IRVINE, CA—Certain office markets have not been able to generate the job growth and leasing to work off the high vacancies left by the Great Recession, and other markets that enjoyed stronger fundamentals are now contending with increased supply, Ten-X’s chief economist Peter Muoio tells GlobeSt.com.
According to a report from the firm, the office segment saw 0.6% growth in January, making it the only segment to post an increase for the month. However, this growth only partially reversed the sharp 0.8% decline from December, and pricing in the office segment remains flat. Searches related to office demand fundamentals were a primary driver for this month’s increase, which correlates with the broader strength in economic indicators, and the regional picture remains mixed, with large gains in the Southwest and Northeast offsetting declines in the other three regions.
We spoke with Muoio about his expectations for office pricing in the coming year and the potential drivers and headwinds for this sector.
GlobeSt.com: Do you expect to see more pricing increases in the office sector as the downward trend seen in December reverses itself?
Muoio: The situation with fundamentals suggests office pricing gains may be hard to come by. National vacancies have been stagnant at a high level. This reflects two things: certain markets just have not been able to generate the job growth and leasing to work off the high vacancies left by the Great Recession, and other markets that enjoyed stronger fundamentals are now contending with increased supply. The end result will be vacancies that remain high and limited rent growth, impeding NOI growth. The stagnation in fundamentals, coupled with further rate raises in the coming year, suggests valuations will remain muted.
GlobeSt.com: What are the potential drivers of office pricing growth for 2018, and do you see them coming to fruition?
Muoio: There are two potential drivers for office pricing growth in 2018. One is if the tax cuts boost the economy enough to generate stronger absorption and shift the office market out of its lassitude. If office NOI is boosted by declining vacancies, and with it increasing rent growth, pricing could follow suit. The other possibility is if the new tax law attracts significantly more capital into commercial real estate. If the numerous favorable tax treatments to real estate investment income in the new tax law attract additional capital, we may see buyers become more aggressive in searching for investments and drive prices up.
GlobeSt.com: What are the headwinds for this sector as we inch closer to a predicted recession in the next two years?
Muoio: A major headwind for the office segment beyond cyclical risk is the shrinkage of office space owing to changes in workstyles (hoteling, working remotely, etc.), modern office layouts limiting space per worker (fewer enclosed offices and cubicles) and less needed space for file cabinets, servers, libraries and such.
GlobeSt.com: What else should our readers know about office pricing?
Muoio: So far in this cycle, capital has flowed toward gateway cities and CBDs; this has led to far faster price appreciation in these markets then elsewhere. Something to watch is the bifurcation within suburban markets between urban-like, walkable areas and leafy, campus-style areas. As Millennials begin to have children and re-think their living choices, urban-like suburbs may become the next hot location area in which to attract the workforce companies need. This could boost pricing in these type of office markets.