New York TImes
Published: January 3, 2009
BY most accounts, the commercial property market reached its pinnacle in early 2007 with the Blackstone Group’s acquisition of Equity Office Properties Trust and its prized cache of more than 500 office buildings.
The $39 billion deal was the largest of a spate of mergers and acquisitions. Back then, trophy towers were a hot commodity for large investors with seemingly insatiable appetites for commercial properties and copious credit to buy them.
(In fact, with the ink barely dry on its agreement, Blackstone, a private equity firm, was able to resell a big chunk of the E.O.P. portfolio.)
But the credit crisis and recession crushed deal making in office buildings in 2008.
From January through December, there were just 1,410 transactions nationwide, valued at $49.3 billion, versus 4,410, valued at $207.2 billion, for the corresponding period in 2007, according to the latest data from Real Capital Analytics, a research company. It predicted that sales would total $53 billion to $55 billion for all of 2008, further below a recently reduced forecast of $61 billion.
At the same time, demand for offices has softened as companies have cut back or consolidated operations; many of them are already subleasing space that they no longer need. Office vacancies nationwide rose to around 13.5 percent by mid-December from about 12.5 percent, on average, in 2007, according to Reis Inc., another research company.
Of course, all these negative conditions are taking a toll on investors.
Some property owners are dealing with tighter cash flows and reduced profits from lost tenants or falling rental rates. In Manhattan alone, rents are expected to plunge 10 to 20 percent by 2010, and nationally by 5 to 15 percent, according to Cushman & Wakefield, the commercial broker.
Shareholders in real estate investment trusts that focus on office properties have watched their returns plummet as well.
Industry analysts expect little improvement this year. “It’s safe to say that it’s going to get worse before it gets better,” said Maria Sicola, the executive managing director of research at Cushman & Wakefield, noting, too, that the office market tends to lag the overall economy because of its long leases. She said, “2009 will be a difficult year — we’ll continue to see job losses in many regions of the country.”
About 1.9 million jobs have been lost since January 2008, about a third of them among office workers, and many of those are in the troubled financial services industry, according to Raymond G. Torto, the global chief economist for CB Richard Ellis, the commercial brokerage firm. He predicted that as many as two million more jobs could vanish by the end of 2009.
On the positive side, new development remains under control. “This was our saving grace,” said Sheila K. McGrath, a real estate analyst at Keefe Bruyette & Woods, explaining that high construction costs and tighter financing had helped to curtail new projects.
So what can investors do to minimize their losses until the next growth cycle?
For landlords, whether they own trophy towers or modest suburban buildings, the advice is simple. “You will need to maintain cash flow and tenants and minimize expense — that’s your only strategy right now,” Mr. Torto said. “As an owner in a highly illiquid market, it’s too late to sell,” except at distressed prices.
But what about buying? That question seems harder to answer.
“If you’re a buyer, you’re looking for prices to settle lower,” Mr. Torto said. “Some buyers cautiously see this as an opportunity. This is a time when core trophy properties become available, and they would never be able to get in that market before.”
Indeed, a big investor could find deals in distressed or potentially troubled properties; in a recent report, Real Capital Analytics identified 649 of them nationwide. Those on the list included several Manhattan office buildings that were acquired through Blackstone two years ago by Macklowe Properties. Macklowe, in turn, gave them up because of financing problems.
“Blackstone was extremely savvy — or very lucky — by disposing of the E.O.P. property as quickly as it acquired it,” said Paul E. Adornato, a senior real estate analyst at BMO Capital Markets.
For the smaller investor, there may be some buying opportunities in modest buildings outside urban areas, as well as in office REITs, which are dividend-paying companies that hold portfolios of properties. The office REIT sector over all was trading at a discount of nearly 36 percent to net asset value in mid-December, according to Mr. Adornato.
Office REITs had a 44 percent loss, on average, for the year through Dec. 30, according to the latest data from the National Association of Real Estate Investment Trusts, compared with a 40.5 percent loss for all property REITs during that same period.
Industry analysts urge investors to exercise caution when picking REITs, however. “While we acknowledge deep discounts available, we don’t necessarily see a catalyst now to get the stocks moving,” Mr. Adornato said.
Still, he and others maintain that some office REITs are better positioned to weather the anemic economy and tight lending environment, and they advised investors to pay close attention to company balance sheets, focusing on cash reserves and debt levels.
“You want to look at who’s got loans coming due,” said Ritson Ferguson of ING Clarion, explaining that refinancing can be dicey these days.
Because of their lower-than-average leverage, Mr. Ferguson said, he is relatively optimistic about Vornado Realty Trust, Highwoods Properties Inc. and Office Property Trust. He said he also preferred Boston Properties Inc. because it has longer-than-average lease terms — “north of seven years” — on its buildings.
Ms. McGrath, meanwhile, said she favored Alexandria Real Estate Equities, which specializes in laboratory space. While the REIT was not immune to the economic slowdown, she said, she viewed its “concentration in life science and lack of exposure to financial tenants as a positive.”
Mr. Adornato also ventured from the plain-vanilla office companies. He was positive about Douglas Emmett Inc., which owns office space, along with apartments, in “high-barrier-to-entry markets,” where there are often obstacles to new development. He singled out another REIT hybrid, Liberty Property Trust, which owns office and industrial property in diverse regions.
While most analysts see few regions as particularly strong, some are upbeat about the Washington area, given the continuing demand from the federal government and the incoming Obama administration. “I think defense intelligence will remain a top priority for the country,” Mr. Adornato said, “and you need office space for that.”
He was also more bullish about so-called Class A buildings, which are often in superior locations and attract the highest-quality tenants and rental rates. “I would think that the Class A property will likely do better,” he said. “The tenants who could not afford Class A before would be able to move up from Class B as prices are lowered.”
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