By Jim Costello on August 10th, 2017
The demise of the suburban office market has been heralded throughout this economic expansion. The argument was that as millennials continued to move to cities, suburban investment would be curtailed. Funny thing though, office investment in suburbs is growing quickly even as it falls in CBD locales.
The divergence between suburban and CBD deal activity is as large as it has ever been over the last 15 years. In most periods, there is little difference between the deal volume in each of these geographies. The periods from ’04-’07 and ’15-’17 stand out as notable exceptions.
Suburban office volume surged ahead of CBD volume starting in ’05. With the housing boom underway, the real estate sector was feeding on itself with strong suburban leasing tied to mortgage brokers, developers and sales agents needing office space in growing suburban locales. At the peak of the frenzy, deal activity in the suburbs surpassed that of CBD locales by $30.2b in the four quarters up to Q2’06.
Deal activity in suburban locales for the four quarters up to Q2’17 stood $29.2b higher than the levels seen in CBD locales. The sale activity seen today, however, is different from the frenzied activity of the housing boom. Annual volume was growing only at a 13% pace into Q2’17 versus 41% annual growth rate from ’04-’07.
A better yield opportunity for suburban office assets helps to drive the outperformance for suburban offices today. Into Q2’17, the suburban office cap rates for the top 25% of assets averaged 6.0% vs. a 4.6% benchmark for the best CBD assets. For a yield-hungry investor, that extra 140 bps of spread is valuable in this low yield environment.
Writing off the suburbs was and is a bad idea. True, certain assets might not have as many takers as in the past. As for that 1980s vintage asset at the end of a cul-de-sac with a green marble, oak and brass lobby — major capex may be needed in that case. There are however attractive, stabilized assets in suburban locales that are offering up attractive yields in the current environment. Little wonder then that deal volume continues to grow.