Office Investment Demand Improving as Clarity Emerges

The investment outlook for the office asset class is improving, despite the current lackluster level of leasing. 

The release of pent-up buyer demand paired with the shift in risk preferences lifted the average office sale price by over 6 percent in 2021 and compressed the mean cap rate below 7 percent for the first time since before 2000, according to Marcus & Millichap.

It predicts that gaps between bids and asks should narrow as the year progresses and more companies make formal decisions regarding their future office space use. 

Institutional investors are focusing on offices with one or two tenants in place for an extended duration as a hedge against a lower-than-expected return to offices. 

Additionally, there is a strong emphasis among tenants and investors for offices that are compelling to modern employee needs and sentiments, according to the report. 

Sellers Maintain Properties’ ‘Long-Term Value’

Transaction velocity markedly improved last year following a pandemic-induced contraction in 2020. Investors who paused decision-making during initial uncertainty re-entered the market, favoring properties with stronger tenant rosters and longer lease terms. 

Looking forward to 2022, sales activity may be tempered slightly by incongruities in buyer and seller expectations, the report  found. Some investors are focused on pursuing discounted pricing amid the headwinds currently facing the sector, while potential sellers continue to maintain the long-term value of their properties.

At a high level, the distribution of trades among Class A and B/C buildings, as well as across primary and secondary/tertiary metros, has stayed about the same through the pandemic. 

Finding the ‘Right’ Neighborhood

The changes in investment sentiment are clearer at a micro level. Buyers are carefully evaluating where an office is located at a neighborhood level, the build-out of the asset, and the current and prospective tenant roster. The labor market, especially for high-skill professional service positions, is incredibly tight. These in-demand individuals will vote with their feet if they do not want to work in a particular building. 

This benefits the Class A sector, where amenities and new concepts can be more readily implemented. Mid-tier offices will focus on companies’ needs for non-prestige spaces. While some firms may reduce expenses by taking lower-skill roles remote, others will hold onto space for information security and staff oversight. 

Some investors may look to renovate assets to meet the greater need for collaborative and open spaces, while much older stock may be converted to other uses. Ultimately this will benefit the sector as obsolete space is removed from the market. 

Amenities, Layouts, Technology are Key

Sought-after amenities include a dichotic mix of collaborative and private spaces. A year or more of remote work habits, paired with a tight labor market are putting pressure on companies, and by relation property owners, to offer compelling office amenities to attract talent. 

Layouts and technology that facilitate collaboration with a hybrid team, as well as private work spaces to limit health concerns, are top of mind for both tenants and investors of higher-end office facilities.

Investors Hedge Against a Lower-Than-Expected Return to Office

Institutional investors are focusing on offices with one or two tenants in place for an extended duration as a hedge against a lower-than-expected return to offices. Demand for these low-risk-perceived trades is high, resulting in notable prices. Recent sales in major California metros are commanding per-square-foot pricing above $800.

Areas of strong household growth a consideration for offices. One factor that investors may give more weight in the future is household formation. 

To accommodate hybrid work schedules, more firms will locate offices near where their employees want to live, which is increasingly suburban settings in Sunbelt and Rocky Mountain metros. As such, there is a clear relationship between where households are forming and where future office demand is likely to notably improve.