, institutional and other buyers gained market share in terms of office acquisitions to 12 percent and 13 percent, respectively.

 

The first half of the year proved to be a difficult environment for office properties. With fundamentals negatively impacted by a sharp contraction in demand and rising vacancies, office space has been abundant. Meanwhile, a growing number of distressed properties pushed prices lower. The silver lining has been an increase in transaction activity. It remains to be seen if the pace of sales continues to rise for the remainder of the year, considering the efforts aimed at addressing the issue of credit availability.

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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