Commercial Real Estate Blog

A federal judge today gave the ok for an IRS investigation to move forward against UBS, a swiss bank. The summons is fairly unprecedented as Swiss banks pride themselves on privacy. In a tax-evasion investigation, IRS is seeking information about US citizens who have not disclosed swiss bank records to the IRS.

UBS is currently battling mounting losses stemming from the subprime financial shenanigans, and the IRS may be seeking to take advantage of UBS’s wobbly condition to bring them to their knees on this issue.What is happening at UBS, if it proceeds, likely would pave the way for further action against Swiss Banks. It should be noted that it is not clear whether UBS will in fact release any information. If they do, the trust in Swiss Banking will fall dramatically, possibly spurring a flight of capital.

This brings me to Singapore. Singapore is growing quickly as a rival to Switzerland as a banking haven. By cutting personal income taxes to 20% and tightening account privacy, Singapore is quickly becoming a go-to haven for Asia’s growing number of millionaires.

Other features of Singapore banking are that any authority seeking information from a Singapore bank must prove that the customer violated tax laws; a tough thing to do if they’re looking for information in the first place. Trust accounts in Singapore are much more flexible than those in Europe as well; and as a result; the amount of assets in trust accounts in Singapore is now over $100B.

Singapore has also revised its laws allowing foreigners with enough assets to acquire property. Given what is happening with UBS and the wealth creation in Singapore; it is an office space market and economy to keep a very close eye on.

Over the past few decades, real estate investment has become increasingly sophisticated. Large institutional investors and developers have seen the line blurred between traditional investment banking for securities and that for real estate. Everything from the market analysis to the financing of the project has changed.

Investors in commercial real estate often classify projects and assets into various classifications, which we’ll try to explain below. In similar fashion to classifying office space as Class A, B, C, there is no absolute criteria by which an asset is graded, but most investment professionals are able to generally agree on which category an asset falls under. That said, the classifications investors generally hear about are:

• Core, or Core-Institutional: These assets are the highest-grade real estate asset. They are easier to finance, and generally command the lowest Capitalization Rates. An example of a core-institutional investment would be a fully or nearly fully-leased office property in a historically strong office market such as San Francisco or New York City.
• Core-Plus: A Core-Plus asset is an asset which is also high quality, yet one which represents to an investor the opportunity increase the asset’s investment yield through some event. For example, the asset might have some scheduled vacancy or leases rolling over which would give the owner the opportunity to increase rents. Another characteristic of Core-Plus is an asset which could benefit from some upgrades or renovations by which the investor could then command higher rents and improve his return.
• Non-Core: These assets generally fall into the “B” category. An example might be a “C” asset in an ”A” location, or even a Class A asset located in a secondary (”B location”) or tertiary market. These assets are generally overlooked by larger institutional investors, and generally have a higher vacancy rate, and slower rental rate growth, and investors demand a higher Capitalization Rate when acquiring these assets.
• Value-Add: Assets which fall into this class are those where a buyer has an opportunity (that’s the expectation at least) to acquire an asset, and add significant value through a major event. An example of a value-added asset might be one which an investor acquires an older office building, performs significant renvoations to the building’s interiors and exterior to reposition it from a Class B asset to a Class A, and leasing it at higher rates. Another example is an investor acquiring an asset and increasing density, to add value. Value Add is generally the riskiest investment class of those we have discussed so far.
• Opportunistic, Distressed: These assets represent one of the highest levels of risk for a property investor. An example could be a bank foreclosure or an asset whereby the seller is in financial difficulty. Given the condition of capital markets today, many are expecting these opportunities to begin to surface and funds have been setup to focus specifically on these types of investment. An example of an opportunistic deal would be to acquire a note on a property belonging to a troubled seller, negotiate control of the property, and then provide the equity or financing to renovate the property.
• Development, Redevelopment: These types of assets represent those whereby a buyer could acquire an asset which would benefit from a higher and better use. They can either be ground up development, or a redevelopment of an existing site. These assets demand the highest returns because of the inherit risk in both acquiring and constructing the asset, but also leasing and market risk taken on by the investor and/or developer. A local example would be Santana Row. The site Santana Row sits on was formerly a Town & Country shopping center, a single-story, surface-parked retail center. Federal Realty (NYSE: FRT) acquired the property and re-developed into a massive mixed-use project encompassing hotel, condos, apartments, retail, and office.  

