03/21/2012 | by
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Despite weak fundamentals, there is evidence that investors remain optimistic about the office REIT market.

"Across the board, office REITs appear to be underperforming in comparison to the broader REIT market," said Jason Lail, senior industry analyst with SNL Financial. For 2012, SNL is projecting median funds from operations (FFO) growth of 1.4 percent in the office sector, compared to a median projected FFO growth of more than 7 percent for REITs as a whole.

Additionally, office REITs ended February trading at a 5.12 percent discount to net asset value (NAV), lower than the 2.77 percent discount for all equity REITs, according to Lail. The office sector also ended 2011 with higher leverage than the rest of the REIT market.

However, according to NAREIT data, through March 21, the office REIT sector had total returns for 2012 of 10.5 percent, while equity REITs had total returns of 9.6 percent. Despite lingering concerns, data from accounting firm PwC's first quarter real estate investor's survey suggest general optimism towards the office sector.

Mitch Roschelle, partner with PwC and leader of the firm's U.S. real estate advisory practice, said he sees that measured largely in the reduction of cap rates.

"We generally look at the fact that investors are willing to accept a lower yield, meaning cap rates are going down, which means they are increasingly bullish on the asset class," he said.

Roschelle said fears of a double-dip recession appear to be subsiding, another promising sign for the sector. Job creation, albeit at a slow rate, is stimulating capital investment, according to Roschelle, which is fueling an increase in demand for office space. Lail noted that the unemployment rate, a leading indicator for the office REIT sector, has trended downward "steadily," from 9.2 percent in June 2011 to 8.5 percent at the end of 2011.

However, new development in the sector apparently remains stalled. Data from PwC show that developers broke ground on 59.0 million square feet of office building space in 2011, the lowest level tracked since at least 1960.

Both Lail and Roschelle agree that it will take more jobs for the sector to truly get back on its feet.

"It's job growth that's going to drive the office sector back to a full recovery," Roschelle said.