Get Yer Red-Hot Office Towers

Sellers are putting their trophy properties on the market for big bucks. Did somebody say bubble?

If the savvy real estate tycoon Samuel Zell is selling, why are so many others falling over themselves to buy? In May, a private real estate investment trust paid Zell's Chicago-based Equity Office Properties Trust (EOP ) $174 million for the U.S. Bancorp Center -- a prominent downtown Minneapolis office tower. This was no fire sale, says Marshall G. Berol of San Francisco's Malcolm H. Gissen & Associates LLC, which manages real estate investments for clients. "Zell is not the kind who sells at bargain-basement prices."

It was just the latest deal for Zell, dubbed "the Grave Dancer" back in the 1980s for turning distressed properties into personal bonanzas. His firm has sold about five dozen buildings in the past year, collecting $800 million, including $255 million just this year. Says President Richard D. Kincaid: "The buildings are worth more today than we thought they were worth, so we sold them."

Good reason to sell, but maybe not one to buy. Bidding wars are pushing up prices fast: The 1,317 office buildings sold in the first quarter nationwide went for a total of $9 billion, vs. the $5 billion that 1,438 buildings fetched in the same period last year. The average price per square foot jumped 13%, to $158, according to CoStar Group (CSGP ) Inc., a real estate data firm in Bethesda, Md.

What's fueling this frenetic pace? Simple: interest rates at four-decade lows, plus a rush of new money looking to own something with better returns than bonds and, until recently, stocks. Real estate mutual funds took in $3 billion from investors last year, up from $50 million in 2001. And consider the June 24 initial public offering of American Financial Realty Trust, led by former Salomon Brothers mortgage-securities pioneer Lewis Ranieri: It raised $699 million, the biggest IPO this year, that investors bid up 14% on the first two days of trading.

The money is too tempting to pass up for the owners of many trophy buildings. The feuding partners who own the General Motors building in New York agreed in June to hang out the for-sale sign. Troubled insurer Conseco (CNCEQ ) Inc. and über-developer Donald Trump bought the landmark building overlooking Central Park in 1998 for $814 million. Asking price today: about $1 billion, say real estate pros. And Robert J. Sorrentino, president of Bertelsmann Inc., a U.S. arm of German media giant Bertelsmann, said on June 23 that his Times Square green-glass skyscraper is on the market. This is no retrenchment, he adds -- it's just smart corporate finance. Bertelsmann, which occupies 400,000 square feet of the 44-story tower, which it intends to lease from the new owner, paid $119 million for the building in 1992. Sorrentino believes it's worth north of $450 million now, money that will help offset sagging book, magazine, and CD sales. "This is the perfect time for those of us who own New York trophy properties to capitalize on their value," he says.

Indeed, even a share in the midtown Manhattan tower that houses Business-Week -- the McGraw-Hill (MHP ) building -- could be sold. The McGraw-Hill Companies is open to offers for its 45% stake and could pocket up to $600 million, according to IGDNYC Inc., a New York firm that helps companies buy office space. (The Rockefeller Group International Inc. owns the remaining 55%.) "Because commercial real estate values are at record highs, we would likely sell our share if we receive an attractive offer," says Steven H. Weiss, McGraw-Hill's vice-president for corporate communications.

These days, those attractive offers are most likely coming from private partnerships. Four of them -- including Wells Real Estate Funds of Norcross, Ga., which bought Zell's Minneapolis building; Inland Real Estate Group in Oak Brook, Ill.; and CNL Financial Group in Mission Viejo, Calif. -- are expected to raise more than $6 billion this year, up from $1.4 billion in 2001, the most since the real estate boom of the 1980s. The buildings they buy will pay off, as long as they can provide leases at below-market rates to attract long-term tenants, says Joe Cosenza, chairman of Inland's acquisitions group, which recently paid $91.3 million for four office buildings.

But if the real estate frenzy turns out to be a bubble, the funds could be playing a risky game. Some private real estate investment trusts put down 30% and borrow the rest at very low rates. But when the economy turns up, so will interest rates and the cost of variable-rate mortgages. Moreover, real estate values may fall as capital flows back into the stock market. "If they are overpaying for these assets now," says Stephanie Krewson, a REIT analyst with BB&T Capital Markets, "it's highly likely they will ultimately suffer huge capital losses."

Such a buyer could end up with the GM building, for instance. Given its size, tenant mix, and rate of lease turnover, the net annual return could be just 6%, say real estate pros. That sounds pretty good compared with other investments, but it's mighty low by historical standards -- and could erode quickly if vacancy rates and maintenance keep rising. "A 6% return is not going to make it for most owners," says Robert B. Emden, vice-chairman of USI Real Estate Advisors in New York, a U.S. consultant for corporate tenants. It seems this market is not just location, location, location, but timing, timing, timing.

By Mara Der Hovanesian in New York, with Michael Arndt in Chicago

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