Not New York Towers Rise With Embrace of Yield: Mortgages
Trophy office towers are for sale across the U.S. as landlords from Seattle to Atlanta offer properties to investors seeking higher returns in second-tier cities where rents are beginning to rise.
IDS Center, the tallest building in Minneapolis; 1201 Third Ave., Seattle’s second-highest; and Williams Tower, the third- tallest in Houston, are among the new listings in the past three months. They join marquee properties in Denver; Charlotte, North Carolina; and Austin, Texas sold in 2012.
Properties beyond the so-called gateway U.S. cities are benefiting from “robust” demand and helping to fuel deals, according to Real Capital Analytics Inc. Secondary and tertiary markets -- which exclude New York, San Francisco, Los Angeles, Washington, Chicago and Boston -- made up 31 percent of office transactions this year through the third quarter, compared with a 23 percent share in all of 2011, preliminary data from the research firm show.
“You’re starting to see a healthy rise in volume as sellers try to take advantage of the recovery,” Greg MacKinnon, economist and research director at the Pension Real Estate Association, a trade group for institutional property investors, said in a phone interview. “It’s spreading to the smaller markets because yields are pretty thin in the gateway cities.”
The Federal Reserve’s policy of keeping its benchmark interest rate near zero has investors seeking higher-yielding assets. Returns in secondary cities are higher than those in large markets and Treasury yields, and occupancy gains, increased financing options, and a dearth of new supply are bolstering demand, according to data compiled by broker CBRE Group Inc. (CBG) and research firm Green Street Advisors Inc.
Investor confidence that the property market is recovering is fueling demand for debt tied to skyscrapers and other types of commercial buildings. An index tied to bonds that were originally given top credit ratings during the market’s peak and have been cut to junk has risen 16.1 percent this year to 65.7 cents on the dollar.
Total office sales for January through September rose 7.7 percent from a year earlier to almost $48 billion, according to Real Capital’s preliminary data. Deal volume for all of 2012 may total more than $70 billion, the highest since the market peaked at $212 billion in 2007, assuming pending transactions for New York’s Worldwide Plaza and other trophy properties are completed, Dan Fasulo, managing director, said in an interview.
Investors paid $161 a square foot on average for office buildings in secondary locations like Philadelphia; Nashville, Tennessee; and Salt Lake City in the first half of 2012, less than half the cost in primary cities, Real Capital data show. Capitalization rates in such markets were 7.7 percent on average during the period, compared with 6.3 percent in major cities, according to the New York-based firm. Cap rates are a measure of yield derived by a property’s net operating income divided by its sales price. In Manhattan, the biggest U.S. office market, the average cap rate was 5 percent.
“There’s good demand from any investment fund that’s got an office real estate allocation,” said Jeffrey Bramson, senior managing director for Holliday Fenoglio Fowler LP and broker for the 792-foot (241-meter) IDS Center in Minneapolis, a complex with 1.43 million square feet (133,000 square meters) that was listed July 19.
Owner Inland Real Estate Corp. (IRC), an Oak Brook, Illinois- based real estate investment trust, is seeking to sell for $300 million, after paying $278 million in 2006 and getting reliable cash flow from the property, Bramson said.
Mary Tyler Moore
Designed by architect Philip Johnson, IDS Center is situated on Nicollet Mall, the main downtown shopping area, with tenants including law firms Briggs and Morgan, which leases 132,000 square feet, and Lindquist & Vennum, which leases 120,000 square feet, said Bramson. Interiors appear in the opening credits of “The Mary Tyler Moore Show,” where the star flings her hat toward the sky.
Top-quality buildings, called “trophy” assets because buyers compete to own them, charge higher rents and have tenants that can better weather downturns, said Jed Reagan, analyst at Newport Beach, California-based Green Street. Cash flow tends to be relatively stable, making them attractive to would-be investors seeking higher returns without as much risk, he said.
“It’s not a Treasury bond, you won’t get the rent growth of a gateway city, but those assets have strength through physical appeal and location and should capture their share of tenants if the market turns,” said Richard Pink, Los Angeles- based managing partner for real estate investment firm Clarion Partners.
Office prices in the six primary markets rose 16 percent in the first half from a year earlier, while fixed-rate loans for overall office purchases fell 20 basis points to 5.4 percent on average, according to Real Capital data.
Banks issued about $6.9 billion in securities backed by commercial property loans in September, the most since December 2007, in another boost for real estate deals, data from Bank of America Corp. show. CMBS may total about $40 billion for the year, “adding liquidity to a broader spectrum of markets and products,” said Chris Ludeman, CBRE’s capital group president.
