Emerging Trends in Real Estate 2012 - Urban Land Institute

Chapter 4: Property Types in Perspective
Exhibit 4-17
U.S. Office Property Total Returns
buildings make their cut.” Even administration-intensive law firms
eliminate secretarial bays and slice support staff. “Downsizing
space realizes immediate savings for businesses with bottom-line
impact,” and landlords must grin and bear it.
Best Bets
Institutional-quality, core office buildings in 24-hour cities remain
blue-chip-portfolio keepers for investors satisfied with solid
income-oriented returns; otherwise, owners should sell out into
the capital rush. Recapitalizations of overleveraged trophies may
offer chances to gain attractive equity positions at somewhat
better pricing. In general, owners need to diversify tenant bases
as much as possible and avoid dependence on large space
users, which have plenty of options and can always coerce major
concession deals. “Signing big tenants means writing big checks
just to keep NOIs stable.” Health care trends—rising older demographics
and skyrocketing costs—make medical office space a
logical play, but this niche sector with limited opportunities investing
in smaller buildings could easily be overwhelmed by capital.
Avoid
During early recovery phases when often-sluggish markets cope
with high vacancies, interviewees traditionally raise red flags
“about whether older buildings burdened by obsolescent features
will ever lease.” Typically, cyclical demand improves enough and
lower-quality office space can be filled—albeit at comparatively
low rates. But what about now, when tenants orient to “less is
more” strategies, want greater flexibility, and crave convenient
locations to attract employees In the new world order, it appears
many commodity office parks will struggle for survival away from
Exhibit 4-16
U.S. Office Vacancy Rates
25%
20%
15%
10%
5%
1990 1992
Sources: CBRE Econometric Advisors.
*CBRE Econometric Advisors.
Suburban
Downtown
1994 1996 1998 2000 2002 2004 2006 2008 2010 2012* 2014*
60%
50%
40%
30%
20%
10%
0%
-10%
-20%
-30%
-40%
-50%
1991
1993
Sources: NCREIF, NAREIT.
*Data as of June 30, 2011.
1995
1997
1999
NAREIT
NCREIF
2011*
burgeoning suburban nodes. “It’s tough to make the suburban
case with vacancies so high—20 percent or more. Demand
doesn’t work to bring up puny rents, and these properties need
costly makeovers to compete.” Not only does younger employee
talent gravitate to urban action, but “they also want to work in
newer buildings with sustainable features, and more companies
want green space to attract them.” Some languishing “B and C
office will be torn down,” following the unfortunate “path to oblivion
of many lower-quality suburban shopping malls.”
Development
No surprise: office builders struggle to find work, and new construction
limps along at the lowest level in five decades. Other than
a one-off tower in a major gateway city or a build-to-suit campus
for a large corporation, “you won’t see new building.” Developers
orient projects to provide efficient floor plates and more contiguous
space with sustainable, energy-saving features employing
natural light and under-floor air systems for better air quality. LEED
ratings—the higher the better—become the necessary standard.
Despite higher asking rents, these new buildings will offer enough
advantages to lure top-tier tenants out of last-generation office
product and hasten the decline of low-end dinosaurs.
Outlook
Vacancy rates will continue to edge down in 2012, but not enough
to restore much landlord pricing power, except for prime space
in the most sought-after gateway city locations. “The further you
drive out of town, the more risks investors take.” In addition to
the lackluster economy, secular changes in corporate workforce
deployments, staffing needs, and use of office space will mitigate
chances for a robust sector recovery. Executives in cubicles and
work-at-home options appear to be here to stay. “I’m sharing an
office,” says a top honcho. “The message is get used to it.” That
tough love advice also applies to investors and developers: “Office
ain’t what it used to be.”
2001
2003
2005
2007
2009
Emerging Trends in Real Estate ® 2012
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