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Sector Focus: Slow and Steady in the Office Sector

07/11/2013 | By Carisa Chappell

Having underperformed the S&P 500 in the first half of 2013 and performing slightly higher than the broader REIT market, office REITs in the United States are still trying to gain ground that was lost in the recession.

Through the end of June, office REITs had total returns of 6.71percent, according to the FTSE NAREIT U.S. Real Estate Index Series, higher than the 6.49 percent gain for all equity REITs but lower than the 12.50 percent return of the S&P 500.

The sector has lagged both of these broader indexes in returns over each of the last three years, evidence that the office sector has been one of the slower sectors to rebound from the recession,” said Jim Stevens, senior analyst with SNL Financial.

Jed Reagan, analyst with Green Street Advisors, said the current office recovery has been one of the slowest witnessed among recent recoveries.

“That is largely a function of the poor job growth climate,” he said. “What has made things worse for the office sector is those office tenants are really in efficiency mode. They’re getting much tighter with their office space usage.”

With the national unemployment rate at 7.6 percent at the end of June, the small gains in job growth have not translated into office demand.

“Employment growth is the critical macroeconomic factor to watch with regard to office REIT performance,” Stevens said. “Office REITs will not be able to grow rent and occupancy unless the job market allows for employment and corporate growth.”The economy’s growth remains slow and steady, and the same holds true for office occupancy, according to Reagan and Stevens.

Stevens said analysts are optimistic that the recovering economy, albeit slow, could allow office REITs to raise rents during the remainder of the year. However, he noted that properties in central business districts (CBDs) are more likely to sustain higher rents.

“As the economy continues to improve, the CBD office sector stands to improve at a much faster rate than suburban office,” Stevens said. “Attitudes are still positive towards suburban office growth, but the pace is simply expected to be slower.”

He added that notable industries driving CBD office growth include technology, biotech and energy. The more popular geographic markets are major areas such as New York, Boston and San Francisco. The Manhattan office market has been stagnant over the last few years, but is now showing signs of improving, according to Reagan.

“There’s some momentum building, both in terms of fundamentals and asset value appreciation,” he said.

Cuts to government spending have created uncertainty in the historical office stronghold of Washington, according to Stevens.

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