Executive Summary
- 2015 marks post-recession peak in office sales volume
- Manhattan is the top target for investment from 1997 to 2017
- the Bay Area boasts highest post-crisis increase in office sales
- the most active office buyers of the past 20 years: Tishman Speyer, JPMorgan
- office investors and lenders much more cautious after 2008 crash
It’s been nearly 10 years since the financial crisis hit U.S. real estate like a sledgehammer, effectively putting the brakes on the loose credit spending and regulation that brought it about. The residential market took the biggest hit, as home prices plummeted, many lost their properties to foreclosures, unemployment went up and financial juggernauts such as Lehman Brothers went bankrupt.
The commercial real estate market was also heavily impacted by the 2008 crisis, though it never really crashed in the same way the single-family housing market did. Fortune Magazine suggests that the office, retail, multifamily and hospitality sectors managed to avoid a crash because the commercial market wasn’t nearly as ‘overbuilt’ as the residential one. Moreover, commercial property owners managed to maintain the income flow through rents paid by tenants, while private equity firms stepped into the limelight and took over distressed properties. Instead of defaulting, commercial property owners put their assets on the market, renegotiated loans or handed over the properties to the banks. So what happened next?
Tracking 20 Years of Office Sales Activity–2015 Marks Post-Recession Peak
While the commercial market was able to avoid a major crash, it didn’t come out of the downturn completely unscathed. We wanted to see the exact impact that the financial crisis of 2008 had on the office sales sector, and how the market performed in the years before and after the crash. Our analysis, based on Yardi Matrix office data, aims to paint a comprehensive picture of the U.S. office investment landscape before and after the recession. In order to achieve that, we analyzed all office sales above $5 million of properties over 50,000 square feet to close between 1997 and 2017 (see ‘Methodology’). To ensure that our analysis is valid, each sale price was adjusted with the corresponding annual inflation rate.
What is immediately obvious is that office sales activity has been on the rise starting with 2010, and reached a post-downturn high in 2015–a high very close to the 2007 pre-recession peak. The market then started to slow down to more sustainable levels, as 2016 followed a slight downward trend, and we expect this year to follow the same path. We adjusted the 2017 total to include our estimated sales volume for Q4, based on historical data. Our forecast estimates a yearly office sales volume of close to $80 billion at year-end 2017.
Keep reading to see which markets fared the best following the financial crisis of 2008, which were the key players trading properties and how the office sales realm has evolved as a whole from 1997 to the present day.
Manhattan is the Top Destination for Office Buyers Before and After Crisis
The Manhattan office market was the top target for office buyers from 1997 to 2007, recording a 10-year sales volume of over $118 billion–well above all other U.S. markets and the only market to surpass the $100 billion mark during the decade. By comparison, the second best-performing market in the 10 years before the recession was Washington, D.C., which boasted a sales volume of $71 billion. Chicago, Los Angeles and Boston complete the top 5, each boasting a 10-year sales volume in the $40 million range.
Fast forward to the next decade, a decade of recovery for the U.S. real estate market, and we get to see if and how buyer interest has fluctuated post-recession. Manhattan did not lose its appeal to office investors after the financial crisis, and the 10 years that followed the recession actually showed increased interest in the market. The sales volume for Manhattan office buildings rose 9% from one decade to the next, totaling $129 billion from 2008 through September 2017.
The Washington, D.C., office market, on the other hand, recorded a 22% drop in sales volume in the decade that followed the financial crisis, from $71 billion in 1997-2007 to $55 billion during 2008-2017. This drop in office sales volume did not, however, affect D.C.’s position on our list of top markets for office investment. The market managed to keep its second spot, aided, no doubt, by the fact that other markets saw office sales decrease, as well.
Chicago was the third most attractive market for office buyers from 1997 to 2007, recording more than $48 billion in office sales. Transaction velocity decreased 24% in the decade following the recession, and the Chicago office market lost its spot in the top 3. A total of $37 billion worth of Windy City office assets changed hands from 2008 through September 2017, making Chicago the 6th most appealing market for office investors during the past decade.
