Capital commute: Why investors are loving suburban office
CHICAGO, Feb. 13, 2018 — Lenders and investors alike continue to find value outside of the Central Business District. One big reason? Asking rents for suburban office continues to trend upwards, while givebacks in CBD Class A office are pushing rents toward stabilization.
"There is this false notion that the suburbs aren't desirable for investors," said James Postweiler, JLL Managing Director. "The fact is there is strong demand that we only see getting better."?
The numbers are clear: rent growth has been strong for suburban Class A product.
Since 2010, suburban Class A rent has increased 23.1 percent and has seen a large uptick in the last two years. Meanwhile, CBD Class A rents have grown 34.2 percent and hold a 57.5 percent premium to suburban buildings.
"There's no question that CBD assets are at the top of many investors' lists, but where the suburban product has an advantage is for investors looking to tap into a much stronger relationship between risk and return," said Postweiler. "The credit worthiness of suburban tenants is equal to or better than the CBD, and yields favor suburban product as well."
Postweiler notes Chicago's suburbs as an example. The suburbs there have a ratio of Fortune 500 companies of nearly two to one.
Financing for suburban office product, especially Class A, remains attainable, according to Managing Director Keith Largay, JLL Capital Markets, Finance.
"Investors still prefer the CBD overall, but as cap rates compress, they are finding strong fundamentals in the inner suburbs," Largay said. "All lender types are lending in the suburbs: life companies and banks are focused on the premier assets and submarkets, debt funds are extremely aggressive on transitional properties, and CMBS lenders are aggressive on Class B properties or assets where lenders need maximum leverage."
Transit, walkability drive value
Not all suburban office product is created equal. According to JLL research, proximity to transportation and walkability are two key factors in determining rents for suburban office.
Walkable suburban submarkets have just 9.9 percent vacancy, while transit served submarkets are showing 12.0 percent vacancy. However, Postweiler notes, these numbers do not include owner-occupied space, which would push suburban vacancy much lower.
Those that are both walkable and transit served are rare — there is only 34 million square feet available. But here's the kicker: JLL research shows those markets that allow easy access to transit have rents that are 42.8 percent higher than those without transit accessibility.
"We've seen a development of clusters where Class A offices are near amenities like retail and provide easy access to transit as employers realize that urban-suburban feel can effectively attract talent," said Sean Coghlan?, JLL Director of U.S. Investor Research.
One example of this is the Renaissance Office Park in the Philadelphia suburb King of Prussia. JLL secured a $79.25 million loan from LoanCore Capital for a cluster of 14 Class A offices. The deal was competitively bid thanks to credit tenants and an amenity rich surrounding area with easy access to two thoroughfares.
The national office market is well along in the cycle, with construction at near-cyclical highs. New deliveries have pushed suburban Class A vacancy by 100 basis points year-over-year, compared to just 20 points in CBD Class A. That being said, development has mostly been balanced and absorption has remained strong.
With tenants continuing their flight to quality, that new supply has created an increase in vacancy that landlords will aggressively be looking to fill.
"With where we are in the cycle, we anticipate investors to take a long look at suburban office when considering the longer term leasing landscape," said Coghlan.
Added Largay, "With higher cap rates for suburban assets and the same cost of debt capital as CBD assets, current cash flow yields for investors are significantly better on suburban assets, which should bode well for continued investment."?
JLL Capital Markets is a full-service global provider of capital solutions for real estate investors and occupiers. The firm's in-depth local market and global investor knowledge delivers the best-in-class solutions for clients — whether a sale, financing, repositioning, advisory or recapitalization execution. In 2017 alone, the firm's 2,000 Capital Markets specialists completed $170 billion in investment sale and debt and equity transactions globally.
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JLL (NYSE: JLL) is a leading professional services firm that specializes in real estate and investment management. A Fortune 500 company, JLL helps real estate owners, occupiers and investors achieve their business ambitions. In 2017, JLL had revenue of $7.9 billion and fee revenue of $6.7 billion; managed 4.6 billion square feet, or 423 million square meters; and completed investment sales, acquisitions and finance transactions of approximately $170 billion. At the end of 2017, JLL had nearly 300 corporate offices, operations in over 80 countries and a global workforce of 82,000. As of December 31, 2017, LaSalle had $58.1 billion of real estate assets under management. JLL is the brand name, and a registered trademark, of Jones Lang LaSalle Incorporated.