US Trend Favours the Single Tenant Office
The most movement and interest in the US commercial property market over the last couple of years has been the single-tenant side of the market. A feature of US commercial property correction and recovery has been the lack of construction especially among the office market. Some would put this down to the imbalances in the relationship between property and financial markets.
We now know how the office market was overbought, and although pricing was in line with fundamentals, it was not always properly aligned with underlying risks. Most would agree that the financial crisis rectified many of these imbalances, but with a price tag that included a severe recession and a swift correction in commercial real estate pricing and fundamentals.
The upside is that the financial crisis squashed funding for projects in infancy and impeded a development cycle that was already underway in many markets. The slow pace of recovery in the economy has translated into a comparatively tame office recovery as well. Vacancy rates are still tracking 15.5% and effective rents still 13% below pre-recession peak real rents remain well below replacement costs. Landlords are still struggling to maintain operating income.
If you’re and investor it makes far more sense to invest in established properties rather than in new buildings that will need to be leased up from scratch. As a result, new supply is now coming online at the slowest rate since the early 1990s. In a small but growing number of office markets, employment has already reached its pre-recession peak and rents are growing fast enough that new supply could be handled tentatively.
However multi-tenant development remains below trend and in line with the US average. The most movement and interest in recent years is on the single-tenant side of the market, where development now accounts for nearly half of all new office construction. Due to weak fundamentals and soft leasing trends, the development pipeline has shifted away from multi-tenant buildings, in favour of single-tenant and owner-occupied buildings.
From a market perspective it makes sense, as new buildings have lengthy lease-up periods that can be lengthened by a soft market. Single-tenant buildings are often built to suit and do not break ground without a tenant having already committed to a lease, so this is one way for investors to mitigate risk. New construction can be an attractive option for occupiers, assuming they have the capital to undertake such a project. Configuring space themselves is one plus. It also allows tenants to design specific IT requirements directly in the build-out process. Both Amazon and Microsoft have gone this route, developing impressive corporate headquarters in Seattle. Vertex Pharmaceuticals have done this in Boston and Devon Energy in Oklahoma City.
New single-tenant buildings may suit the needs of occupiers, but they also leave a void in multi-tenant buildings, as tenants tend to relocate within the same market. Much of this, however, depends on individual market characteristics, and we have yet to see significant negative effects from recent single-tenant development. Investors have shown interest in targeting single-tenant assets. These assets can offer competitive pricing, but also stable and simple-to-manage lease structures that likely include long-term tenants. They also carry a higher rollover risk in that, if a tenant does leave, it immediately reduces operating income to zero.
Throughout the recent recession in particular, single-tenant properties have performed well from the perspective of stability of income and occupancy. Simply put single-tenant office and industrial properties today are achieving higher yields than their multi-tenant counterparts. Concerning the single-tenant trend, the costs are high. Capital requirements may not be an issue for well-established high-tech firms or energy companies, but smaller start-ups will have different requirements. As we see the economic recovery mature this trend will likely firm up and include small firms as capital becomes more readily available.
Posted on July 15, 2013, in Commerce, Property and tagged financial crisis, multi-tenant buildings, single tenant, single-tenant buildings, US commercial property market. Bookmark the permalink. Leave a comment.