Bay Area Records Highest Sales Volume Increase Post-Recession
From 1997 to 2007, the Bay Area office market was the eighth most appealing destination for investors, with $21 billion worth of office properties traded. Looking at the next decade, the market climbed just one spot and currently occupies the seventh position. However, taking a closer look reveals an impressive evolution: Bay Area office sales rose 69% from one decade to the next, with $35 billion worth of assets changing hands from 2008 through September 2017. The Bay Area thus recorded the highest increase in office sales volume, this growing appeal being fueled by the area’s emergence as a tech Mecca.
Tracking down yearly sales activity in the Bay Area, this increase becomes even more obvious–the market hit a 20-year peak in office sales in 2015, when 82 transactions closed for a total of over $8 billion. The market had previously peaked in 2006, when 57 deals closed for $5.2 billion in sales volume. Following a steep drop in 2009, the market managed to bounce back strong and surpass the levels it recorded in the years preceding the recession.
San Francisco’s office market also climbed one spot from one decade to the next, and is now the fifth most appealing target for office buyers in the U.S. Home to the likes of Google, Apple, Facebook and Twitter, among many others, San Francisco and the Bay Area markets continue to rise in popularity and attract both national and offshore office investors.
Two other markets that saw a significant spike in investment appeal following the recession are Dallas and Seattle. The Dallas office market climbed six spots on our list of top markets for office investment, recording a 48% increase in total sales volume between the two decades. A total of $19 billion worth of office assets changed hands in Dallas over the past decade, and the market currently occupies the 10th spot on our list. Seattle managed to climb two spots and is currently the eighth most active office sales market in the U.S., with $24 billion worth of office sales closed from 2008 to 2017. Amazon’s home base is one of the most active office markets in the country at the moment. According to recent JLL research, the Seattle-Bellevue area has accounted for 29% of year-to-date national net absorption, proving that the demand for Emerald City office properties continues to grow.
The markets that suffered the most after the 2008 crash, losing some of their appeal to office buyers, are Bridgeport – New Haven, which recorded a 62% drop in sales volume from one decade to the next, Philadelphia, with a 32% decrease, and Phoenix, with a 27% drop in sales volume.
Where Are They Now? The Top Office Buyers Before and After the Crash
Both before and after the 2008 financial crisis, private buyers, REITs and institutional investors were the major players on the U.S. office deals landscape–and you might already be familiar with some of these ‘top dogs.’ We wanted to identify the main office buyers betting on the market in the 10 years preceding the financial crash, and whether they remained just as active in the decade following it. Our analysis reveals interesting–and striking–results: only three of the top office buyers during 1997-2007 managed to land a spot in the top 10 after the downturn.
Tishman Speyer, one of the giants of U.S. real estate, was the most active office buyer between 1997 and 2007, bagging $19 billion worth of properties during that time period. Partial owner of iconic New York City landmarks such as The Chrysler Building and Rockefeller Center, Tishman Speyer is probably best known for its dealings on the residential market. In 2006, the company acquired the massive Stuyvesant Town-Peter Cooper Village community in New York City for a whopping $5.4 billion, marking the priciest single-asset real estate deal ever to close in the U.S. Tishman also partnered with Lehman Brothers to acquire a $22 billion residential portfolio from Archstone Smith. Yet New York City-based Tishman was also a strong player on the commercial market. The firm closed the largest real estate deal in Chicago history in 2007, when it paid $1.7 billion to acquire five office buildings from Blackstone. The buildings were part of the Equity Office Properties Trust portfolio that Blackstone chose to sell after buying out the trust.
Fast forward to the years after the crisis, and the numbers paint a different picture. In 2010, Stuy Town owners Tishman and BlackRock Realty defaulted on their loans and handed over the property to the lenders. The Stuy Town loss, coupled with a failed rail project with the MTA and the downfall of the Lehman Brothers, with which Tishman had partnered on the purchase of the Archstone Smith portfolio, put a dent in the company’s activity around the time of the crisis. The company’s activity on the commercial side also slowed significantly in the decade following the recession–Tishman Speyer failed to make our top 10 list of office buyers between 2008 and 2017.
The top office buyer in the decade following the crisis was JPMorgan Asset Management, which wasn’t even one of the top 10 players before 2007. In fact, our pre-recession list features just one investment bank: Morgan Stanley, occupying the ninth spot. Institutional investors became more active on the U.S. office sales market after the recession, and JPMorgan Asset Management proved to be the most active of all. The investment banking arm of JPMorgan Chase–the largest bank in the U.S., with a history going back to 1799–acquired nearly $11 billion worth of office properties from 2008 through October 2017.
