Has The Trend In Favor Of Downtown Office Markets Reversed Course?

As investors pursue stronger yields in this mature cycle, high central business district prices and flat cap rates are making suburban markets increasingly attractive.

While overall office investment activity slowed last year compared to 2016, suburban assets were in high demand in 2017, with suburban office sales accounting for 63% of the total $131.9B transacted last year. Total office sales were down 8% year to year, Colliers reports, as was the sale of CBD assets, which fell 21% to $48.8B. 

“A couple of things are bubbling under the surface,” Colliers International National Director of Office Research Stephen Newbold said. “You can see absorption was down last year [as was] the amount of office sales. We don’t see any immediate market correction, but net absorption was lower last year and the amount of money invested in office properties was down. Suburban investment is holding steady.”

Marcus & Millichap's U.S. Office Investment Outlook report states that suburban properties can offer initial returns of about 100 basis points more than downtown assets.

“I’m not saying people aren’t going to downtown markets, but if you’re looking to chase higher yields, that’s predominantly in the suburbs,” Newbold said.

While office absorption fell 28% year over year nationwide to 41.9M SF, according to Colliers, vacancy rates have held firm within a range of 30 basis points for the past eight quarters, falling to 12% in Q4.

Shifting Demographics

The suburbs have several factors working in their favor at the moment — more available land on which to build, cheaper rents for office occupiers, strong live-work-play synergy for aging millennials looking to start families, stellar public transit options and an abundance of value-add opportunities that, with the right amenities assortment, could generate strong yields. 

Marcus & Millichap Senior Vice President and National Director of Specialty Divisions Alan Pontius said suburban assets are increasingly accounting for a larger portion of net office absorption as demographic shifts stir population growth in suburban markets, particularly from millennials between ages 20 and 34.

“We’re clearly seeing an impressive pick up in suburban office leasing activity and it’s because of some powerful demographic trends,” Pontius said. “It’s not that all of a sudden the urban core is out of favor, it’s just there’s a lot of people out, and the millennial population is, in fact, getting older. You’re simply seeing characteristics within that population that are not terribly different than what you would have seen in previous generations.”

West Coast markets continue to lead the country in suburban office rent growth, with the San Francisco-Bay Area boasting the highest suburban office rents in the country at $50.17/SF. Seattle, Los Angeles and Orange County all experienced a minimum 6% in rent gains last year. Suburban markets in Miami, Palm Beach and South Florida also made the top 10 list for suburban office rent growth, Colliers reports.

“Absorption in the suburbs for the last 24 months has exceeded new deliveries," Pontius said. "Demand is outpacing the introduction of new supply and we’re seeing a continued decline in suburban vacancy."