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'Frightening Tsunami': Office Investment Nose-Dives In Q1 To Lowest Point Since 2010

Investment in office properties across the country fell 68% in the first quarter to $10.7B, the lowest level since 2010 and an indicator of the degree of deep freeze property markets plunged into after their most challenging year in more than a decade.

Sales of all property types declined, according to Colliers, citing new MSCI data. But in the face of rising interest rates, shriveled office demand and grave uncertainty about the direction of the economy, office trades fell furthest and fastest, with many owners selling for a loss as valuations dropped through the floor.


“It’s a frightening tsunami of problems coming at us, because there’s not a lot of demand for office — especially for Class-B and C buildings,” Compass Vice Chair Adelaide Polsinelli told Bisnow. "This is absolutely the new normal where properties, especially office, are selling at losses. Valuations have dropped significantly."

The collapse in investor interest has been mostly driven by cyclical factors, like rising interest rates and economic turmoil, but particularly acute ones augmented by an unprecedented hesitation in office leasing, differentiating this pullback from its predecessor.

During the Global Financial Crisis, cash-flowing assets couldn't be refinanced due to a near-collapse of the financial system. That took everything down, regardless of asset quality, Colliers Research Director of U.S. Capital Markets Aaron Jodka said. This time around, it’s challenging to get financing, and sellers might come to the table with different expectations than buyers. Still, deals can get done.

“Today we're seeing a challenge with financing deals,” Jodka said. “Banks have pulled back and, of course, interest rates are high. We're still seeing that bid-ask spread between buyers and sellers.”

But the drop-off in deal volume has occurred more quickly than in the late 2000s. The peak of deal activity before the start of the GFC was Q1 2007, a full two years before the trough in activity during that downturn. The most recent peak in sales volume for office assets was only a year ago, during the first quarter of 2022.

Asset prices are dropping in the sector as well. The RCA commercial property price index for offices was down 5.9% in Q1 2023 from a year earlier. The pace of decline is more pronounced in recent quarters, however, with the contraction in prices quarter-over-quarter between Q4 2022 and Q1 2023 representing an 11.4% annualized decline, according to MSCI.

During the current investment slump, the sales volume for central business district office assets has dropped more than for suburban properties, Jodka told Bisnow.

“That's where we've seen the biggest pullback in overall sales on the office side,” he said.

Specifically, CBD sales volumes are down 78% in Q1 compared with a year ago, which is also the lowest since the first quarter of 2010. In a larger context, there have only been five other quarters going back to 2001 with lower CBD sales volumes, and all of them occurred during the GFC, Jodka said.

“Suburban properties may be better positioned from a standpoint of interest rate increases — generally suburban office product has traded with about 100 basis points higher cap rates over the past decade, so that gives those assets a bit more insulation against impacts in the debt markets,” JLL Research Manager Jacob Rowden said.

But Rowden disagrees with the idea that prolonged remote work and the desire for shorter commute times to offices closer to home are behind the shift in investor interest to suburban properties, at least when it comes to high-quality offices.

Remote and hybrid work are no longer a meaningful barriers to office sales in the high-quality segment of the market because those assets had a track record of continued leasing demand and rent growth over the past three years, Rowden said. 

The secular headwinds of prolonged remote work are there, but the capital markets were starting to normalize from that impact in late 2021, he said. Pricing and liquidity had essentially returned to pre-pandemic levels at that point and it wasn’t until rate hikes that the momentum shifted.

The 138K SF Black Canyon Office Center in Phoenix, which sold in Q1 2023 despite market conditions.

“Before the rate hike cycle we had historically low interest rates for most of the past 15 years, and that low cost of capital underpinned a compression of cap rates across commercial real estate throughout the cycle,” Rowden said.

Office underutilization was priced in over the course of 2021, he added.

“By the end of the year we saw office volume and pricing recover nearly to pre-pandemic levels, but below the surface there was a stratification according to asset quality — occupier and investor demand for best-in-class assets actually grew, but lower-quality segments of the market never saw a full recovery,” Rowden said.

“Investors take a longer-term view and we’re gradually forming a consensus around remote work: Some reduced space needs from remote and hybrid employees, but a recognition that offices will continue to serve as the primary location for white-collar labor over the medium and long term,” Rowden said.

Still, the direction many investors are taking when thinking about spending money indicates they're more interested in nontraditional office spaces, like labs, production studios or low-rise flex spaces. 

Blackstone, on the heels of closing the $30B Blackstone Real Estate Partners X — the largest private equity fund ever raised — said it would continue its pre-pandemic shift away from office, focusing instead on industrial, rental housing, data centers and life sciences properties.

Blackstone's co-Head of Real Estate Kathleen McCarthy told Bisnow earlier this month making money on office properties was getting more difficult, even before remote work's proliferation. 

“We started pivoting away around 2015-2017,” McCarthy said. “Even before the pandemic, it was a capital-intensive business. Tenant demands were getting greater and greater, and attracting them and retaining them became more and more capital-intensive. That’s when office lobbies started to look like hotels — that has a cost.”

Redcar Fund Management this month closed on a fund with $418M in equity commitments that will focus on "creative" office properties in Austin, Texas. The company believes it will be able to repeat its successes with its first such fund, which acquired 1.4M SF in Los Angeles submarkets populated by content creation studios, gaming, music, fashion and media companies.

Redcar’s creative office buildings are low-rise, with dedicated outdoor space, direct entrances, natural light and air, operable windows and are built with materials such as natural wood, marble and steel doors and windows, co-Managing Partner Christopher Chee told Bisnow.

And Barings recently closed on its first major U.S. fund in seven years, with investors proving more interested than expected. The fund, which will target “specialized office space,” raised $680M, besting the $500M target for the vehicle when Barings launched it in 2021.

In other words, companies will invest in spaces that are suitable for life sciences and tech users.

"The leasing performance of this specialized subset of office has substantially outperformed the overall office market since the beginning of the pandemic," U.S. Real Estate Equity Acquisitions and Portfolio Management Joe Gorin said.