By GARY STACHE
A number of factors are influencing investor demand for low-rise office buildings.
The 10-year treasuries are now at 4%, which means attractive loans and positive leverage for investors. Meanwhile, average rents for garden office buildings are climbing, which further will increase buyers’ yields.
Market vacancy for low-rise buildings has dropped almost 20% from a year ago. Office employment has continued to grow and leasing activity has picked up.
Less expensive class B and low-rise buildings saw increased activity last year, with more than 1.3 million square feet absorbed.
During the past year, cap,or capitalization,rates have dropped from 8% to between 7% and 7.5%, depending on the quality of the building, location and tenancies. (Cap rates are determined by dividing annual net operating income by the purchase price of a property. The number represents the return on real estate investment. The higher the cap rate, the better the income.)
Even at a 7% cap, garden office buildings offer the greatest spread between cap rates and interest rates,70% loans are available at a 5.75% fixed rate, amortized over 25 years.
In addition, many lenders are offering interest-only loans for a couple of years to increase net equity cash flow. Sellers are looking to take advantage of the lowest cap rates in history for garden office buildings.
Once interest rates start rising, cap rates will follow and values will be negatively impacted.
At the UCLA Business Forecast, the head of the university’s Anderson School of Business predicted that 10-year treasuries would be at 5.75% by the end of the year, as did the chief investment officer from City National Bank. Ten-year treasuries are currently at 4%.
The only way to recover the loss in value associated with the move in cap rates would be to wait for an increase in lease rates. The potential impact of a 100 basis point swing in the cap rate would be a $1.25 million reduction for a $10 million property.
Long-term holders can look forward to rents increasing during the next couple of years. But for those shorter-term holders that are considering selling during the next five years, now is the time to take advantage of an overheated investment market.
Currently, 80% of private client group transactions involve 1031 exchange buyers who are paying premiums for properties.
A number of investors are selling and moving into markets in other states that are producing much higher yields. Areas such as Phoenix, Denver, Las Vegas and Houston are where Orange County was two to four years ago in terms of vacancies, and the buying opportunities and yields are much better there.
Other investors say that with the current federal deficit and the lowest long-term capital gains rate in history, now is the time to take profits, wait for the market to adjust and then buy into a better yielding market.
Stache is an executive vice president with the private client group in the Newport Beach office of CB Richard Ellis Group Inc.
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