Institutional investors have remained notoriously selective about the types of commercial real estate assets and markets they buy during the country's choppy economic recovery in 2010, with little tolerance for properties with high vacancies -- or any, outside a handful of core markets for that matter.
Well-leased, steady income-producing commercial buildings for sale in Washington, D.C., New York, Boston, and San Francisco have fetched huge prices after setting off intense bidding wars, while well-occupied, high-quality office buildings for sale in secondary markets drew scant interest among institutional buyers for much of 2010.
But an accelerating number of recent, high-value trophy deals in markets such as Houston, Denver and even Minneapolis may indicate that investors are broadening their horizons in search of greater yields. Some analysts believe that the number of high-quality property offerings will spike as investors become more risk-tolerant and financing conditions continue to improve over the next 12 months.
CoStar is also seeing a trickle of transactions where investors are willing to take on additional leasing risk in the biggest markets, a trend that will accelerate in 2011 and likely spread to secondary markets by the end of next year, said Josh Scoville, director of strategic research for CoStar.
Bidding wars for the few available institutional-quality assets with stable, predictable cash flows in top markets have driven up prices and compressed yields, creating a sales market divided between high-end properties fetching premium prices and a wave of distressed assets hitting the market. The search for yield by investors with pent-up capital could help fill in the middle market by creating more buying opportunities.
"The scarcity premium for 'safe' assets reminds me a lot of 2003," Scoville said. "Those are the types of assets that investors first started scooping up during the last recovery. As job growth becomes steadier and more accepted as the reality that it is, investor confidence in future leasing conditions will rise. That will lead to a growing interest in assets that have leasing risk as investors seek higher total returns over the longer term. This will be particularly true as vacancy rates continue to fall and as rent growth trends add some confidence to future leasing market conditions."
"Secondly, more sellers, whether they're existing owners or lenders with REO, will start to take some of their chips off the table by responding to this improving investor demand for product. While the resulting increase in supply is not likely to overwhelm the amount of capital looking to get invested, I do think it will increase the number of available opportunities and will start to chip away at that scarcity."
Several recent office sale transactions highlight this emerging trend.
- Hines Global REIT closed the purchase of Fifty South Sixth, a 29-story, 698,606-square-foot, class A office building in downtown Minneapolis for $180 million, or $258 per square foot. The building is 94% leased, with international law firm Dorsey & Whitney occupying about 48% of the space under a lease of 333,264 square feet that runs through September 2016.The sale by German investment firm KanAm Grund Kapitalanlagegesellschaft mbH marks the largest single-asset transaction in Minneapolis since 2006, when ASB Capital Management LLC acquired the city's tallest building, 225 South Sixth Street, for a reported $245 million, or about $175 per square foot, according to CoStar information.
- Granite Tower, a high rise in downtown Denver, recently went under contract for purchase by an affiliate of KBS Cos. of Newport Beach, CA, for an estimated $150 million, or $267 per square foot, according to media reports. If it closes by the end of the month as expected, the sale would likely be Denver's largest office sale of the year.
- Brookfield Properties Corp. (NYSE: BPO) recently closed on the 53-story, 1.15 million-square-foot Heritage Plaza at 1111 Bagby St. in downtown Houston. Privately held Atlanta-based Goddard Investment Group LLC sold the tower at 1111 Bagby St. for $321.5 million, or nearly $280 per square foot. Heritage Plaza is nearly 85% leased. The trade is the second-largest commercial property deal ever in Houston, surpassed only by M & M Properties' acquisition of the Bank of America Center from Hines for $370 million in 2007. (CoStar COMPS #2015311)
- Unilev Capital has reportedly agreed to acquire three Class A office towers totaling 1.1 million square feet at the Houston Galleria complex in the West Loop/Galleria submarket of Houston from Walton Street Capital about $175 million, or about $159 per square foot. The deal was brokered by HFF Inc. (Holliday Fenoglio Fowler), just over two months after HFF announced the marketing of the property. Walton Street sold its interest in the mall to partners Simon Property of Indianapolis and Calpers in the June in a deal valuing the property at $1.6 billion.
The Houston office space for lease market recorded positive net absorption of 210,600 square feet in third-quarter 2010, compared with negative 405,872 square feet in the second quarter.
Robert O' Brien, leader of the U.S. real estate practice for Deloitte, agreed with the CoStar assessment that the transaction market will broaden over the coming year.
"We're going to continue to see increases in transaction volume, to some extent filling in the bifurcated market," O' Brien said. "A couple of transactions have been announced in Houston for example in the past month that implies {demand] has moved beyond just the coastal markets and Chicago."
The market has also seen an uptick in distressed transaction activity of late, a smaller-than expected wave that arrived later than most observers thought, so "it's logical that with all the capital out there waiting to deploy, that [investors] begin to fill in the middle," O'Brien said.
"There's an interest in finding transactions that are less competitive. The one complaint I keep hearing in the market is that when investors do find an opportunity, there are 25 other people lined up to bid on it. The difficulty is there appears to be debt capital available to do the higher profile deals, but it's still very challenging to find lenders interesting in some of the value added, riskier type deals."
Hedge funds, pensions and real estate funds need to deploy capital that originally was directed at distressed assets or quality assets they expected would be offered at diminished pricing, noted Rich Walter, president of Irvine, CA-based Faris Lee Investments.
"A lot of investors were prepared to take advantage of the opportunities as they came, but obviously it hasn't transpired as of yet," Walter said. "That money gets trigger happy. And it chases the quality side of the market. If investors don't place it, they may lose it to one of the other sectors, or even have to give the money back."
Thus, a window of opportunity has opened for sellers, but Walter is "not confident, and a lot of my clients aren't that confident, that the window is going to stay open for a long time. It's a great time to take advantage of it and I think investors will.
"In the first quarter of 2011, we're going to see a lot more opportunities and offerings and properties for sale."
