Square Feet: After Hibernation, the Office Market Is Waking Up
January 10, 2011
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.
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