Friday, February 19, 2021

Opportunities Abound for Growing Office Users Amid Pandemic’s Disruption

By Adrian Ponsen CoStar Analytics

 Across the mid-Atlantic, available office space is piling up at the fastest pace in two decades.

Unlike America's previous two economic downturns, the coronavirus-induced recession hasn't fallen particularly hard on most white-collar employers. But office tenants across a range of industries are still shedding space, as the pandemic forces many business owners to learn the hard way that their firms can still run effectively with large numbers of employees working from home.

Still, amid this challenging backdrop, predictions of the death of the modern office as we know it also seem greatly exaggerated. Law firms still need office space to meet with clients, medical office users can't provide their full range of services online, and new hires in most industries need more than just a Zoom conference call to master the tricks of the trade and learn from their colleagues.

Putting the office sector’s uncertain future aside, one thing is clear: Office users still willing to think proactively and make long-term commitments to new offices are in control in today’s market. Many even face enormous money-making opportunities.

As the pandemic continues to fuel more work-from-home arrangements and drive up office vacancies, investors are becoming increasingly skeptical about the re-leasing potential for occupancy-challenged properties. Average pricing on distressed office sales in the mid-Atlantic has already fallen more than 20% since late 2019 and is back down at the lowest levels in five years.

In contrast, after making big gains in 2019, pricing for fully leased office properties has held strong in recent months. This comes as lower interest rates have left investors desperate for income-producing assets of all shapes and sizes.

With yields disappearing in the bond market and stocks' price-to-earnings ratios soaring, income-seeking investors are more than happy to continue paying up for well-leased office properties, regardless of any long-term risks to office occupancy that the pandemic might have created.

In fact, the pricing premium that well-leased properties are commanding — in other words, the difference between the red and blue lines in the previous chart — is also at the highest levels since the years immediately following the global financial crisis.

Office tenants who can acquire low-occupancy properties and then offer them up sale with their own long-term leases in place can exploit this market dislocation.

CoStar Group pursued a similar strategy in 2010 when it purchased the Mortgage Bankers Association’s former Washington, D.C., office for $41 million, only to sell the property one year later in a sale-leaseback for $101 million. CoStar Group is the publisher of CoStar News.

While too little time has passed since the pandemic began to single out properties that have followed a similar path following the recent crisis, there is evidence that investor appetite for sale-leasebacks remains strong.

One of the country's largest office sales so far in 2021 involved Thrivent Financial's sale-leaseback of its newly built headquarters in Minneapolis for $130 million, or about $542 per square foot at a 4.25% capitalization rate.

New Jersey's largest sale-leaseback last year closed just outside of Trenton during December when Investors Bank sold its 47,000-square-foot facility at 2300 Route 33 in Robbinsville and then leased the property back from the buyer, Realty Management Systems, through 2034. The deal closed for $20 million, or about $424 per square foot, 11% above its initial asking price and only five months after being listed for sale.

As appetite for office investment thaws further in the months ahead and the pandemic abates, many more sale-leasebacks like these may follow. For office users with the financial wherewithal to take ownership of their next space, there is no time like the present to start shopping.

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