March 22, 2004—Price tags for office buildings continued to climb while vacancy rates deteriorated throughout most of 2003, fueling speculation of a fragile pricing “bubble” looming over the office real estate investment market. However, despite the high prices and weak market, continued investment in real estate last year appears rational and justified, according to a new report issued by Grubb & Ellis Company, PNC Real Estate Finance, member of The PNC Financial Services Group, Inc., and Real Capital Analytics.
The report, entitled “Bubble Re(W)Rapped,” retested the theory of rational exuberance in the office market first researched and reported by the same team one year ago. The conclusion remained unchanged: a widespread bubble—defined as pricing appreciation that is both unjustifiable and unsustainable—does not appear to exist in the office market.
The leasing market appeared to have turned the corner in the fourth quarter of 2003, says the report, when the vacancy rate declined for the first time in three years, ending the year at 17.5 percent, down from 17.6 percent the previous quarter.
“Any positive news regarding the economy or the office market, however unsubstantiated or isolated, further supports more aggressive underwriting,” said Bach.
The report also identifies pockets of concern in the office investment market such as Washington, D.C. where survey respondents stated “you can sell anything,” even buildings with leasing risk, for a high price.
The unlisted or non-exchange traded Real Estate Investment Trusts (REITs), is an important category of buyer to watch in 2004. According to the report, the unlisted REITs are driving pricing in many markets.
While the report dismisses a cataclysmic bursting of a pricing bubble, the office market is not without its challenges this year. Areas of concern include: global outsourcing of service jobs, surging productivity that allows companies to substitute technology for labor, global competition that forces companies to stay lean and rising healthcare costs that discourage hiring. Recovery in the leasing market will be slow. Rising interest rates are also a primary concern for the investment market.
A summary of the report is available online.