Though likely not surprising to anybody, year over year investment sales both in the United States and on a worldwide basis are down dramatically. According to a Jones Lang LaSalle (NYSE:JLL) report cited by NREI, first quarter investment sales in the US came in at $39.2 Billion, a number which is down 69% from the year ago period.

Internationally, investment sales during the first quarter were $154 Billion, which is down 46% less than the $283 Billion number from a year ago. This statistic was provided by Real Capital Analytics.

There is a lot of money currently waiting on the sidelines to acquire assets, but for the time being sellers are not conceding much on price. That might change though over the course of the next one to two years as loans mature. As Macklowe Properties found out, refinancing a short term loan in this market is difficult to do. If owners don’t can’t meet the heightened equity requirements currently facing those looking to acquire or refinance assets, they might be forced to sell.

According to the Allen Matkins/UCLA Commercial Real Estate Survey, San Francisco rents and occupancy will both fall over the next two to three years. This comes on the heels of several years of rental rate increases and a strong office market.

It should be noted that the economic models UCLA has prepared have a difference of opinion from the panel’s analysis. Citing continuing employment numbers, the model forecasts that office space supply in the city could in fact be in short demand within four years.

On June 18, UCLA will release its full findings at its 2008 Economic Outlook and Real Estate Conference.

Valter Mainetti and his Sorgente Group have acquired a majority piece of the Flatiron Building in New York. Estimated to be worth about $180-190M, the Flatiron building is a landmark building sitting at the intersection of Fifth Avenue, Broadway, and 23rd Streets.

In another notable deal, Abu Dhabi investment council (United Arab Emirates) is currently in negotiations to acquire a 75% stake in the Art-Deco Chrysler building. The deal would value the building at about $1 Billion. The building is on a 140+ year ground lease from Cooper Union with the remaining 25% stake being owned by Tishman Speyer.

High oil prices and the weak dollar have made New York a prime target for middle eastern investors and sovereign wealth funds. For Europeans, the weak dollar has spurned tourism and investment in the United States, from flats and vacation homes, to institutional grade real estate assets.

First time real estate investors are often torn between investing in commercial real estate, or residential/multi-family property. A while back we wrote a post about Rentometer, a quick and dirty rent analysis tool apartment investors could use to gauge market rents.

HotPads.com has gone one step further and introduced a Rent vs. Buy Heatmap showing areas which have a low (or high) ratio of Avg. Home Prices to Annual Rent. It is not exactly scientific, and the system is only as good as the data, but the heat maps provide some insight as to what areas might warrant further research.

The system shows North Sunnyvale/Alviso as having a low ratio of Prices:Rent, but it seems the system has been gamed by limited availability of rental units and for sale housing that is mostly mobile homes. That said, other areas hit hardest by foreclosures (Brentwood, Tracy, Hollister, etc.) seem to have decent amounts of data on both rentals and for sale making the heat maps more relevant.

They also have heat maps for median rent, foreclosures per household, and others.

After seeing rents continuously rise over the past 24 to 36 months, Tenants are finally beginning to see an easing in rental rates. During the past two quarters, net absorption in the South Bay and Peninsula markets have either been flat or mildly negative. In the Silicon Valley, depending on whose numbers you use, net absorption in the first quarter was in the range of minus 50-100k. At the same time rents remained fairly static.

Landlords, experiencing a marked slowdown in leasing activity have now begun to question the strength of the market. In some instances, Landlords are keeping asking rents up but getting more aggressive in providing concessions. Equity Office, which first used this approach with some of its projects, has now begun to actually lower their asking rents in some of their projects.

It helps to understand how the debt markets had an impact on the rapid rise in rents, and what could be the beginning of a period of weakness in the markets. During the past several years, cheap financing coupled with lax lending standards allowed investors to buy and sell buildings and projects at an unprecendented rate. 

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