Suburban Office Sales in Secondary Markets Fared Better in Q2

Without a doubt, US office sales took a hit in the second quarter, but properties in suburban markets turned out to be more resilient, according to a new report from Marcus & Millichap. The firm’s Beyond the Global Health Crisis Special Report shows that office sales in the CBD decreased 72% year-over-year in the second quarter, while suburban office sales fell only 54%, which is the highest share of quarterly transaction volume since 2009 when it was 66%.

During the pandemic, navigating the market dislocation and uncertainty hasn’t been the only challenge for investors; locating opportunities and securing financing have also been problematic. In secondary markets, however, investors have had better luck. Philadelphia, Denver and Phoenix have been the most active markets for office sales velocity, with secondary markets in general posting stronger sales volumes during the pandemic. This, of course, isn’t necessarily a new trend. Pre-pandemic, capital was flooding into secondary markets chasing yield and investors are continuing to find more attractive yields in these markets as the pandemic rages on. By contrast, primary markets, including San Francisco, Miami-Dade, and Seattle-Tacoma recorded the tightest yields.

Overall, spreads for office assets have widened as a result of the 10-Year Treasury falling below 1%, according to the report. Office cap rates nationally have stabilized at 7% with the average price per square foot at $280. For primary markets with narrow yields, cap rates are in the 4% to 5% range, while assets in secondary markets are trading in the mid-6% to mid-7% range. Outlying tertiary markets, largely located in the Midwest, are trading in the mid-8% range. Through the pandemic, cap rates have remained largely stable and average prices continue to trend slightly above 2019 pricing.

Meanwhile, lenders continue to be cautious if not hesitant to consider office deals. However, the fundamentals through the pandemic have remained strong. The national office vacancy rate only decreased 60 basis points to 13.6%, a relatively nominal decline considering the market shift. In addition, asking rents are $31.99, well above the prior peak and a .3% increase for the second quarter. In addition, office rent collections at the end of July were 96%. For that reason, there are more lenders active today in the office market than there were at the start of the pandemic—but these lenders have new underwriting standards that reflect the new market conditions.

This might not help to fuel more transaction activity, however, Marcus & Millichap warns, as there is currently a widening gap between buyer and seller expectations. With fundamentals likely to soften through the end of the year, according to the report, as the reality of the recession and market shift is fully realized, there will likely continue to be a downward trend in office transaction activity.