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Burbank to Brookline Soar in Suburb Shift: Real Estate

Photographer: Tony Avelar/Bloomberg

An airplane flies over an office building in Sunnyvale, California. Close

An airplane flies over an office building in Sunnyvale, California.

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Photographer: Tony Avelar/Bloomberg

An airplane flies over an office building in Sunnyvale, California.

Clarion Partners LLC, a real estate owner overseeing almost $30 billion, made millions buying Manhattan office buildings and towers in Seattle and Houston after the U.S. property crash began six years ago. It’s now moving to the outskirts of big cities.

“Investors see high quality just outside major metros,” said Tim Wang, head of research at Clarion, which acquired buildings in Arlington, Virginia, and Brookline, Massachusetts, last year. “As the recovery broadens in 2014, you’ll see more capital flowing into secondary markets and select suburbs.”

Commercial properties from Brookline to Woodlands, Texas, and Burbank, California -- areas just beyond major markets -- are selling at premiums to real estate in cities such as Boston and Los Angeles. Sales in top suburbs surged to more than $25 billion last year, and the spread in capitalization rates, a measure of yield used by real estate investors, was the widest in 13 years relative to all U.S. transactions, according to Real Capital Analytics Inc.

“These are places where companies are hiring and the new economy is forming, centers of gravity that feed on themselves,” said Dan Fasulo, managing director of the property-research company, which compiled pricing data on more than 105 suburban ZIP codes for Bloomberg News.

Office-building prices in top suburbs rose 4.7 percent last year to $311 a square foot, just 7 percent below the 2007 peak and showing a rebound “in the fourth or fifth inning,” Fasulo said, referring to the midpoint of a baseball game. High-end retail values reached $489 a square foot, a record level that’s still a discount to new construction, said Bill Whalen of New York-based Cantor Commercial Real Estate.

Debt Available

“Fear seems to have gone away from the market,” said Whalen, head of the commercial mortgage-backed securities lender’s San Francisco office. “There’s plenty of debt and equity capital.”

Cap rates for transactions in top suburbs were 5.8 percent last year, compared with a U.S. average of 6.9 percent. The difference of 110 basis points was the biggest since 2000, and probably will grow as the economy improves, Fasulo estimates. A cap rate is calculated by dividing a property’s net operating income by its purchase price, so it moves down as values rise.

Deal volume jumped from $17.7 billion in 2011, when the cap-rate spread was 73 basis points, according to New York-based Real Capital. In the years after the financial crisis, primary U.S. markets were seen as less risky bets than suburbs and drew the bulk of investment until downtown yields became so unattractive that buyers began seeking opportunities further afield, Wang said.

Investor Migration

Sales figures were compiled from deals since 2000 that were priced higher than $10 million and $250 a square foot and located outside of core U.S. markets New York, Boston, Washington, Chicago, Los Angeles and San Francisco, along with Miami, Houston, Las Vegas, Phoenix, San Diego, Seattle and Austin, Texas -- cities “where the new economy is moving,” Fasulo said.

Investor migration from cities makes sense after a 32 percent jump in downtown office prices since 2010 pushed up costs for tenants as well as buyers, Fasulo said. Occupancy in U.S. suburbs overall gained 1 percent last year to outpace a 0.1 percent increase in central business districts, according to a separate study from Los Angeles-based brokerage CBRE Group Inc. (CBG)

‘Beaten Down’

Suburban offices were “beaten down” in the multiyear focus on downtown assets and should gain favor in 2014 as the Federal Reserve raises interest rates and scales back its bond-buying program, known as tapering, New York-based analysts at BMO Capital Markets led by Richard Anderson wrote in a Jan. 2 note. Higher loan costs will erode returns and lead more buyers to seek opportunities away from cities, Wang said in the interview.

CMBS issuance may rise 33 percent to $120 billion this year as confidence improves, with the growth in volume fueled by rising values that allow the bundling of larger loans, Cantor Commercial Chief Executive Officer Anthony Orso said in an interview.

Added liquidity is “good for all, like a rising tide,” Fasulo said.

The best suburbs maintain their appeal as “incubation zones” for dynamic industries, according to Michael Phillips, chief operating officer for Jamestown, an Atlanta-based investor that paid $314 million in July for Lantana Media Campus in Santa Monica, California. The four buildings, with 462,000 square feet (42,900 square meters), are a hub for digital video and 97 percent leased, he said.

‘Like-Minded’

Consumer technology companies have long gravitated to Silicon Valley towns near San Francisco, defense-related firms to northern Virginia suburbs outside Washington, energy firms to the outskirts of Houston, and film, television and video production companies to areas outside downtown Los Angeles, Phillips said.

“You get clusters where like-minded people want to be and that become their own ecosystem, with all the amenities and services of a city,” he said.

