Office

How High Can They Go?

Investors pay top dollar to acquire premium office properties.

I nvestors who are vying for premium office properties are reaching deep into their wallets. The $835 million paid for Chicago's 110-story, 4.4 million-square-foot Sears Tower earlier this year seems like a bargain compared to the record-setting $1.4 billion paid for the 50-story, 2 million-sf General Motors Building in New York last year. Clearly, trophy office buildings continue to command top dollar.

Office investment sales activity in general has been red hot as private and public investors alike scramble to find safe havens for capital in light of Wall Street's instability. In fact, office building sales prices still are climbing in many markets nationwide. For instance, Boston reported record-high sales prices for the 12 months ending in the first quarter, with central business district prices reaching as high as $672 per square foot -- well above the $276 psf average, according to Real Capital Analytics.

"We're seeing record prices psf and record capitalization rates," says Harry D. Miller, CCIM, SIOR, first vice president at CB Richard Ellis in Houston. "The really upper-tier product garners a lot more interest, because it appeals to broad-based private capital and institutions alike, while smaller, less-quality property will not have as wide a demand."

Median sales prices among office transactions valued at $100 million and higher have continued to climb every year for the past five years. Year-to-date through April, office buildings in this category fetched median prices of $276.79 psf -- a 6.3 percent increase compared to 2003's $259.37 psf median price and a 30 percent hike over 1999's $194.27 psf median, according to Marcus & Millichap and CoStar Group.

Escalating prices coupled with soft fundamentals, such as rising vacancies and declining rents, are squeezing cap rates. "Cap rates are as low as I've ever seen," says Eugene L. Bentley, CCIM, associate vice president at Norris, Beggs & Simpson in Portland, Ore. Across the country, cap rates average 7 percent for top properties. These low rates are a function of the enormous amount of capital vying for properties, inexpensive financing, and the limited number of properties on the sale block, Bentley adds.

Limited supply has driven prices higher in the Portland market. The 316,000-sf Robert Dunkin Plaza sold in May for $69.8 million, or approximately $220 psf. Built in the 1990s, the property brought in top dollar due to its high occupancy and good location. The building is 95 percent occupied, predominately by government tenants, and it is well situated on the light rail line, Bentley says.

Market Outlook

The lack of for-sale trophy buildings is investors' biggest hurdle. "We get people from all over stopping in our office on a weekly basis. There is just not that much available, particularly high-grade properties," Bentley says.

Despite record prices, many owners are reluctant to sell because they can't find good alternative investments. "It's an absolutely perfect time to be a seller. The real question is what you are going to do with your money," Bentley says.

Some investors are circumventing the property shortage by scouting for trophy buildings in secondary and tertiary markets. Not only are buyers finding properties, but opportunities to find better deals exist. Cap rates on CBD office towers in secondary markets average 9 percent -- more than 155 basis points higher than major markets such as New York and Boston, according to Real Capital Analytics.

Increased investor interest is readily apparent in markets such as Houston, which continues to see record-setting transaction volume. In the first quarter, Houston reported 18 office transactions totaling more than 4 million square feet and $412 million. That pace is already ahead of 2003, which set a record with 51 transactions totaling $983 million and 11.4 million sf, according to CB Richard Ellis.

Best of the Best

It is no wonder premium buildings are getting top dollar. Many trophy properties have maintained healthy occupancies and continue to demand premium rents. For example, notable New York assets such as the General Motors and Henri Bendel buildings command rents up to $100 psf.

Slumping office markets have pushed some investors to opt only for these "best of class" properties. "Buyers are really looking for the good assets that are highly occupied with credit tenants," says James M. Brown, CCIM, SIOR, president of Hawaii Commercial Real Estate in Honolulu.

The Davies Pacific Center, a class A building in downtown Honolulu, sold last year for approximately $57 million. At the time of the sale, the property was about 87 percent occupied with noteworthy tenants such as New York Life. The $163 psf price seemed high at the time, but prices in the market have continued to climb for premium class A buildings with good occupancies and high credit tenants, Brown says.

An abundance of capital and intense competition has created an overheated office investment market. "Investors are clamoring for trophy buildings in New York City," says Craig C. Evans, CCIM, senior managing director of Colliers ABR in New York. In Manhattan, office buildings reported prices as high as $955 psf over the 12 months ending in March -- well above the $329 psf average, according to Real Capital Analytics.

But trophy properties are limited, and those that do hit the market quickly are enmeshed in bidding wars. Miller recently represented the seller of Four Oaks Place, a 400,000-sf, four-complex property in Houston. More than 80 investors requested brochures, and the property attracted about 30 bidders -- two to three times the volume of a more typical market.

Honolulu's Waterfront Plaza currently is on the market, and its final bid is expected to be about 30 percent higher than anticipated, Brown says. The class A building located at the CBD's edge includes 425,000 sf of office space and 92,000 sf of retail. One factor that pushed up pricing was intense competition. The property received 18 bids -- four or five times the number of bidders in past sales. "Across the United States there is just an enormous amount of capital chasing the top-quality assets," Brown says.

The anticipated rise in interest rates actually may help to spark more trophy property sales activity in the year's last quarter and into 2005. "Now that interest rates are starting to move, a lot of the fence sitters with stabilized properties are going to start marketing their properties," Miller says. If interest rates begin to creep higher, it may be a sign that prices are at or past their peak, which would encourage some owners to sell.

Beth Mattson-Teig

Beth Mattson-Teig is a business writer based in Minneapolis.

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