The Office Market Is Waking Up



After a two-year hiatus, the investment market for office buildings has sprung back to life, with some properties commanding prices reminiscent of the boom years. Bidding for well-occupied, high-quality buildings in major cities like New York and Washington has been so fierce that some buyers have been priced out of the market.

Brookfield opted not to buy 1330 Avenue of the Americas, in Manhattan. It sold for $400 million.

And so, for the first time since the collapse of the commercial real estate market, investors are beginning to take risks. Some are buying buildings with vacant space, and others are going after buildings in markets that still have a lot of vacant space and could take much longer to rebound.

Though the market is only now becoming active, last year about $27.7 billion worth of office properties worth $5 million or more had changed hands through mid-December, more than twice the volume in 2009, according to Real Capital Analytics, a New York research firm that tracks sales.

Some deals have been so costly that buyers have had to settle for low initial rates of return of 6 percent or even less. These yields, known as capitalization rates, have fallen faster for office buildings than for any other type of commercial real estate, Real Capital Analytics said.

Despite the optimism in the commercial real estate market, the industry still faces obstacles. The job market — the main driver of office leasing — has yet to recover. The national vacancy rate was 17.6 percent during the third quarter, up from 16.6 percent in the same quarter in 2009, said Victor Calanog, the director of research for Reis, a New York research company. More than $48 billion worth of office buildings nationwide are in default, bankruptcy or foreclosure, according to Real Capital Analytics.

Yet in New York, Google outbid about a dozen other parties to buy 111 Eighth Avenue, which occupies the entire block between 15th and 16th Streets, for $1.8 billion, a yield of 5.25 percent. That transaction has prompted many previously reluctant sellers to reconsider, said the broker who handled the sale, Douglas Harmon, a senior managing director of Eastdil Secured. “The real estate industry has awoken from a long slumber,” he said.

A smaller building, 434 Broadway, at Howard Street, subsequently sold for $41 million, a 5 percent cap rate, in a deal that took only 10 days to go from contract to closing, said Richard Baxter, a vice chairman of the brokerage Jones Lang LaSalle. “In my 30 years in this business, I’ve never seen a closing happen so quickly,” Mr. Baxter said.

In Washington, JPMorgan Chase recently paid $80 million in cash for 1501 M Street, a 177,000-square-foot building that is 97 percent full, said William M. Collins, a senior managing director of Cassidy Turley, a national brokerage. The initial yield on that building was 5.9 percent, but some deals expected to close this month will have even lower capitalization rates, Mr. Collins said.

In another deal, the World Bank recently paid $216 million for 1225 Connecticut Avenue. The price per square foot — $900 — was the highest ever paid for a Washington building, according to the seller, Brookfield Office Properties of New York.

Though New York and Washington, where the demand for office space is greatest, have commanded the highest prices, some prominent deals have also occurred in other cities. In July, Hines, a private real estate company based in Houston, sold a new, nearly fully leased 60-story building it developed at 300 North LaSalle Street in Chicago to KBS, a real estate company based in Newport Beach, Calif., for $655 million, an initial yield of 6 percent.

And last week, Boston Properties, a publicly traded company that specializes in office buildings in major markets, closed on its $930 million purchase of the 62-story John Hancock Tower, Boston’s tallest building. The Hancock tower, which is 95 percent leased, has a capitalization rate of around 4 percent.

Douglas T. Linde, the president of Boston Properties, said the low yield was temporary because the previous owner agreed to a long period of free rent for a new tenant, Bain Capital, which is leasing 220,000 square feet.

With this purchase, Mr. Linde said, Boston Properties now controls nearly 40 percent of the Back Bay office market, giving it a strong leasing advantage there. “Private equity funds, money managers and hedge funds have gravitated to the Back Bay,” Mr. Linde said. “That is where people want to be.”

Rents are rising in the Back Bay, which has a vacancy rate of 8.8 percent, compared with a 15.9 percent vacancy rate for the Boston area as a whole, said Brendan Carroll, a senior vice president at Richards Barry Joyce, a Boston brokerage house.

The KBS and Boston Property deals notwithstanding, investors can expect to find better deals if they look outside New York, Washington and San Francisco. Hines, for example, recently bought two other prime buildings in smaller markets — Fifty South Sixth in Minneapolis for $180 million and Hock Plaza in Durham, N.C., for $98.3 million — with yields of around 8 percent, said Robert M. White Jr., the president of Real Capital Analytics.

Hines’s new buildings are nearly fully occupied. But some companies are acquiring buildings with a lot of vacant space, which carries more risk than it did when the market was stronger. Then, vacant space was desirable because many existing tenants were paying rents that were well below the market, said Michael Knott, a managing director of Green Street Advisors, a Newport Beach, Calif., company that analyzes real estate investment trusts. Now, however, new tenants may expect to pay a little less than existing tenants, he said.

In a deal that Real Capital Analytics said approached a record for Houston, Brookfield Office Properties paid $321.5 million for Heritage Plaza, a 53-story office tower that is 84 percent occupied. Brookfield may have been more motivated than other companies to buy Heritage Plaza because the company already had a major presence in Houston.

“Houston has been a good job-growth story,” said Dennis Friedrich, the chief executive of Brookfield’s United States commercial operations. Part of what made the deal attractive was low-interest financing, “which we would not have been able to get a year ago,” he said.

In another opportunistic deal, Brookfield bought a smaller building in Washington, the eight-story 650 Massachusetts Avenue, near the convention center, for $113 million. The building is more than 25 percent vacant.

But Brookfield found the pricing on 1330 Avenue of the Americas, a boutique office building between 53rd and 54th Streets in New York, too rich because the rent-growth projections seemed unrealistic. “You had to be underwriting rentals by 30 percent in a two- to three-year period,” Mr. Friedrich said. “We opted to put our pen down on that one.”

The buyer was an investment group led by RXR Realty, which paid $400 million for the 534,000-square-foot building. Scott Rechler, the chief executive of RXR, said he was already discussing rents in excess of $100 a square foot with prospective tenants, which consist of smaller financial services companies.

Despite the potential to find bargains, Mr. Rechler said he did not plan to venture outside the top markets. “We’re not comfortable going to secondary markets,” he said. “We’d rather pay for high-quality assets in good locations, where we know there’s good demand.”

Mr. Linde of Boston Properties said his company had followed a similar strategy, after disappointing experiences in Baltimore and Richmond, Va. Investors buying in less robust cities were usually seeking an opportunity to make a quick profit as the market improved, he said.

“It’s more of a trading mentality,” he said. “We’re not looking to get into Minneapolis at the right time and then get out.” (credit t. pristin,nyt)


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