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Yardi Matrix April National Office Report: So Far, It’s a Waiting Game

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COVID-19 has drastically reshaped life and the economy, but the pandemic’s full effects on the U.S. office market have yet to come to light in the data. The latest Yardi Matrix office report shows that national full-service equivalent listing rates held steady through March. Moreover, in terms of sales, Q1 2020 was on par with the first quarters of the two previous years and, at the end of March, Yardi Matrix had yet to see any project cancellations in its data.

Granted, all this is likely to change. But, it will take a while to see the full scope of the crisis. Office activity is now on hold, as everyone is waiting to see how the pandemic and economic recovery will play out. Read on for a more detailed overview of the Yardi Matrix April 2020 Office Report.

March Listing Rates Not Affected

Office rates have yet to respond to the pandemic. In March, national full-service equivalent listing rates averaged $37.99 per square foot — a 0.2% increase over the same month last year and down only 26 cents, or 0.7%, from February. National vacancy rates decreased 60 basis points compared to February, resting at 12.8%.

Despite the dismal news coming from New York, Manhattan full-service equivalent rates grew 14.2% year-over-year, the biggest increase in the nation. The market ended March with an average price per square foot of $85.84 and a vacancy rate of 7.4%.

Manhattan was also at the top of the list for same-store growth, with a 13.3% increase. Other markets with notable same-store growth in March were San Francisco (8.3%), Seattle (6.7%) and Tampa (6.25%).

Meanwhile, with minimal leasing activity on the market, lowering rates wouldn’t have an effect at the moment. Significant movement in rates is likely only after shelter-in-place restrictions are lifted and people start returning to the office.

Q1 Sales Solid; IRS Grants 1031 Exchange Extensions

Very few sales will take place in the second quarter of 2020. But, before the downturn, this was a promising year in terms of office transactions.

The first quarter reported $20 billion in sales, on par with Q1 2019 and Q1 2018. Overall prices continued to grow, reaching an average of $310.47 per square foot — growth that was evident across all asset classes and locations, and, therefore, not driven by outliers.

One element that is bound to have an impact on the office transaction market is the IRS extension for 1031 exchanges. These like-kind exchanges allow real estate investors to sell one asset and use the proceeds to buy a similarly valued property without paying capital gains taxes on the original sale.

Previously, investors had to find the replacement property within 45 days of the sale and close on it within 180 days. However, the IRS extended these deadlines to July 15. As a result, deals that might otherwise have been rushed to meet the deadlines can now be put on hold as investors wait to see how the economy evolves. Alternatively, some investors might choose to forgo the exchanges altogether and, instead, pay the capital gains tax so they can hold on to the money during the crisis. Either way, these extensions could leave capital available for transactions once the market regains momentum.

Supply Likely to Decrease, Miami & Houston Most at Risk

At the end of March, 148.9 million square feet of office space was under construction across the U.S. However, this number is expected to decline despite the fact that many states have exempted construction form stay-at-home orders.

In a recent weekly survey from the Association of General Contractors cited by Yardi Matrix, 19% of the respondents reported that “an owner (including a public owner regarding its own projects) had directed them to cancel construction on a current project or one scheduled to start in the next 30 days.” The figure is raising concerns, as it grew from 7% in the same survey two weeks before.

Most markets with new construction representing a high percentage of stock have low vacancy rates and high employment growth. As a result, they may be able to bounce back easily when everything returns to normal. But, the underlying conditions in Miami and Houston may impede a smooth recovery.

Specifically, Miami had 2.5 million square feet of office space under construction by the end of March, representing 3.8% of its total inventory. But the market showed only a 0.9% Y-o-Y growth in office jobs and had a middle-of-the-road vacancy rate of 12%. What’s more, nearly half of this expected construction is made up of Class A properties in the Miami North submarket, which might not be as appealing after an economic downturn.

Houston’s 4.2 million square feet of new office construction represents only 1.8% of its existing stock, but it could be in trouble due to the fall in oil prices. And, although office jobs in Houston increased by a good 2.9% Y-o-Y, the market’s vacancy rate of 20.6% was already one of the highest in the nation, even before the pandemic.

The good news is that the ability to work from home might insulate office-based jobs from the initial effects of the downturn. However, it looks like we’ll have to wait and see how the office market will come out of this crisis.

This report covers office buildings of at least 50,000 square feet.

Yardi Matrix uses aggregated and anonymized expense data to create full-service equivalent rates from triple-net and modified gross listings.

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