Now the wider push has put Pasadena, California, where East West Bank and Downtown Properties bought Plaza Las Fuentes at a 5.7 percent cap rate in July, and Scottsdale, Arizona, where Oaktree Capital Management LP purchased the Republic Services Corp. headquarters at a 5.8 percent yield in June, on the level of such established areas as Princeton, New Jersey, and Greenwich, Connecticut, Real Capital data show.

Lower Yields

Jamestown’s Santa Monica purchase came with a 5.4 percent cap rate, Phillips said. A month earlier, Hudson Pacific Properties Inc. paid $130 million for the Pinnacle II offices in Burbank at a 5.9 percent cap rate. Both transactions were less than the 6.4 percent average yield in downtown Los Angeles, Real Capital said.

Cap rates for office deals fell to 5.06 percent in Manhattan and 5.12 in San Francisco at the end of last year, the lowest among the Moody’s/Real Capital core commercial index and less than a 6.37 percent average for U.S. central business districts.

Clarion last year bought a $66 million stake in a mixed-use Arlington complex and paid $121 million for offices in Brookline. Both properties are in areas with expanding regional economies that appeal to younger, “knowledge-based” workers, said Wang, the Clarion senior vice president. About 48 percent of the New York-based company’s office deals were in “select suburbs” in 2013, up from 18 percent a year earlier, he said.

Market Pivot

Clarion’s pivot from primary markets followed 2012 deals including the redevelopment of Manhattan’s 380 Madison Ave. and acquisitions of 475 Brannan St. in San Francisco and 1201 Third Ave. in Seattle, and the 2011 purchases of New York’s 636 Avenue of the Americas and Houston’s Wells Fargo Plaza, Wang said.

The investor’s 10 Brookline Place purchase in the Longwood Medical Area had a 5.9 percent cap rate, compared with 6.1 percent in central Boston, Real Capital data show. The stake in Carlyle Overlook in Arlington, with four office floors, street-level retail and a parking garage, was completed at a 6.2 percent yield, a bargain compared with 5.4 percent cap rates in the District of Columbia’s central business district, Wang said.

“That’s very accretive to total return,” he said.

Tishman Speyer Properties LP last month paid $102 million for California Plaza, an office complex with almost 379,000 square feet in Walnut Creek, California, according to a person with knowledge of the sale who asked not to be identified because the transaction details are private.

Submarket Migration

Walnut Creek, 25 miles (40 kilometers) east of San Francisco, is “beginning to capture a growing number of tenants migrating into the submarket” in search of lower rents, Holliday Fenoglio Fowler LP said in August marketing materials for the property. California Plaza was 89 percent leased and is near a major highway and transit station, according to the brokerage.

Suzanne Halpin, a spokeswoman for New York-based Tishman, declined to comment on the acquisition.

Suburban rents have been stable as occupancies gained, and kept pace with downtown rates since 2010 despite the perception of greater risk, said William Wheaton, a Massachusetts Institute of Technology professor and co-founder of CBRE’s Boston-based forecasting and econometrics group.

“Suburbs have been every bit as strong and less volatile,” Wheaton said in a telephone interview.

Occupancies Rise

In northern Virginia, occupancies last year grew 5.2 percent in Reston and 2.3 percent in Vienna, while rising 0.3 percent in the District of Columbia, according to CBRE. In The Woodlands, where Exxon Mobil Corp. (XOM) is building its new headquarters, growth was 20 percent, compared with a 0.1 percent decline in Houston.

As the hunt for yield picks up, it’s becoming harder to find top suburban assets, according to Don Wise, CEO of Metzler Real Estate. The Seattle-based firm, which invests in the U.S. for German institutions, paid $100 million in the third quarter for offices outside Austin at a cap rate “100 to 200 basis points higher” than a comparable core-market deal, its only purchase since 2012, he said, declining to give further details.

“It’s important to be disciplined on the hunt for places that haven’t turned into the hot spot,” Wise said in an interview. “We’re looking for solid job growth, typically in tech, energy or health-care markets with a research university, lifestyle appeal and good long-term liquidity prospects.”

Silicon Valley

The recent surge has occasionally compressed yields to less than cap rates in Manhattan, including a purchase at 4 percent in Palo Alto, south of San Francisco, and one at 3.9 percent in Beverly Hills, both among California’s most coveted office locations, according to Real Capital data.

CBRE last month brokered the sale of research-and-development buildings in Sunnyvale, in Silicon Valley, at a lower cap rate than office purchases in some primary markets, according to the brokerage. The 500,000-square-foot property is among numerous similar sites in the valley, Russell Ingrum, a CBRE vice chairman, said in an interview.

“Most of Silicon Valley R&D is not the most physically attractive real estate, but it’s sitting in Sunnyvale, and that’s what makes it valuable,” he said.

To contact the reporter on this story: Dan Levy in San Francisco at dlevy13@bloomberg.net

To contact the editor responsible for this story: Kara Wetzel at kwetzel@bloomberg.net

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