Trepp: Stabilizing Economic Outlook Driving Office Performance
Recent economic volatility presented obstacles for office sector expansion, but steady oil price growth along with heightened international market stability led to a calmer outlook in recent weeks, said Trepp, New York.
Office market growth slowed in recent months as firms looked for economic indicators. JLL, Chicago, reported that firms demonstrated caution regarding their expansion plans in early 2016, noting that the proportion of expansionary-related leasing activity declined from 52 percent to 40 percent between the fourth quarter and the first quarter.
“Post-crisis office market recovery has been aided by higher commercial real estate property valuations and improving conditions in the U.S. labor market,” Trepp said. “Growing labor force participation, higher average hourly wages and new job offerings in recent months have eased fears about a potential recession and will encourage firms to ramp expansionary plans for the rest of the year.”
Ryan Severino, Senior Economist with Reis, New York, noted that the mean office cap rate of 6.8 percent is up 30 basis points from first-quarter 2015 when it stood at a post-recession low 6.5 percent. But he said that 6.5 percent reading looks like an anomaly in retrospect–every other quarter over the last two years had cap rates within a very narrow 6.8 percent to 7.0 percent range. “Therefore, once we account for this apparent outlier, it appears that cap rate compression has stalled, at least temporarily, for the office sector,” he said.
Severino noted cap rate flattening over longer timeframes as well, saying the 12-month rolling cap rate has remained effectively flat since fourth-quarter 2014. But several things indicate that cap rate compression is not over for the office sector, he said. “First, the outlook for office fundamentals, while not as bright as in past recovery cycles, is still relatively optimistic,” he said. “Office revenue growth should remain healthy for the next few years. Second, as we had seen with apartment cap rates in the not-too-distant past, a pause does not mean a reversal.”
Severino said all signs point to continued office cap rate declines over the medium term. “Prior to the first quarter, apartment cap rates had been little changed for six quarters,” he siad. “Then the big fall this quarter. Therefore, don’t put too much faith in the current lack of compression in office cap rates.”
