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Pricing Pressures Illuminate the Balancing Act in Southern California's Office Real Estate Transition

1/03/24

This report was provided by real estate services firm N.A.I. Capital Commercial

Toward the yearend, Southern California witnessed a decline in office building sales, signaling a shift in individual markets. The slowdown in significant office asset transactions became evident, with total sales volume in 2023 reaching approximately $3.9 bil as of December, down 44.1% from 2022. This marked the slowest year in both dollar volume and the number of properties sold since the Great Recession.

The Federal Reserve played a pivotal role in this trend by raising interest rates four times during the year, starting from March 2022. Despite the Fed's current pause in rate hikes, the decision has led to a decline in the sales volume of office real estate. Recent data indicates a slowdown in growth and a moderation in inflation, as observed in the price per square foot for office buildings, which has experienced a significant 32.4% decrease from the previous year.

Market -- # of Transactions -- $ Sales Volume -- Building SF -- Average Price Per Bldg SF -- Average Cap Rate

Los Angeles County -- 305 -- $2,442,261,517 -- 9,809,878 -- $295 -- 5.6%
Inland Empire -- 131 -- $250,103,773 -- 1,449,409 -- $179 -- 5.6%
Orange County -- 135 -- $1,044,136,037 -- 5,686,888 -- $220 -- 5.7%
Ventura County -- 39 -- $129,337,990 -- 704,183 -- $198 -- 6.4%

Total SoCal -- 610 -- $3,865,839,317 -- 17,650,358 -- $223 -- 5.8%

The downturn in transaction volume and asset re-pricing has left its mark on every market, making it challenging to distinguish between relative winners and losers. From major urban centers to smaller suburban areas, its pervasive impact is evident. However, one thing is certain: this downturn is not akin to the financial crisis of the Great Recession.

Los Angeles County

In Los Angeles County, the average cap rate for office properties in 2023 increased by 60 basis points from the previous year, averaging 5.6%a notable shift from the peak of 7.2% in 2011 during the recovery from the Great Recession. Despite this rise, Los Angeles County maintains a dominant market share, currently representing 63.2% of Southern California's office sales volume. Concurrently, with the uptick in cap rates, the average price per building square foot sold at $295/sf has experienced a notable decline, dropping by 40.5% year over year. Sales volume also decreased by 42% to $2.4 bil.

Inland Empire

In the Inland Empire, the average price per square foot for office buildings sold experienced the lowest rate of decline in Southern California, dropping 11.9% year over year to $179/sf. However, sales volume plummeted by 59.6% from the previous year to $250 mil. Unlike the peak of 8.9% cap rates in 2009 during the Great Recession, the Inland Empire has undergone significant changes in office investment, currently averaging cap rates at 5.6%.

Orange County

In Orange County, the average price per square foot for office buildings declined by 32.7% year over year, reaching $220/sf. Sales volume plummeted to little more than $1 billion, down 38.4% from the previous year, as investors await improvements in the economy or capital markets before committing to transactions. In contrast to the peak of 8.5% cap rates in 2010 during the Great Recession, Orange County has seen office investment demand, with cap rates currently at 5.7%.

Ventura County

As the smallest investment office market, Ventura County experienced the largest decline in sales volume, plummeting to less than $130 mil, down 67% from the previous year, as investors stayed on the sidelines. The average price per square foot for office buildings sold declined by 32.5% year over year, reaching $198/sf. In comparison to the other office markets in Southern California, the average cap rate is also the highest at 6.4%.

Given the poor pricing and higher borrowing costs tightening financial conditions, the slowdown in office sales highlights a crucial question: why sell an office property now? While an even lower number of properties sold or went back to the lender this year associated with distress, many sellers face pricing pressures. Some sellers, not necessarily distressed, have identified demand for well-leased, Class A properties. However, overall sales have significantly decreased, with a preference to hold rather than sell at low prices.

Despite reports of ample prospective buyers and sellers, few transactions are being finalized due to a shortage of realistic and motivated sellers at current market prices. The reluctance to sell is widespread, with investors waiting for improvements in the economy or capital markets before committing to transactions. There is a growing pent-up demand to sell; however, the duration of this demand remains uncertain until the market shows signs of improvement. In 2024, there will be a focus on exploring pricing in the office investment market.

This report was prepared by J.C. Casillas, Managing Director, Research, N.A.I. Capital Commercial







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