Medium Cool: Investment Sales Volume Spiked in 2011, but Future’s Still Cloudy
Jotham Sederstrom Feb. 29, 2012, 2:41 p.m.
A self-described car guy, Woody Heller, executive managing director and head of the Capital Transactions Group at Studley, sees parallels between automobiles as hard assets and commercial real estate investment sales velocity in New York. Apart from the obvious luxury to be found in cars and Class A buildings alike—his 33-million-square-foot transaction volume likely doesn’t include a jalopy—both markets have also lately been bolstered by similar factors.
“With debt available and with interest rates so incredibly low, it encourages one to buy because money is so cheap,” he said. “If the asset class is in favor compared with what much of the alternatives are—if borrowing costs are incredibly low—it continues to steer people to want to invest in hard assets like real estate.”
Investment sales figures for the past few years bear this out. According to data from Cushman & Wakefield, the total volume of Manhattan investment property sales closed in 2011 was the third-highest total on record—at $25.8 billion. This marked an 88 percent increase over 2010, to levels not seen since 2007. And Massey Knakal’s Pricing Index, a measure of the change in price per square foot across all property types in New York City, registered a 6 percent increase in 2011 from the year before.
Still, experts said that velocity for the rest of the year, and whether it speeds ahead or screeches to a halt, is subject to a number of different factors.
Clearly the most unyielding of those is supply, which Helen Hwang, executive vice president of the Capital Markets Group at Cushman & Wakefield, recently described as “in check,” particularly for office space.
“The existing inventory is about 400 million square feet in New York—that’s just Manhattan,” she said.“The only thing that’s really under construction right now are World Trade Center Towers One and Four, which is about five million square feet, and you’ve got Boston Properties’ deal—250 West 55th Street, which is about a million square feet.” Ms. Hwang continued adding up square footage under construction in Manhattan and then subtracted the World Trade Center total, which, as she pointed out, is not new but replacing what has been lost.
“Effectively what’s under construction right now that will be added to the market is about 1.5 million square feet,” she concluded, “which is really not a lot for a market this size.” This leaves very little from which to choose, for buyers who experts say are keen on Class A office space.
On top of this, with the market still improving, not everyone is convinced that it’s a good time to sell. Plus, with a huge pool of real estate loans coming due in 2012, some partners just want out, leading to a trend that Ms. Hwang seemed reluctant to mention, given that it’s been bandied about so much.
“This has been said a great number of times,” she offered, “but we saw a great number of recapitalizations.” Last year, she estimated, 40 percent of total deals in the office arena were recapitalizations, whether to replace an existing partner or to infuse new equity into a deal that needed the capital.
“There’s not much out there—that’s what’s keeping pricing so high,” said Andrew Simon, executive managing director in the New York office of Colliers International. “I think that you’re going to see buildings that have maturing debt and they have to figure out what to do, how to hold on. That seems to be the primary story these days and that’s why you’re seeing deals like both Park Avenue Plaza and 299 Park—you saw the 49 percent interest in both buildings traded.”
Over at CBRE, Paul Gillen, a senior vice president in the Investment Properties Institutional Group, pointed out that his firm closed several major transactions last year, including the aforementioned 299 Park Avenue, with recaps as a theme. The Alaska Permanent Fund snapped up the Rockpoint Group’s 49.5 percent stake in 299 Park in a deal that revalued the property at $1.26 billion.
But with recaps serving as what Ms. Hwang calls a hedge in the improving market—sellers keep a portion, let a portion go—overall investment sales for 2012 are largely predicted to remain flat, a point Newmark Knight Frank president Jimmy Kuhn makes, with one caveat.
“In the very near term I don’t see velocity increasing that much because a lot of people in New York aren’t sellers,” Mr. Kuhn said, adding that that could change depending on one future condition. “And that is, if it appears that the administration is going to dramatically change the tax structure, people may bail out. That may be the linchpin to cause increased velocity. If people want to take the old capital gains tax rates before they change.” The current capital gains tax is set to expire at the end of the year and any new rate is up in the air, pending November’s presidential election.
Peter Von Der Ahe, who deals primarily with multifamily, agreed that the issue of capital gains could put pressure on sellers, providing an opportunity for foreign buyers in particular. The Marcus & Millichap first vice president of investments said that with “capital gains most likely increasing in 2013, there’s a financial incentive to sell your property this year.” He predicted that, for multifamily at least, as more buildings start to trade it will create a snowball effect of sorts. “It becomes self-perpetuating on the positive side, too—that’s what I see happening this year.”
As for the investment sales buyers, they constituted all the usual suspects in 2011, though institutional investor participation in the market rose to fill a gap left by private capital for the year. According to the Cushman & Wakefield data, institutional investors accounted for 36 percent of 2011’s total sales, REITs and private capital 26 percent each, and foreign investors 9 percent. For 2010, private capital was at 35 percent and institutional investors were at 15 percent.
Mr. Simon, at Colliers International, said that there is serious capital out there looking for a home. “Any of these big institutional, international groups have to look at New York as a safe haven.” He added that investors are looking for value-add opportunities and opportunities to boost returns, in a cap rate environment that has been low “for a very long time now.”
From Mr. Gillen’s perspective, REITs were obviously big in 2011 but there was another foreign influence, apart from, say, the Canadian REIT that bought 2 Gotham Center for $415.5 million in a deal he helped broker, or the Kuwaiti firm that paid $485 million—all cash—for 750 Seventh Avenue in another CBRE-brokered deal. “A lot of times, the name on the transaction wasn’t necessarily all the capital,” he said. “You had a lot of global capital backing the more traditional names in the city.”
Newmark Knight Frank’s Mr. Kuhn agreed. He anticipates foreign investors to continue looking for opportunities in New York. “But if they don’t team up with a local operator they will not be able to move fast enough and they will make a mistake,” he said. “Foreign buyers, if they don’t have a presence in New York and they don’t have an operating partner, I don’t see them as big competition.” He added that Newmark Knight Frank had just been hired by a large Australian group looking to partner with a local operator to build an office building.
Another barometer for investment sales velocity is leasing vacancy rates. Mr. Heller, at Studley, pointed to 200 Fifth Avenue, the old International Toy Center, where in 2010 the firm represented Tiffany & Co. in its 345,000-square-foot headquarters relocation. “The most recent rent paid was $85 a foot for a prewar building in Midtown South,” he said, “which had been a somewhat sleepy market for decades.” Drastically declining vacancy rates had changed all that.
Mr. Simon, fresh from a Grand Central District Office Building committee meeting, related how he had piped up about this lag between vacancy rates and the price a building can garner when sold. “I said to them, ‘I’ve been telling people for a long time that in the leasing market there continues to be a disconnect between what’s going on in leasing and what’s going on in investment sales,’” he said. “Because in the investment market there is very little product out there and what does come to the market sells at a very big price.”
At the end of the day, the ease of getting a loan for new development projects might be the best way to gauge investment sales velocity for the year. One source said he had just had lunch with a lender buddy from the workout department at a major bank, who described lending requirements as loosening and the bank as expecting to get paid off at par for loans still on its books.