Demand from Tech Tenants Continues to Propel Office Markets

This article is republished with permission from REITCafe.

Technology tenants are influencing office market fundamentals and the real estate investment trusts (REITs) that hold these properties. Strong demand from technology, advertising, media, and information (TAMI) tenants, combined with limited new office supply, has allowed for healthy rent growth. Overall U.S. office vacancy fell to 14.5 percent at year-end 2014 from 15.3 percent at year-end 2013, and overall gross rents gained 3.8 percent during 2014, according to Cushman & Wakefield. In markets like New York and San Francisco, vacancy is closer to 10 percent.

REIT investors are attracted by office markets’ improving fundamentals. As a core property type, office REITs are also considered less risky than some other REIT investments. The office sector’s 2.89 percent dividend yield is below average for equity REITs, but in the current low-interest-rate environment, it is attractive compared with other investment options. Office REIT performance has been comparatively strong so far in 2015. The year-to-date total return of 3.85 percent for office REITs exceeds the FTSE NAREIT All Equity REIT average of 2.06 percent.

The large coastal office markets where many of the largest REITs invest are among the best-performing markets in the country. TAMI tenants have had a particularly strong impact on markets like New York, where leasing momentum has shifted away from traditional finance and law tenants.

• Which metro areas: Tech and, until recently, energy have been widely acknowledged as the drivers of the recent office market recovery. Large office markets like New York, Boston, San Francisco, and Seattle have thrived, while smaller markets have struggled. Part of the reason for this trend is the clustering of tech and creative talent in these markets. A new report from CBRE, Scoring Tech Talent, ranks 50 U.S. markets according to their ability to attract and grow tech talent. The report notes that technology businesses accounted for the greatest proportion of U.S. office leasing activity in 2013 and 2014 and names the Silicon Valley; Washington, D.C.; San Francisco; and New York as its top large markets.

• Urban vs. suburban: In recent years, central business districts (CBDs) have outperformed non-CBD office markets. Millennials today want to live and work in urban centers, and companies are migrating from suburbs to the cities to attract talent. This week, the Wall Street Journal described some of the large office users that are giving up suburban campuses to be in urban centers, largely because their desired workforces prefer these urban locations (“Companies Trade Suburbs for City Life,” Wall Street Journal, April 21, 2015).

• Space configuration: One trend started by the tech sector that has caught on among other office users is demand for less space per person. Private offices and even cubicles are increasingly being replaced by open floor plans and collaborative spaces, which require less space per employee. Physical storage needs also have been reduced as paper files have given way to online work. With less space needed per person, more jobs must be created to generate demand for the same amount of office space. Traditional parking ratios have changed, too, as buildings are more densely occupied nowadays.

• Fun space: Businesses are using their office space to project their brand. Workplaces have become fun, and access to sunlight is critical. “Green” also is important to tenants.

The best-performing office owners have adapted to the new paradigm. With better access to capital to acquire and upgrade offices, REITs are among those embracing the change. In light of solid fundamentals, the outlook for 2015 is for further growth in the office REIT sector.

* TREPP-i Survey Loan Spreads levels are based on a survey of balance sheet lenders. For more information, visit Trepp.com. ** - 10 yr. Treasury Yield as of 4/24/2015