by Brianna Crandall — June 29, 2016 — Rents for the office buildings that make up the skylines of North American cities have jumped into record territory in 2016 — an average of $43.79 per square foot, more than 7% higher than the first quarter of 2015. And rents for trophies (those ultra-premium office towers within the skyline) are even pricier at $56.82 per square foot. But global commercial real estate services firm JLL’s 2016 Skyline office space report shows that rent growth may be moderating, especially in high-growth markets that have recorded consistent rent appreciation over the last several years.
Highlights of the JLL Skyline: 2016 Mid-Year Update report:
- Skyline and trophy rents at record highs; owners retain leverage due to limited stock
- Rent growth expected to moderate
- Foreign investors, especially Canadians and Germans, remain focused on primary markets but moving to hot secondary markets along with their domestic counterparts
- Landlords need to retain gold standard of skyline assets, not letting them tarnish through complacency
Julia Georgules, vice president, JLL Research, commented:
Tightening conditions mean that tenants won’t see a reprieve for a few more quarters, but we do anticipate rents in the skyline will begin to moderate. We expect annualized skyline rent growth this year to rise by just half the rate of 2015, which is welcome news to tenants in markets such as Oakland and Austin, where skyline rents are up by more than 68% and 43%, respectively, since 2010.
New construction commands a premium
Owners, especially those with skyline properties currently under construction, still have the upper hand for now. Rents for those rising towers are hitting $61.23 per square foot, a nearly 40% premium over average skyline asking rents due to greater efficiencies inherent in such factors as layouts and operating costs. And in some places like New York (Hudson Yards) and San Francisco (Salesforce Tower), landlords are asking more than $100 per square foot.
Modest declines in investment volumes
Overall investment volumes into the skyline fell slightly in 2015, due to strong demand and liquidity for skyline office space assets earlier in the economic cycle as well as the generational nature of many acquisitions since the Global Financial Crisis. The scarcity of opportunities meant only 9.5% of the skyline across North America traded in 2015, down from 10.7% in 2014. Investment volumes in the first quarter of 2016 declined 72% in primary markets and nearly 47% in secondary markets.
Jonathan Geanakos, president, JLL Capital Markets, pointed out:
We’ve seen six consecutive years of cap rate compression and heightened liquidity across the skyline, which has led to strong pricing gains for investors. But volatility in the macro markets, current record pricing levels and an increasing sensitivity to risk caused investors to take a more cautious position in the first quarter of the year. We expect to see modest declines in overall transaction volumes this year, but new investor demand — especially from foreign capital — will drive near-term price stability and leave room for further modest cap rate compression.
Foreign investors now own more than 14% of the skyline, with Canadians and Germans claiming more than 60% of that total. In 2015, those cross-border buyers remained focused on the biggest and the best — with more than 60% of those dollars targeting trophy assets. And they have not strayed far, planting nearly 94% of their investment dollars into primary markets such as New York ($4.6B), Boston ($1.4B) and Seattle-Bellevue ($700M).
This has caused a change in investment strategies across North America. Challenged by peak pricing and scarce investment opportunities, both foreign and domestic buyers will continue to be drawn to hot secondary markets where rent growth is still achievable and tenant demand will persist in the months to come. Atlanta, Portland, Miami and even Cincinnati, Phoenix and Pittsburgh have all benefitted from that interest.
What have you done for me lately?
Despite the rise in popularity of older creative buildings and fringe markets, assets within the skyline are still the gold standard, but owners should not let them tarnish through complacency, reminds the report. For example, in sunny downtown Los Angeles, that means landlords have had to make significant lobby and plaza upgrades.
Josh Wrobel, managing director with JLL Agency Leasing in Los Angeles, said:
A growing number of tenants are no longer willing to focus only on traditional office space in a well-located trophy asset — they want their space and their building to reflect the image of their company. Rooftop decks, plenty of open space and wellness are huge factors that will increase an asset’s value, and owners need to be willing to make this investment in these common areas.
JLL’s Skyline
Investors and tenants alike can access the JLL Skyline: 2016 Mid-Year Update via a digital platform. The fully interactive Web site will feature JLL’s proprietary market insights regarding office supply, demand, rents, leverage and investment into 52 markets across the United States and Canada, with the ability to compare and contrast individual markets or multiples of markets as well as individual properties or portfolios. In addition, the site will offer videos and infographics. All information will also be available via mobile access.
