An influx of investment from abroad is pushing rental rates higher at the top end of the U.S. office sector, according to a report from financial and professional services firm JLL.
The JLL report tracks what it refers to as the “Skyline” assets—high-end office properties in urban centers–in 43 cities across the country. Rents in the primary Skyline markets rose 4.6 percent in 2013, according to JLL data.
Properties within the highest subset of these upper-echelon assets are far outperforming the broader Skyline market with respect to occupancy levels and rents, said John Sikaitis, managing director of research at JLL.
“The most tightness is really in that upper end of the Skyline marketplace, where you’re seeing high levels of demand and few options, particularly among the mid-size and large-size options. That’s causing a swelling of rental rates, which is trickling down to the next parts of the market,” Sikaitis said.
He notes that tightness is also being felt in the bottom tier of the Skyline assets, which in turn is squeezing the middle of the market. JLL expects the middle of the Skyline market to see “potentially some of the most momentum over the next couple of years from a leasing demand perspective,” Sikaitis observed.
While market fundamentals are tightening, construction still remains limited, according to Sikaitis. At the same time, the level of demand from non-U.S. investors is “something that we’ve never seen before.”
Capital Flowing In From Around the Globe
Last year, for example, the Norwegian Government Pension Fund Global bought 49.9 percent of five U.S. office properties valued at $1.2 billion. Meanwhile, China’s Fosun International Ltd. announced in October that it was purchasing One Chase Manhattan Plaza in New York for $725 million.
“There’s just a much larger appetite from foreign capital than we’ve seen in the past, and we don’t think that’s really going to stop as we head into 2014 and 2015, either,” Sikaitis noted.
In 2013, he explained, about 51 percent of assets that traded hands in the primary Skyline markets of New York, Washington, Boston, Chicago, Seattle, San Francisco, Bellevue and Houston were bought by non-U.S. investors. That compares with an average annual level of 10 to 15 percent in years prior, he said.
Non-U.S. investment in New York almost tripled last year and doubled in Boston, according to JLL. Sikaitis noted that demand is coming from across the globe, as non-U.S. investors are drawn by yields that, while at record lows from a U.S. perspective, compare favorably to those found in their home markets.
Higher Rents Incorporated into Underwriting
Low yields are prompting non-U.S. investors to incorporate higher rents into the underwriting of these projects, Sikaitis explained, along with fewer concessions for tenants.
“It’s a perfect storm for landlords as space options in the Skyline are decreasing. This has fueled their confidence to raise rents,” added Gregory Green, international director at JLL.
Meanwhile, the influx of non-U.S. capital has had a knock-on effect on domestic institutional investors and REITs, Sikaitis said. Both have started to explore new geographic markets and taking on a higher level of risk within their existing office market footprint, he noted.