The Future of Net Lease Office Sales: What Investors Need to Know

CEO Khai Intela
Image Source: Northmarq, Real Capital Analytics The net lease office market has experienced a significant decline in sales volume, raising concerns about the future of this asset class. With the rise in interest rates and...

Image Source: Northmarq, Real Capital Analytics

The net lease office market has experienced a significant decline in sales volume, raising concerns about the future of this asset class. With the rise in interest rates and the uncertainty surrounding remote work, investors are questioning whether office spaces will remain relevant in the coming years. However, despite these challenges, there are still opportunities and bright spots within the sector.

A Challenging Market Landscape

The third quarter of 2023 saw a 31 percent decline in investment sales volume, with a staggering 63 percent decrease year-over-year. Net lease office sales have also plummeted by 82 percent since the all-time high in the fourth quarter of 2021. One of the key reasons behind this decline is the impact of rising interest rates. However, many investors wonder if a stabilization or reduction in debt costs in 2024 and beyond will be enough to entice them back.

Niche Opportunities and Changing Workplaces

While traditional office spaces face a challenging road ahead, there are still areas within the net lease office sector that offer potential. Healthcare remains an important subset, with urgent cares, dialysis facilities, and medical office buildings presenting investment opportunities. Additionally, there is potential for crossover into research and development or lab space, which supports the medical office sector. Furthermore, the demand for less traditional office space, such as lab facilities and call centers, is growing, especially within fast-growing sectors like pharmaceuticals and technology.

The Uncertain Outlook

The current outlook for the office sector may appear uncertain, but it is not beyond repair. The values of office spaces are falling, tenants are returning unused space, and property owners are considering alternative uses, such as multifamily conversions. However, it is important not to overlook the resiliency of the commercial real estate market. While the future of the office sector remains unknown, it is essential for owners and investors to weather the storm and find creative solutions to attract and retain tenants.

Cap Rates and Market Trends

Cap rates for single-tenant office spaces have been steadily increasing, reaching a mid-year average of 6.38 percent. This reflects a 16-basis point rise from the previous quarter and a 35-basis point increase compared to the sector's record low in the third quarter of 2022. With interest rates expected to remain elevated, it is likely that investors will see further cap rate expansion in the coming quarters.

The Importance of Office Spaces

While the market landscape is evolving, it is important to remember that general office spaces are unlikely to become obsolete. Instead, they will evolve to meet the needs of the next generation of workers. The demand for medical office spaces continues to grow, driven by an aging population and the need for various healthcare facilities. Additionally, less traditional office spaces, such as labs and call centers, offer opportunities in sectors like pharmaceuticals and technology.

The Way Forward

Investment sales activity in the single-tenant office sector has experienced a decline, but there are still notable transactions occurring across various asset classes. Suburban and urban areas continue to attract investor interest, and office portfolio transactions remain a significant portion of investment activity. Furthermore, cross-border investment activity may increase, offering potential supply as international investors divest quality assets.

As the market continues to navigate the uncertain landscape, it is crucial for investors to consider the long-term potential of net lease office spaces. While challenges exist, the office sector has proven its resilience throughout history. By adapting to changing workplace dynamics and exploring niche opportunities, investors can weather the storm and find ways to generate long-term value for their assets.

Lanie Beck is the Senior Director of Content & Marketing Research at Northmarq. With an extensive background in research, marketing, and communications, she provides valuable insights into the commercial investment sales division.