Commercial Real Estate Blog

Costar is reporting that GE is planning a $10B haircut to its real estate holdings next year. This comes at a time when the cost of capital is increasing, its availability decreasing, and the supply of real estate assets available for sale will be spiking (think Lehman, AIG, Merrill, just to name a few).

The Fed has talked about lowering interest rates shortly and that might help deal with the problem, but the writing is on the wall. Rental and occupancy rate uncertainty, increasing costs of capital, and increase in supply clearly indicate that cap rates will continue to rise unless the credit markets are somehow unclogged.

It will be an interesting scenario for developers - who for the past several years have been using alarmingly low cap rates to underwrite deals - when they find themselves in a situation where the market is looking for a capitalization rate 200 basis points or more higher than what they had forecasted.

I’ve even seen a proforma as recently as early this year for a $100M+ project in San Jose whereby the exit sales number for the development project was a nice big round number, and the cap rate looked like something they pulled out of a hat (or worse), clearly indicating the developer was working backwards from a per square foot sales price! Go figure that out.

Lehman Brothers (LEH: 0.00 N/A), in a move to raise capital and reduce its real estate exposure, is said to be in talks to liquidate about $14B in commercial real estate assets. Lehman is said to be in talks with BlackRock for the assets. Lehamn currently owns about $10B worth of real estate, and an additional $29.4B in commercial mortgages.

Last month, Shorenstein acquired a piece of mezzanine debt on McCandless Towers from Lehman Brothers. For the past few years, Lehman Brothers had been extremely prolific in mortgage backed securities, and in 2007 had underwrote more than any other firm. In addition, Lehman Brothers is selling apartments it acquired through the Archstone-Smith acquisition (which it partnered with Tishman Speyer on). In the past few months it has sold Archstone assets in Santa Clara and Dublin, and will be looking to liquidate others through the end of the year.

I’m not quite sure how the $14B number surfaced, but it seems that Lehman’s financial condition might just have it bailing out of nearly everything, stabilizing itself, and then when the bond issuance market returns, Lehman gets slowly back on the horse.

Doug Linde, President of Boston Properties (NYSE:BXP), discussed on their second quarter earnings call the state of the various markets they are players in, amongst which are San Francisco and San Jose. He went into additional detail about the investment climate, as well as financing. Things to take away are that San Francisco demand for space is slow, valley market is being impacted by supply (interestingly he made mention of the Oracle/Sobrato tower), and that financing north of $100M is extremely difficult and that yield requirements to make deals pencil have shot way up.

Anyhow, here’s a transcript of his comments on the above:

Activity in San Francisco in the CBD continues to be pretty slow. There are really no large users in the marketplace for new requirements. Absorption in the second quarter was slightly negative but with a direct vacancy rate of under 9% and overall vacancy under 10%, the market still remains very tight.

There has been really no change in asking rents, so it’s our belief that the market for top space has settled out in the high 80s to low 90s. There continues to be modest organic growth from smaller firms, but there are no large requirements in the market other than those that are created by contractual lease expirations.

If you look at our occupancy statistics this quarter, you will see a reduction in occupancy in San Francisco. And that’s really from contractual lease expirations on tenants that we moved that happened to be in space in the third quarter, excuse me, in the first quarter, as well as in the first quarter, in both EC3 and EC4, and in the second quarter, they have moved out of EC3, and so you saw a decline in occupancy in EC3 this quarter.

The new development at 555 Mission, which is about 550,000 square feet, is rumored to have completed one additional lease on the top floor of the tower, sort of giving you a sense of what the top end of the market is, with average rents in the mid 80s bringing its leasing to about 30%.

The Valley continues to show job growth in the computer electronics and manufacturing sectors, where most new space requirements are really in the 15,000 to 70,000 square-foot range, i.e., smaller users.

Large user activity has moderated from the pace of the last six months, though Google has committed to build another 1.2 million square foot campus in Mountain View at Moffett Field.

New speculative development has come online, and it has led to an increased vacancy this quarter. In particular, a building that Oracle owned from BEA Systems is now in the market in San Jose, and that adds about 350,000 square feet of availability this quarter.

Just about everyone is being cautious about making decisions, and rental rate growth has slowed, and in some cases it has probably dipped 5% to 10%. But there is still incremental new demand.

Now let me shift my focus and make some comments about the financing markets before I turn things over to Mike, since they really are the key to understanding the acquisition market and individual asset pricing and where and when transactions can be accomplished. Read the rest of this entry »

Shorenstein has acquired a $51.1M mezzanine loan collateralized by McCandless Towers in Santa Clara. Globe St. is reporting that the the debt was acquired at a discount.

McCandless Towers was purchased by Tishman Speyer last July at a cost of $500 PSF ($213M), representing a 4.5% cap rate. McCandless Towers features two 11-story, 210,000 square foot, Class A office buildings anchored by McAfee. The project was completed between 1986 and 1988 and features a 1,400 stall parking garage. The project was built by Swinerton and designed by Hoover Associates.

Shorenstein has been an active buyer of junior debt in primary markets, picking up debt in Washington D.C., New York, LA, and more locally, a $40 mezzanine loan on the Moffett Towers project in Sunnyvale which we wrote about back in October of 2007.

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.  

The Royal Bank of Scotland’s (RBS) chief credit strategist Bob Janjuah has issued a report to its clients to be prepared for a global credit and equity crash. Bob Janjuah forewarned against last year’s looming credit crisis. According to his report, the next three months will be nasty.

The report includes warnings that the S&P could fall by more than 300 points to 1050 by September. In debt markets, they are forecasting that both the high grade and low grade iTraxx indexes could soar. This index is a European index designed to allow people to trade the “Riskiness” of European debt, with the US having a seperate set of similar indexes as well.

What is key in the report has to do with inflation, the fed pumping money into the market, and what needs to be done about it. All the money being pumped into the market by the Fed is causing headline inflation to increase. Unfortunately we find ourselves in economic conditions which don’t easily allow the raising of interest rates. The economy, both domestic, international, and emerging markets will then be faced with further tightening of credit causing global growth to cool significantly.

The impact on commercial real estate could be significant; you would have the cost and availability conditions of debt to continue to deteriorate, coupled with the fact that risk premiums will have increased in other asset classes. This would suggest a similar jump in expectations for commercial real estate, which translates into higher cap rates and tighter, more conservative underwriting from institutions. Things are trending in that direction, and RBS’s report could suggest that we’re aways away from any reverse.