Smile State Office Markets Outpace Big 6

“Gateway market office volumes peaked in 2015 and are now declining, while secondary Sunbelt office market investment sales volumes continue to rise,” says Noble Carpenter with Cushman & Wakefield.
Carpenter says the trends favoring Sunbelt markets are poised to continue through 2019.
Evidently it’s not only lower prices, and therefore higher yields, that draw investors to office properties outside the six gateway markets. It’s also comparatively strong fundamentals.
Research from Cushman & Wakefield Capital Markets shows that secondary office markets, mainly in the Sunbelt, are outperforming when it comes to rent growth and net absorption. On a year-over year-basis through June 30, for example, rent growth in secondary Sunbelt markets has been 4.5%, compared to an average of 3.2% for the likes of San Francisco or Manhattan. Leading the way are Nashville (9.9% Y-O-Y), Austin (8.7%), Baltimore (8.3%), Miami (6.5%) and Phoenix (5.8%).
Looking ahead, office rent growth through 2019 is projected at 2.6% for these markets in the so-called “smile states”—including Atlanta, Dallas, Charlotte, Miami and Phoenix—or twice as fast as the 1.3% projected for the gateway cities. That dovetails with projected growth in office-using jobs of 2.3% for secondary Sunbelt cities and 1.1% in gateway markets.
Cushman & Wakefield’s research also shows that secondary Sunbelt markets have absorbed office space at 3.3% of the average inventory over the past eight quarters compared to 1.7% in the six gateway cities. As a result, vacancy in these markets has fallen, while vacancy in the gateway markets has risen 72 basis points since hitting its low point in 2015. At the same time, the spread between gateway and secondary Sunbelt market vacancies has shrunk to 240 bps, the lowest point this century.
“Reflecting these strong fundamentals, investment capital is shifting to secondary office markets, where properties are generally undervalued,” said Noble Carpenter, Cushman & Wakefield president, capital markets, Americas. “Gateway market office volumes peaked in 2015 and are now declining, while secondary Sunbelt office market investment sales volumes continue to rise. We project these trends will continue through 2019.”
Citing Real Capital Analytics’ Commercial Property Price Index, Cushman & Wakefield says that gateway office prices were 70% above their previous cyclical peak as of this past June, while secondary markets are 8% above their previous peak. Undervaluation extends to cap rates, too: in the previous cycle, the spread between gateway and secondary Sunbelt office market cap rates averaged 105 bps, but has since expanded to 163 bps on average. In recent quarters, though, the spread has begun to compress.
The continued undervaluation occurs at a time when the gateway markets have a construction pipeline equal to 3.3 times the annual average absorption over the past two years, as compared to only 1.3 times for the secondary Sunbelt markets. The pattern persists when looked at relative to inventory, Cushman & Wakefield says. Office product under construction in the gateway markets amounts to 2.7% of inventory as opposed to 2.1% in the secondary Sunbelt markets.
“Secondary Sunbelt markets continue to offer highly attractive yields on a risk-adjusted basis, with upside from further cap rate compression at a time when many asset classes, particularly Gateway-market office, are fully valued,” says David Bitner, senior director and head of Americas capital markets research at Cushman & Wakefield. “We see a wave of investment opportunity in secondary office markets, particularly with suburban assets, which have stronger momentum and have been less picked over by investors so far in this cycle.” Since 2010, 72% of CBD office inventory has traded, compared to just 65% in the suburbs, he adds.
By: Paul Bubny (GlobeSt)
Click here to view source article.