Office vacancy rates and return-to-office employee volume have been key metrics used to gauge the sector’s post-pandemic recovery, but an analysis of the capital markets’ interest in the space suggests a stronger recovery is underway than that data suggests.
According to a JLL limited distribution client report provided to CNBC’s Property Play, office transaction volume during the first half was up 110% from a year ago, more than twice that of other major property types, including data centers. The trend suggests a shift from “office curious” buyers to “office serious” buyers propelled by lower interest rates, said the report.
Further indicating rising interest in the sector, the number of bids per transaction was up 50%, with $16 billion in office bid volume during the second quarter. That is the highest quarterly total since the second quarter of 2022, when the 10-year Treasury yield was below 3%.
Typically, after a downturn, opportunistic high-net-worth private capital returns first, followed by REITs and then institutional capital like pension funds, separate accounts and offshore capital, said Mike McDonald, senior managing director and office group leader at JLL.
Large deal demand – over $100 million – was up 130% for the first half of this year, which JLL attributed in part to increasing institutional investor appetite for higher quality offices. As top-tier office buildings fill up, second-tier ones will start to see increased demand and could outpace higher quality properties in rental rates and absorption over the next five years, McDonald said.
A dearth of supply will fuel the sector’s recovery, with only six million square feet of office set to deliver next year, 90% below the four-year annual average. McDonald said the slowing construction momentum is more like “hitting a brick wall.” Office inventory is also diminishing as older assets are torn down or converted to residential, hospitality, self-storage or other uses.
“We call them dark matter, and they do matter. It’s that 1-million-square-foot tower in downtown Detroit or Pittsburgh or Cleveland or Dallas that is 40% occupied,” said McDonald.
“Capital looking for highly distressed, very opportunistic returns, very low basis, where an asset may have traded five years ago at $300 a foot, and they can buy it now for $50 a foot. At that lower investment, they can reduce rents and have more velocity because their basis is lower, they have more of a competitive advantage.”
Other tailwinds will help office recovery, including stabilizing employee and space downsizing trends. Companies previously were shedding almost 20% of their space during relocations. That has fallen to an average reduction of 3%.
Lower interest rates likely will help by lowering the cost of debt for dealmaking. However, lower rates foretell weakness in the economy, which could signal headwinds for office market demand.
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