Investors Bid Up
Office-Space Prices

Foreign and institutional investors are bidding up prices for office properties in the nation's biggest markets, paying more than private investors and real-estate investment trusts are willing to offer, a real-estate research firm says.

Los Angeles, New York, San Francisco and Washington, D.C., are among the areas where foreign and institutional investors have been the most active in the past year. Competition for office properties has been fierce in those markets among all investors because of strong or improving leasing activity and rising rental rates. Foreign and institutional investors have been more aggressive in their efforts to win office assets in those markets, says Robert White Jr., president of Real Capital Analytics Inc., a New York real-estate research firm.

"Foreign capital, especially German capital, is highly targeted to just a few markets" close to international airports, Mr. White says. Institutional investors end up focusing on the same markets because their "research-driven nature pushes them to invest in the best demographic areas," he said, adding that "institutions are loath to go into secondary and tertiary markets because they don't think the liquidity is there."

As every real-estate broker knows, foreign buyers have always paid more than locals. But in the past year, foreigners, along with institutional investors, have paid still higher prices for properties in prime areas. The average price per square foot paid by foreign buyers for office properties rose 14% last year, while the average price paid by institutional investors rose 19%. By contrast, REITs and private, local investors are now paying less on average than they were a year ago.

What is more, the average initial yield on office assets acquired by foreign buyers was 7.4%, below the 7.7% average for all office properties and slightly less than the 7.5% that institutional investors accepted.

Meanwhile, many private local real-estate investors have been focusing primarily on office properties in suburban markets or markets outside of the top metropolitan areas, where competition for properties is less fierce. So far, that has been a smart move.

Suburban office markets are improving more quickly than major metropolitan areas, according to real-estate brokerage firm Grubb & Ellis Co. Since the overall office-vacancy rate peaked in early 2004, the vacancy rate for office properties in suburban markets has fallen 2.2 percentage points, compared with the decline of 0.4 percentage point in downtown markets. The annual average asking rent for suburban office space increased 2.4% to $24.40 a square foot at the end of March from a year earlier. During the same period, the rental rate for office space in central business district locations declined slightly to nearly $35 a square foot.

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