Rising risks, including an eventual increase in interest rates, are leading commercial-property investors to borrow less and expect lower returns, said real estate executives including Rob Speyer and Richard J. Mack.
AREA Property Partners LP isn’t building U.S. offices without signed tenants, even as commercial values increase, Mack, chief executive officer for North America, said at the Bloomberg Commercial Real Estate Conference today in New York. Tishman Speyer Properties LP has used “average leverage” of less than 50 percent in deals since 2010, said Speyer, the New York-based office developer’s co-chief executive officer.
“Our investors are less interested than you might think in taking advantage of all the money they can borrow, and more interested in investing their cash,” Speyer said. The company is trying to provide them a “margin of safety,” rather than high-risk strategies with potentially greater upside, he said. “We know not everything goes as you plan.”
Real estate in the U.S. has benefited from the Federal Reserve’s policy of keeping its benchmark interest rate near zero, with investors drawn to assets such as well-located and leased offices, hotels and apartment buildings that beat yields on Treasury bonds. Sales of commercial property nationwide rose 19 percent in the third quarter from a year earlier to $67 billion, according to research firm Real Capital Analytics Inc.
Commercial-property prices have been driven up by the low rates, which in past market cycles have inflated values that at some point fall, Robert Knakal, chairman of New York-based Massey Knakal Realty Services, said during a separate panel discussion.
“Periods of low interest rates for long periods of time create asset bubbles,” he said.
Low rates may be propping up values in New York, where there’s also a reduced inventory of property for sale, said Richard LeFrak, chairman and CEO of LeFrak Organization.
“It’s the gorilla in the room,” said LeFrak, whose family has built hundreds of residential properties in the New York area. “We have been living in a world of low interest rates.”
Opportunistic investors such as Cerberus Real Estate Capital Management LLC are avoiding lower-yielding markets such as so-called gateway cities like San Francisco and Washington, focusing instead on Europe, which is “two to three years behind” the U.S. recovery, Ronald Kravit, managing principal of the New York-based firm, said at today’s conference. The U.K., Germany, Ireland and Spain have the best legal systems for resolution, and plenty of real estate distress, he said.
“We’re not particularly interested in returns of 10 to 14 percent,” Kravit said. Still, investors need to be “very careful” in their quest for cash flow even as debt-laden building owners dispose of properties around the globe, he said.
In the U.S., secondary markets outside gateway cities are drawing investors to lower-priced buildings whose rents are rising, Michael Boxer, a partner at Cowen Group’s Ramius unit, said during a separate panel discussion.
Pittsburgh has office vacancies of less than 10 percent, Houston’s energy sector makes it a “prolific” market and San Diego has a favorable “risk-reward ratio,” said Ralph Rosenberg, head of real estate at New York-based private-equity firm KKR & Co.
Still, potential pitfalls exist in secondary markets, Boxer said. Even New York, considered a safe investment location for global capital, has “political risk” after two mayoral administrations that were “business-friendly,” Speyer said.
“You’ve got to really choose your spots and, in my opinion, you have to have a strong operating capability,” Boxer said.
The current mayor, Michael Bloomberg, is the founder and majority owner of Bloomberg News parent Bloomberg LP.