Investors Love Industrial as Returns on Office Buys Fall

Posted on July 28, 2014

Office and industrial properties achieved full recovery nationwide by the second half of 2014, with cap rates compressing and prices skyrocketing. This is pushing investors to either reposition existing gems in their portfolios or pick up trophy properties in secondary markets.

Commercial real estate properties in general have made a major comeback in values for investors, according to Integra Realty Resources’ recently released Mid-Year Viewpoint 2014 report. While overall U.S. economic growth shrank by about 2 percent, all 66 of the firm’s offices nationwide reported gains for office, multifamily, retail, industrial and lodging properties during the same period. Value appreciation in most office markets has largely erased losses from the recession, and 97 percent of the industrial markets are now reported to be in a recovery or expansion cycle, with more than 50 percent labeled as expansionary, according to the report.

Ray Cirz, senior managing director and chairman of the board at Integra, says investors are frustrated with office properties in major markets because the returns on investment have narrowed. At the same time, they love industrial sites because of spiking rents. Industrial is the one property type that has the greatest chance for value appreciation in the next two years, Cirz says.

“Office core property investment ROIs have gone as long as they can go, clients are starting to look elsewhere,” he notes. “I recently had a client that traditionally invests in San Francisco now looking in Sacramento, where they can try to get some additional yield without too much additional risk.”

Miami and Orange County, Ca. have seen especially strong cap rate contraction, and even markets such as Charleston, S.C.; Chicago, Detroit and Louisville, Ky. saw cap rates contract by more than 25 basis points in the first half of the year. Investors are finding success if they can renovate and reposition buildings in major markets. The suburbs, however, are not the place to look, with less than half of suburban properties now in the expansion cycle, Cirz says.

“There’s still a lot of concern about the employment shift to the downtowns and the consolidation of space by large firms, which drove down demand and rent level in the suburbs,” he says.

Conversely, there are not many places where industrial space isn’t in demand, thanks to factors such as lack of new construction, the expansion of the Panama Canal and increased consumer spending combined with internet retailing. Cap rates contracted in more than 80 percent of class-A industrial markets, according to the report, especially in major cities such as Boston, New York, Philadelphia and Dallas. All markets aside from Jackson, Miss.; Greensboro, N.C. and Portland, Ore. project growth in the next three years, according to the report.

“One thing I’ve seen is that even industrial land values have skyrocketed,” Cirz says. “We’ve seen industrial buildings that have exceeded values that office buildings aren’t even achieving. It’s not uncommon for an older industrial building to sell for $150 per sq. ft., higher than some nice quality office properties.”

He says with values increasing so fast after the recession, it’s possible there could be an “industrial bubble” if prices get to high.

“We’ve heard about rents growing at 5 percent per year. If they don’t realize the expectations they’ve set, the assets might not maintain the value they are seeing now.”