Trophy sales so far in 2012 include Parkway Properties Inc.’s $250 million purchase in June of Hearst Tower, fourth- tallest building in Charlotte; CommonWealth Partners LLC’s $480 million acquisition in April of Russell Investments Center, the sixth-tallest in Seattle; and Beacon Capital Partners Inc.’s $250 million acquisition in April of Wells Fargo Center, the third-tallest in Denver, according to Real Capital.
In Austin, Thomas Properties Group Inc. and the California State Teachers’ Retirement System paid $859 million last month for eight office buildings that are “crown jewels” in the market, according to James Thomas, chairman and chief executive officer of the Los Angeles-based real estate company.
The sold buildings in these cities are among the most prestigious office addresses in their respective markets, and give their new owners “better yields without dilution of security,” Ludeman said in an interview. CBRE was listing broker for the Seattle high-rise, formerly known as the Washington Mutual, or WaMu, Center, because it was the bank’s headquarters.
Among listed trophy assets, Houston’s Williams Tower is an iconic high-rise in the city that’s 95 percent leased, according to owner Hines Real Estate Investment Trust Inc., which began marketing the tower in August. Seattle’s 1201 Third Ave. has award-winning architecture and an “unmatched” downtown location with views of Puget Sound, said owner Shorenstein Properties LLC.
In Atlanta, 999 Peachtree St. is up for sale in the “increasingly vibrant” Midtown area, according to Green Street.
“There are opportunities in secondary cities that are inflation-protected over a long duration,” Ralph Rosenberg, head of real estate at New York-based private-equity firm KKR & Co., said in a telephone interview. “Net office absorption and no new supply make the demand balance favorable to where it was four years ago. These markets are starved for capital but have high-density populations and checks on new supply.”
KKR’s real estate strategy involves taking more risk than buying the best buildings in secondary cities, Rosenberg said. The firm will look at purchases with “lease-up challenges” in a broad range of markets, and use “nimble, flexible capital” while rates remain low, said Rosenberg, a former Goldman Sachs Group Inc. partner, hired to start KKR’s property practice in March 2011. KKR and Hines last month announced plans to co- develop a Houston low-rise business park.
Not every second-tier city appears healthy or cheap compared with major markets, said Kenneth Rosen, chairman of Berkeley, California-based Rosen Consulting Group, a real estate advisory and research firm. Vacancy above 10 percent in cities with a slow-moving leasing market and fewer regulatory constraints on new development may be warning sign for buyers, he said.
In Atlanta, vacancy for the best space, or Class A space, was 22 percent in the third quarter, down from 23 percent a year earlier, with average rents up 5.5 percent to $24.16 a square foot, CBRE data show. Charlotte vacancy fell to 12.4 percent from 12.9 percent, and prime rents there increased 1.7 percent to $24.94 a square foot, the Los Angeles-based broker said.
By contrast, San Francisco’s Class A vacancy fell three percentage points to 7.4 percent and rents soared 28 percent to $48.52 a square foot. New York vacancy was 8.2 percent, up from 7.9 percent, and rents rose 7.5 percent to $65.11, CBRE said.
“You can get higher yields in some of the cities, but there are fewer constraints and a constant need for capital improvements in any high-rise building,” said Rosen, also chairman of the Fisher Center for Real Estate and Urban Economics at the University of California, Berkeley. “I would be very careful in my market analysis.”
Lack of new construction may offset slow leasing growth, said Green Street’s Reagan. Annual office completions in the U.S. are projected to be less than 1 percent of existing supply on average over the next five years, well below the 1.8 percent average from 1988 to 2011, according to the firm’s Aug. 21 forecast. Employment gains through 2015 may be “just good enough” for would-be landlords.
Sentiment has turned brighter for institutional investors, according to MacKinnon of the Pension Real Estate Association. A third-quarter survey showed members expect 2013 office returns to be 8.1 percent, up from 7.7 percent in the first quarter, as “slowly improving demand” gives owners pricing power, he said. The Hartford, Connecticut-based group includes New York-based BlackRock Inc. (BLK), the world’s biggest asset manager, Hines and Atlanta-based Invesco Ltd.
“They’re going up the next rung of the risk ladder from core properties in gateway cities,” MacKinnon said. “It’s coming back, though it’s not the go-go days of five years ago.”
The IDS Center has a 92 percent occupancy rate and more than half of its leases expire over the next five years, allowing a new owner to benefit in an improving market, said Bramson, the listing broker. Minneapolis rents climbed 5 percent in the third quarter from a year earlier to $26 a square foot, CBRE said.
“The building has large floor plates, the best location in the city and has been constantly renovated,” said Bramson, based in Chicago. “High-rise space in Minneapolis is getting tight. Rents won’t spike like San Francisco, but they’re starting to move.”
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