Investors Show Renewed Interest in Suburban Office

Office investors—including institutional capital sources—are showing a renewed interest in suburban office products. A strong local economy and with incentives from the recent tax reform are driving an expanded interest in office product. This is great news for the San Diego office market, which has a large supply of suburban office product. While sales volume has yet to return to the levels in the prior peak, this renewed demand should fuel sales activity through the end of the year.

“Similar to the vast majority of major US markets, trading volume in San Diego County, where 86% of the office inventory is located in the suburbs, has been sluggish over the past few years as capital has been focused on CBD opportunities and other asset classes–namely industrial and multi-family,” Brad Tecca, executive director of capital markets at Cushman & Wakefield, tells GlobeSt.com. “While overall office trading volume in San Diego continues to lag behind past peak levels, positive economic indicators in addition to new policies implemented by the current administration—namely tax cuts—has resulted in renewed interest by investors in suburban office opportunities.”

Interest in suburban office has already started. Admiral Capital has acquired the Balboa Executive Center, a five-story, 120,992-square-foot class-A office building, at strong pricing that exceeded expectations. “What we questioned was how deep of an investor pool would we be able to generate. At the end of the process, we were extremely pleased as we were able to generate double-digit offers, which resulted in an extremely competitive bidding situation,” Tecca, who brokered the deal on behalf of the seller, explains. “This was the first suburban office offering where we received double-digit offers in quite some time and we believe this is a sign that for the right asset in the right location institutional investors are back for quality suburban office product.”

Creative office is getting the most attention lately—and it does tend to garner higher rental rates and stronger leasing velocity; however, Tecca says that there is still demand for traditional office space, especially in San Diego. “I am a strong believer that the shift to creative office product is here to stay and that tenant demand is strong and growing,” he says. “However, there will always be demand for traditional office product that is driven by certain tenant sectors.  Balboa Executive Center is located in a submarket that is dominated by state and federal user groups and tenants within the healthcare, defense and insurance industries who prefer a more traditional office setting.”

The demand for office product is expected to grow in the second half of the year.

“Based on our current offerings and what we have in the queue, I anticipate deal volume to pick up throughout the balance of the year and will be on par with year-end 2017,” says Tecca. “Limited large portfolio transactions will temper the sales volume as compared to previous peaks although we may begin to see multiple asset transactions increase in 2019—it’s all based on how active institutional investors become for this asset class. As volume and offerings pick up, pricing is anticipated to be bifurcated between the ‘haves’ and the ‘have nots’: the haves being assets or projects that either offer a wealth of on-site and/or walkable amenities or the ability to add amenities if they don’t exist; the have nots being assets or projects that don’t have on-site amenities or are located in an area where driving to amenities is required and the existing real estate is not suitable for repositioning.”

The decrease in large portfolio may hinder sales volumes, and as a result, numbers may trend down compared to last year. “Large portfolio offerings that previously buoyed sales volume statistics in San Diego are not projected to be as robust throughout the balance of the year; however, an increase in single-asset or mini portfolios offerings are anticipated to grow with demand,” adds Tecca. “Our recent successful closings indicate that the buyer/seller pricing gap is beginning to narrow and attractive financing solutions continue to play a vital role in rising pricing levels.  As a discount to other West Coast markets, San Diego is benefitting from robust tenant demand and a limited amount of new office deliveries during the current cycle, limiting competition from new construction and putting upward pressure on rental rates.”