Don’t be Fooled by Your Office Building Appraisal
The sooner investors can recognize that prices in the U.S. office space are not where benchmarks have indicated, the sooner they can move forward with assessing and capitalizing on opportunities in the sector.
Where Are Office Values?
The ambivalence and lag of appraisal-based price indexes are misleading investors over the damage done to their private real estate exposure from rising inflation and interest rates. It is happening at a particularly precarious time for global financial markets. During this particular moment, investors need transparency regarding the values of their holdings. Investment managers have a responsibility to provide as accurate an assessment of current value despite the lack of transactional data points, which are usually sparse during periods of turmoil.
As of the third quarter of 2022, office properties in the NCREIF Property Index (NPI) had posted a total return of 3.2% over the past 12 months, consisting of an income return of 4.3% and an appreciation return of -1.1%. For those investors who own institutional-quality conventional Class A office buildings in almost any major market, this is implausible. Traditional office values are way down. Evidence indicates that space needs and preferences have changed and, as a result, office transaction activity over the past year has once again collapsed while a composite share price index of public office REITs has fallen by more than 30% over the same period.1
The U.S. Federal Reserve (Fed) is dealing with broad, persistent inflation unlike anything the nation has experienced in four decades. To restore price and, dare we say it, financial system stability, the Fed cannot follow the same monetary easing playbook as it has since the Global Financial Crisis (GFC). This time, things are necessarily different. Rapid monetary tightening is stressing risk valuations across all risk assets and “yesterday’s prices” are not holding up. If asset managers wait for transactions data to draw conclusions about values, they will likely have missed giving their investors information during this critical juncture.
Those who issue and endorse appraisal values should not be the primary arbiters of market values in such moments. Nor do we need a precise understanding of the future path of the office sector. The industry already has abundant information about where values are. At least, we understand where they are not.
1. Source: Bloomberg. As of September 30, 2022.