Equity Office Properties Trust, which was the second most active pre-recession office buyer, slid down to the seventh spot post-2008. The company was acquired by The Blackstone Group in 2006, in one of the largest transactions to ever close on the U.S. real estate market, valued at roughly $39 billion. Following the merger, Blackstone embarked on a massive selling spree to pay off the debt it had taken on, disposing of the office buildings in EOPT’s portfolio. The sellout process began with the $7 billion sale of seven New York City office buildings to Macklowe Properties in February 2007. With this epic deal (the portfolio price tag equated to roughly $1,000 per square foot), Macklowe became the sixth most active office buyer in the U.S. between 1997 and 2007, acquiring almost $11 billion worth of assets during that time.
Has the Office Lending Landscape Changed After the Recession?
The lenient spending and lending standards that characterized the 2000s came head to head with reality in 2008, when the real estate bubble finally burst. According to Moody’s data, the number of office loans granted on a nationwide level gradually increased during the late 1990s and early 2000s, reaching a peak in 2005, when 835 loans were issued. Banks were granting numerous high-risk and interest-only loans right before the crash, and investors were closing deals at warp speed, betting on a market they thought would continue to grow. As it turns out, they were wrong–and over-leveraged.
The market crashed in 2008 and many investors found themselves unable to refinance or pay off the debt they had taken on. The number of loans granted for the purchase of office assets also dropped significantly during the downturn–lenders issued just 380 office loans in 2008, compared to 804 in 2007, per Moody’s data. As the market slowly bounced back over the following years, the number of office loans also picked up the pace, though it never reached the same heights as it did before the crisis. In 2015, the market hit a post-recession peak, as lenders issued a total of 583 office loans–125% more than the number of loans recorded in 2009.
The U.S. Congress sought to prevent another loose lending trend from recurring, by enforcing the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. According to The Wall Street Journal, the law was ‘the biggest expansion of government power over banking and markets since the Depression.’ The act included a credit risk-retention rule stipulating that ‘the securitizer of asset-backed securities should retain not less than 5% of the credit risk of the assets collateralizing the asset-backed securities.’ This means that investors and lenders now have to share the risks when closing a loan deal.
Average Interest Rates on Downward Path since 2009
The average interest rate on office loans has been on a progressive downward path since 2009, reaching 4.07% at the close of Q2 2017. Data provided by Moody’s shows that the 7.26% interest rate recorded in 2009 was roughly on par with 1999 levels, after four years of positive growth–office buyers were betting big on the market and were taking on high-risk and interest-only loans. Starting in 2010, investors and banks were more cautious, and the average interest rate followed a downward path, reaching a 20-year low of 3.68% in 2016. The lowering of interest rates was also an attempt on the lenders’ side to revive loan issuance activity after the financial slump.
The average maturity of office loans at the close of Q2 2017 was roughly on par with the average recorded 20 years ago–a term of 10 years. Moody’s data shows that 2007 and 2008 recorded the lowest average maturity of the past two decades; in 2008, investors were taking on office loans with a maturity date of just seven years, on average. Starting with 2009, the average maturity increased, peaking in 2015, when office loans had a final deadline of nearly 11 years.
The U.S. office investment landscape has clearly been influenced by the financial crash of 2008, bringing about awareness and cautiousness to the market. Investors and lenders alike want to avoid past mistakes and prevent another boom-and-bust from happening by setting up tight regulations. There are some industry experts who think the market will crash again in the near future–some predicting a turning point as soon as next year. Could the real estate market be heading towards another downturn?
Methodology
We used Yardi Matrix office sales data and Moody’s loan stats to analyze the U.S. office sales market from 1997 to 2017. In order to paint a comprehensive and accurate picture of the market, we decided to include sales over $5 million of office properties featuring more than 50,000 square feet to close from 1997 through September 2017, these thresholds being the most representative of an active office market. We also adjusted the 2017 total sales volume to include estimated Q4 numbers, which we calculated based on historical quarterly sales data.
Our sales volume numbers include individual, partial stake and portfolio transactions; we left out cross-market portfolio transactions because it would be unfeasible to determine the percentage split among markets. To conduct a valid comparison between yearly sales volumes, we adjusted each sale price with the corresponding inflation rate.
