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'It's Pencils Down' As Trophy Office Investors Await Fed Move

Investors are balking at the price tags some office owners are asking for Atlanta properties as the Federal Reserve Bank prepares for another big rate hike and recession concerns mount.

Demand and pricing are likely to moderate for Atlanta office as interest rates rise.

The Atlanta office sales market — already feeling the pinch of uncertainty caused by the work-from-home movement — fell $200M in total sales to $1.3B during the first half of 2022, compared to the same period last year, according to data compiled by Avison Young's Atlanta office. The average price per square foot retreated as well, from $206.50 per SF during the first half of 2021 to $192 per SF this year through June, a 7% drop.

“There's typically a summer slowdown anyways, but that's definitely been exacerbated by people wanting to wait and see what's going to happen on this next rate. It's a moving target on underwriting deals, so until there's some clarity on where rates are going to settle down, it's pencils down,” Avison Young principal Casey Keitchen said.

Already, one recent and one pending sale have seen an impact on pricing: Atlantic Yards and Atlanta Financial Center. But for each, the reasoning is different.

KKR purchased Atlantic Yards, the two-building, 524K SF property on 17th Street in Atlantic Station, earlier this month for $385.3M, or $736 per SF, according to a Q2 Atlanta office market report by Colliers. While that is the second-highest per square foot price for office traded in the city, behind 725 Ponce, which Cousins Properties purchased last year for $806 per SF, the initial expectation was that Atlantic Yards could fetch up to $950 per SF, Colliers reported. 

Atlantic Yards, which was developed and sold by Hines, is fully leased to Microsoft through 2035. Hines did not respond to a request for an interview as of press time.

“I can't speak exactly to what shifted [Atlantic Yards' pricing]. But rising interest rates and inflation are definitely affecting our market,” said Nathan Bell, Colliers' research and business development associate in Atlanta.

Nightingale Properties is under contract to buy the Atlanta Financial Center, the 915K SF glass-encased office complex straddling Georgia 400 in Buckhead, for $182M from Sumitomo Corporation of America. At that price, Sumitomo will recognize a $78M loss from its 2016 purchase and subsequent capital improvements.

Nightingale, in a sales presentation to investors, said Sumitomo is selling the property at a steep discount “because the seller is 'forced' and 'pressured' and needs to transact regardless of market conditions due to investor redemptions and upcoming loan maturity in Q2 2022.”

Atlanta Financial Center, which may be trading to Nightingale Properties.

Overall, landlords selling office properties in Atlanta have been enjoying buyers willing to shell out more per pound than in previous years, even with the Fed hiking interest rates. On June 15, the Fed raised rates by 75 basis points, the largest hike since 1994. Some analysts expect that the Fed will push up rates again at its July 26-27 meeting by a full point to combat pernicious inflation, CNBC reported. The Bureau of Labor Statistics reported that the consumer price index, which measures the price changes for a broad pool of consumer goods, jumped 9.1% in June, outstripping forecasts of 8.8% and the sharpest rise in the CPI since 1981.

Inflation does help sellers of real estate at times. The more it costs to build a building, the more tenants have to pay in rents, which overall increases the value of buildings.

But that trend can only go so far when interest rates rise, which will help to inflate cap rates — the ratio between a property's net operating income and its current market price. According to a Marcus & Millichap report, average office cap rates ranged from the upper 5% to as high as 8% in Q2. Marcus & Millichap said that mean cap rates were in the low 7% range at the start of 2022.

That has killed some deals altogether, said Sara Barnes, Avison Young's Southeast region lead for insight and innovation.

And it has pushed investors to look more at suburban office in Metro Atlanta as they chase better yields and rents that will likely rise in the future, said John Chang, Marcus & Millichap's national director of research and advisory services.

Chang said investors eyeing core or trophy office assets “are taking a more wait-and-see on investments, especially on downtown assets. Their emphasis right now is favoring the suburban areas.”

According to Avison Young, the majority of the office properties listed for sale in Metro Atlanta are out in suburbia, including 12380 Morris Road, the 21-acre, 310K SF UPS Supply Chain Solutions office campus in Alpharetta; the 678K SF Embassy Row office complex in Central Perimeter; and the 763K SF Pennant Park office campus in Cumberland/Galleria next to The Battery at Truist Park, home of the Atlanta Braves.

That shift to the suburbs is not endemic to Metro Atlanta alone, but is happening across the country, Chang said. The trend can also help to push average price per square foot down: Iconic buildings tend to command top dollar, bringing the average price up.

At least one central business district landlord has put the for-sale sign up on its property. Atlanta developer Carter is listing The Met Atlanta — the 1.1M SF adaptive reuse project that transformed old warehouses into creative office and mixed-use space — for sale with Cushman & Wakefield.

But Barnes said she expects other landlords to hold back on selling trophy assets until a new normal with interest rates is established.

Office investors also are trying to price in the uncertainty of a recession as well as the ongoing tug-of-war between executives and employees on what exactly hybrid work will be moving forward and how that could affect overall office demand in the future.

“For office specifically, the uncertainty is going to carry until the job market softens up and there's more clarity on what office space needs are for companies,” Chang said. “It's a very murky outlook in terms of the demand for office.”