Watch for the signs and listen to what is being reported. It is not difficult to see that psychology and economics are shifting and major changes are occurring in the office investment market. Pay attention – cap rates are increasing and, as a result, prices are declining-- unless this phenomenon is counterbalanced by decreasing vacancy, increasing rents, implementing cost controls and increasing Net Operating Income--NOI. The time has come for a renewed focus on operating fundamentals.
Here are a few indicators that we have recently taken notice of. The Cover of the July Edition of National Real Estate for July of 2006, has a bold headline; “ Now Comes the Hard Part, No longer able to count on soaring values, to boost returns investors are pushing for profits in the old fashioned way: growing net operating income.” www.nreionline.com July 2006. In Real Capital Analytics July 2006 Office Capital Trends Monthly , page one reports … “Prices are still rising but the pace of appreciation has slowed…Moreover a slight increase in cap rates was recorded in Q2, the first increase in 4 years”. Seller and Buyers beware—we expect this trend to continue.
Real Capital Analytics which tracks all properties and portfolios of $5 million or greater is considered one of the best sources of accurate third party information in the commercial and investment real estate industry. They note “The price of all suburban office buildings sold last quarter spiked to nearly $200 per square foot, largely due to real and expected improvements in Net Operating Income- NOI, rather than changes in cap rates. Buyers are focusing on potential rent growth to drive prices higher even as the capital markets slow.” In addition they note there is a high correlation of a market’s cap to its vacancy. Buyer’s are paying far lower cap rates in markets with low vacancy rates, where great potential for near-term rent growth is perceived.” Go to www.rcanalytics.com then click on Office Capital Trends July 2006 for more details.
So if you believe what the headlines say, the best way to make money in the office investment market is to buy properties in markets with tightening vacancy, with increasing rents, and managing your expenses wisely. This will lead to increased cash flow and to long term value. This is a different market than the past three years when you could buy and then flip your property in a couple of years without really making many improvements or changes and still make money because of low cap rates and low interest rates. There is still money to be made but it will require better underwriting, better leasing, and better management. Nothing to be frightened of – it just requires focused and strong execution.
So let us tie these national trends back to the Sacramento Region, where we and our firm help investors and users with their commercial real estate needs. The headline in the Sacramento Business Journal, reported on July 25th that Sacramento Office Market is among the Top 10 in the US. Sacramento's second-quarter downtown and suburban office rent increases were in the top 10 nationally, keeping pace with the high demand nationwide. The article continues that Downtown Sacramento's year-to-date rent increase of 7.9% ranked No. 10, just below the national downtown average increase of 8.2%. Office rent rates in suburban Sacramento had a year-to date increase of 10.7%, which ranked at No. 7 nationally. It was well above the national average of 3.8 percent. The increases reflected a strong economy, the report said, and despite a drop in job creation in the second quarter, office-related job growth remained solid. See the article at http://www.bizjournals.com/sacramento/stories/2006/07/24/daily16.html
The Sacramento market has continued to add good jobs that need and use office space. The local economy has diversified in the private and service sectors and yet it continues to have strong State government sector underpinnings. If we avoid a serious recession then vacancies will shrink more and rents will increase. But at 13+% vacancies --tenants are going to continue to have choices and it is likely that rent increases will be single digit at best.
This trend in vacancies and market shift in cap rates has had implications for the Sacramento
office/flex investment market as well. We are tracking more than 80 investment properties on the market. They are taking longer to sell and selling at cap rates that are usually higher than the asking cap rate. So if you have money to spend and are looking for an investment deal, you just may find a good one in Sacramento. Give us a call if we can help you.
This article was written by Jim Gray, CCIM and Nahz Anvary, brokers with NAIBT Commercial Real Estate, who are solely responsible for the opinions herein. They can be reached at (916) 375-1500 or by email at firstname.lastname@example.org or email@example.com Visit our website at www.NAIBTCommercial.com Then click on our Sacramento Office.