How Distress Will Play Out in Office

Investment sales are way down in the offie sector as cap rates push up, price discovery continues and a widening bid-ask spread slows deal velocity. The public markets suggest average office cap rates in the mid-to-high 7% range, to north of 8%, but institutional owners have yet to take such markdowns, according to a new analysis from Colliers.  And the lull in sales could continue for several quarters until interest rates stabilize and the cost of capital becomes more palatable.

“The Fed remains hawkish, suggesting more rate hikes are in the offing. BBB bond rates were higher than transactional cap rates — a historically uncommon trend that is not sustainable over long periods,” Colliers researchers note in a report breaking down the future of the sector. “For this spread to remain negative (lower cap rates than BBB bonds), investors should be pricing in solid NOI gains, which in today’s market are difficult to underwrite outside of the best assets. This suggests that cap rates need to rise, as the historical spread between cap rates and bonds is 2.4 percentage points (bonds above cap rates).”