Where Are Cap Rates Going in the Four Core Property Sectors?

Experts predict little change in either direction in the first half of the year.

With late 2018 jitters gone and investor optimism returning, the commercial real estate market should experience mostly steady cap rates through the first half of 2019, although there are particular market segments and geographies that could experience some bumps.

“On the interest rate side, I think everybody has dismissed, at least for the time being, the inflation threat so that kind of stress on pushing cap rates higher isn’t there right now,” says Manus Clancy, senior managing director of applied data, research and pricing with Trepp. “We went through a tough period in December when people were jittery. Now everybody has taken a deep breath; they don’t feel like the wheels are falling off either the U.S. or the global economy.”

Still some changes, although potentially muted, could be in store. Recent trends suggest there is little room left for cap rate compression, according to Matthew Schreck, quantitative strategist with online real estate marketplace Ten-X. “We expect increases to both interest rates and spreads to drive some loosening in cap rates in 2019 across all property types,” he says.

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Which Office Markets Are Best Bets for Opportunity Zone Investment?

Investors have to keep in mind that to reap full tax benefits, the value of capital improvements has to match the value of the initial purchase price.

Opportunity Zone investments are a hot topic in the commercial real estate industry right now, but which office markets may be the best targets for this type of strategy?

The establishment of Opportunity Zones offers investors a way to defer and reduce taxes on capital gains, while building equity in real estate assets and improving low-income, distressed neighborhoods.

Common traits of Opportunity Zones certified by the U.S. Treasury are: a poverty rate of more than 32 percent, median family income about 37 percent below the area or state median, and an unemployment rate nearly 1.6 times higher than the U.S. average.

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Tech Job Growth Continues to Create Demand for Office Space

Growth in technology-related jobs—particularly computer and mathematics occupations—is expected to keep office leasing strong in certain markets over the next decade.

Overall, between 20 and 25 percent of current office leasing activity is related to technology jobs, particularly computer and mathematics occupations—a subset of STEM (science, technology, engineering and mathematics), reports Rebecca Rockey, Cushman & Wakefield’s economist, head of forecasting for the Americas, and lead author of a new Occupier Insights report on the impact of certain technology occupations on the office sector. This is a stark contrast to the previous office cycle, when leasing was primarily driven by new financial services and business analyst occupations, noted the report.

In total, 1 million new computer and mathematics occupations have been created over the last seven years, bringing the total to 4.1 million computing and 167,000 mathematics jobs in the United States today. STEM jobs are being created at a faster pace than other jobs with seven of the top 10 STEM occupations being computer-related and including jobs such as programmers, network developers and designers. Of these new jobs, 85.4 percent are in office-using industries, making it the largest occupational category driving growth in the office cycle’s current expansion, according to the C&W report.

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One-Time Emerging Apartment Markets Are Becoming Emerging Office Markets

As multifamily rents in core markets have continued to climb, investors, office tenants and residents alike have turned their attention to secondary markets. According to JLL’s Investment Outlook report, secondary markets accounted for 50 percent of all U.S. office transactions last year, due to slowing demand and oversupply of product in core markets.

Renters

The San Francisco Bay Area, home to many of the top performing tech companies in the U.S., boasts some of the highest rents in the country. Several cities throughout the Bay Area were ranked in the top 10 for rent increases in 2017. San Francisco continues to lead the nation with an estimated median rent of $4,000 per month.

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Exclusive Research: Investor Outlook Remains Stable for the Office Sector

Despite the overall consensus that commercial real estate is in the late stages of its current cycle, investors in the office sector continue to see strength in the sector. Expectations for rents and occupancies remain bullish. And while there is a general sense that cap rates will rise, respondents overall remain optimistic about the prospects for the space.

Those were among the findings in NREI’s fourth annual research survey aimed at gauging sentiment about the office sector for the coming year.

Respondents were asked to rank the relative strength of their region on a scale of 1 to 10. The West (8.2) led the way, followed by the South (7.9), the East (7.4) and the Midwest (6.8). The scores for the East, Midwest and South all rose from 2017, while the score for the West remained flat. The West has been the top market in each of the four surveys NREI has completed on the office sector.

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How Lease Agreements Can Protect Against Risk in Single-Tenant Office Assets

Single-tenant office buildings present a greater risk for loan default than multitenant assets because the sole income stream is dependent on one tenant. But there’s advice experts can offer borrowers on structuring leases to help protect their interests if something goes wrong.

In recent years, there has been a rush by investors to acquire single-tenant office buildings, because this type of asset offers better yields than Treasury bonds, says Eric Entringer, vice president of capital markets and investor relations at Dornin Investment Group, a real estate investment firm with offices in Orange County, Calif. and Las Vegas.

He notes that these assets are attracting lots of 1031 exchange investors, as well as investors pulling out of the stock market, but suggests a question they should ask themselves before investing in single-tenant office assets: “Is the risk appropriate in terms of the returns they’ll get over Treasury bonds?”

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