Timing Can be Everything: A Perspective on the Suburban Office Market

By: Darrell V. Koehlinger

The Suburban Office Market: Recent History
The downturn and subsequent recovery of the commercial real estate market and especially the suburban office market in the Twin Cities over the last six to seven years, has been well-documented. To gain some perspective on recent historical suburban office values, we have researched our files and compiled a database of the office sale activity in the suburban metro area for the period 1988 to 1995.

We have analyzed numerous office transactions, encompassing a variety of product ages, sizes, quality of construction, and locations. Within the scope of the study we have used buildings approaching ôinvestment qualityö status within certain parameters. The majority of the properties included in the survey have been constructed since 1970, have at least two stories, and contain at least 10,000 square feet. Not surprisingly, most of these properties are located in the southern and western suburbs, with relatively few found in Anoka, Ramsey, and Dakota Counties. Any sales of predominantly single-tenant leased buildings were excluded; as their sales often suggest values based on market rents from previous years.

Suburban Office Sales 1988-1995

	Average Price per sq. ft. GBA	Average Price per sq. ft. NRA	Number of Sales	Aggregate Sale Volume (in millions)
1988	$52.02	$61.57	19	$65.5
1989	$46.29	$55.01	15	$43.8
1990	$36.14	$44.14	15	$35.8
1991	$28.14	$34.82	22	$42.7
1992	$27.60	$31.79	31	$57.8
1993	$35.00	$40.96	33	$85.7
1994	$41.09	$50.27	23	$73.4
1995	$57.30	$68.26	8	$56.9

source: Shenehon Data Files

As one can see, average sale prices, both on a gross building and net rentable area, declined rapidly beginning in 1988 and bottomed out in 1992. At the same time, aggregate sales volume declined, then began to recover in 1992. The number of transactions actually increased as the market bottomed out, suggesting that the holders of larger buildings had the staying power to survive the downturn in the market cycle, even if they had been foreclosed upon earlier. Further analysis of the sales transactions that occurred during the 1988 to 1992 time period, reveals that large institutions such as pension funds, insurance companies and banks, were predominantly selling near the bottom of the market. Although the number of sales transacted in 1995 is far from complete, the preliminary data indicates that office building prices are approximately at their 1988 levels.



Investment Comparison: S&P 500 Versus Suburban Office Prices
An analysis of the Twin Cities suburban office market as an investment vehicle can be shown by comparing its record over the period 1988 to 1995, to that of an investment in stock equities. (This comparison is far from perfect, but it illustrates an important factor for consideration.) The stock market represents a collection of daily traded, minority equity interests in corporations, while real estate ownership is typically reported as a controlling interest.

Accordingly, a more accurate comparison would be that of real estate limited partnership interests versus the S&P 500, a comparison that would undoubtedly be more one-sided (due to the generally sub-par record of real estate limited partnerships) than the one presented here. For the sake of simplicity, returns on investment, namely dividends from stock investments or operating income from office buildings, are not considered here.

Given these qualifications, if one invested a hypothethical $100 in an average Twin Cities office building in 1988 and also invested $100 in the S&P 500 index, the comparative results would be dramatic. While a hypothetical S&P 500 stock portfolio invested in 1988 would be worth approximately 95% more today, overall suburban office values measured by average sale prices would have gained approximately 10%. The story is not completely one-sided, however, in that office values as measured by average sale prices, have appreciated approximately 100% since 1992.



Typically, commercial real estate investors leverage their purchases with 75% mortgage debt. This leverage works to either an equity ownerÆs extreme advantage or extreme disadvantage. In bad times, declining office values quickly dissipate an ownerÆs equity position. For example, a suburban office buyer in 1988 would have seen his/her equity value greatly diminish over the 1988 to 1992 time period. Without sufficient staying power, this downturn would easily have resulted in the total loss of the investment.

On the other hand, leverage applied in periods of market appreciation can benefit an investor quite significantly. Assuming that the ideal time to purchase a suburban office building began in 1992, improving office values as measured by average office sale prices, have generally magnified the appreciation of a 25% equity investment. Again, although this analysis has not considered income factors, the simple analysis indicates that average suburban office building equity investments have appreciated at a healthy rate since 1992.

"Timing" is a concept that is generally associated with the stock market. However, timing considerations can also be applied to the real estate market. By studying real estate fundamentals, sound investment and timing decisions can be developed, which in turn, can produce above average returns. Understanding that long term trends contain a series of short term market swings, and utilizing that knowledge, can often significantly affect the outcome of a real estate investment.

In summary, real estate values are just as susceptible to business cycles and market anomalies as stock prices. And as with the stock market, in the real estate market and specifically the suburban office market, timing really can be everything.

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