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Why Office Transaction Volumes are Stagnant

Office deal flow has been slow since 2015, thanks to weak fundamentals that are now starting to deteriorate.

by Kelsi Marie Borland | November 2, 2018

Office deal volume nationally has increased only slowly since 2015, thanks to weak fundamentals that are now beginning to deteriorate. Generally, the asset class has seen high vacancy rates and new trends, like telecommuting and file storage, in the office space that has led companies to shed office space. While deal volumes have increased slowly, they are beginning to speed up. Office deal volume has been consistent since 2017, but bumped up 17.5% in the third quarter over the second quarter 2018 and is up 15% year over-year to $34.3 billion, according to Ten-X Research. However, while the quarter was strong, overall office volume trends are slow.

“Year-to-date in 2018, office volume, $92.6 billion, is 3.6% lower than in the same period 2017, $96 billion, illustrating this flat trend in volume,” Peter Muoio, Ph.D., EVP of Ten-X and a speaker at the recent Trigild Lender Conference in San Diego, tells GlobeSt.com. “We also think a slowdown in deal volume could be in store for 2019. Interest rates are on the rise and cap rate spreads are tight, and we expect cap rates to drift higher in 2019 in accordance with those pressures. This would put downward pressure on valuations, which may make sellers reluctant to complete deals.”
In general, single-asset office properties have led investment activity. “Single-asset sales are also driving the office market to a greater degree this year, and single-asset volume grew 21% year-over-year in 3Q’18. Portfolio and entity-level deals swamped the market in 2015-2016 but have since receded,” adds Muoio.

These are national trends, but deal volume varies from market to market. CBD office investment has grown 58% year-over-year to $12.1 billion in the third quarter, rebounding from a slow 2017. “Suburban office volume in 3Q’18, meanwhile, was flat year-over-year at $22.1 billion,” explains Muoio. “However, investors also appear to be showing increasing interest in secondary and tertiary markets. Primary market deal volume grew 12.2% year-over-year in 3Q’18, while office volume in secondary and tertiary markets is up 18.2% year-over-year. Tighter cap rates and a run-up in prices in the large gateway markets this cycle is forcing investors to consider assets in other markets to achieve desired returns.”

There are global pressures that can further impact transactions volumes. Muoio says that Brexit and trade wars are among his top concerns, as well as a potential conflict between Italy and the European Union. “Brexit and Italy-EU have the potential to rattle markets and lead to a liquidity/credit based disruption to the economy and CRE investment flows,” he says. “We have been very concerned that overarching aggressive trade policy with Europe and Asia—specifically China—could put a damper on cross-border investment in US office real estate. Indeed, cross-border investment in the US office sector declined 40% year-over-year to $18.5 billion in 3Q’18, and there is clear trend of foreign investors cycling out of US office over the last two years. The other big, obvious potential effect from a trade war is a slowdown in the global economy, and with it demand for office space in the US.”