Commercial Mortgages: Low office vacancies in Richmond region could lead to rental growth and better property economics

RICHMOND TIMES-DISPATCH

by Andrew Little, Special Correspondent

It is unlikely that Archie Bell & the Drells was referring to office space when the band recorded its chart-topping hit “Tighten Up” in 1967, but the market is getting tighter for growing tenants trying to find office space in many cities, including Richmond.Only six Class A buildings and three Class B buildings in the Central Business District of Richmond have greater than 20,000 square feet of space available today, according to data from CoStar, a research and analytics firm for the commercial real estate industry.Once the search is widened to include vacant space of more than 10,000 square feet, only six more buildings get added.It doesn’t get much easier in the suburbs, either.In fact, according to the latest office report from commercial real estate brokerage Cushman & Wakefield | Thalhimer, overall vacancy in the Richmond region was a low 6.7 percent at the end of the first quarter of 2018.

This compares to a rate of 7.6 percent at the end of the first quarter in 2017.National vacancy rates are hovering at 13.3 percent, according to data from CBRE for the first quarter of 2018. The report, which tracks more than 60 markets nationwide, indicates that only eight markets in the country have vacancy rates below 10 percent, and the Richmond region is one.The five markets with the largest decreases in vacancy are Palm Beach County, Fla.; Westchester County, N.Y.; Portland, Ore.; Salt Lake City; and Richmond.Part of what makes these midsize markets more balanced is that there is less speculative development or new construction for office properties.According to the CBRE report, nearly 50 percent of the total construction in the U.S. is concentrated in five markets — New York City, San Francisco, Washington, Seattle and Dallas.While New York City, San Francisco and Seattle have low vacancies, Dallas has the second-highest vacancy rate in the country at 20.6 percent.

Despite solid office fundamentals where vacancy is relatively low, absorption is relatively strong and supply is somewhat constrained, investment volume across the country is lower in the first few months of 2018 compared to 2017.According to a separate CBRE report, while overall commercial real estate investment volume increased in the first quarter of 2018 compared to the same period last year by nearly 5 percent, office activity was down a whopping 12.3 percent.This trend is also evident in the Richmond area, where the first four months of 2018 have produced few investment sales.The entire region has had fewer than $40 million in office sales, according to information from CoStar.

Considering that there were several building sales in the first quarter of 2017 that exceeded $40 million, it is safe to say volume is down significantly in 2018. Several local investment sales brokers confirm volume is slow but, they add, pipelines are filling up again.The dropoff could be attributed to volatile interest rates.Since the end of 2017, the 10-year Treasury yield has ballooned from 2.40 percent to more than 3.05 percent last week. The quick change has created a gap in expectations that is hard to bridge for sellers and buyers. Buyers think cap rates have moved up with interest rates, and sellers don’t agree.

Rates at the end of 2017 were in the 3.60 to 3.85 percent range for 5- and 10-year loans offered by life insurance companies, and now rates are in the 4.20 to 4.45 percent range for comparable terms, according to the John B. Levy National Mortgage Survey. Conduit pricing today is pushing 5 percent for most loans.The news for office owners in the Richmond area is cautiously good. Low vacancies and less available space is sure to lead to rental growth and better property economics. That is always good news that will lead to higher valuations.Caution against too much jubilation is warranted, however, as interest rate movement is going against owners of all properties and eventually that will hold valuations from rising too rapidly.

John B. Levy & Co. partner and investment banker Andrew Little can be reached at alittle@jblevyco.com.