New York remains one of the world?s major gateway cities?the kind of market that has thrived since the downturn. It is also experiencing renewed interest from apartment dwellers, retailers and corporations, pushing occupancy rates down and property values up. Plus, there is little room for new development in Manhattan, ensuring that even when one retailer or corporate tenant moves out, there?s a line of replacements waiting to sign new leases. On the retail side, JC Penney is just one example of a tenant that took advantage of favorable conditions in recent years to open its first New York City store.
All that is to say that New York, with constraints on supply and enduring demand, remains the belle of the ball for investors. As a result, in 2011 the volume of commercial real estate properties sold in Manhattan alone totaled more than $27.3 billion, making it by far the most active market in the U.S., according to Real Capital Analytics (RCA), a New York-based research firm. (Los Angeles is next on the most active list with $13.9 billion in deals.) Meanwhile, the average cap rate on commercial transactions in Manhattan was 5.6 percent, according to RCA.
The city?s four other boroughs saw an additional $3.9 billion in transactions?a greater volume than markets like Philadelphia, Miami and California?s Inland Empire. And the pace of growth in New York?s boroughs?86 percent and 67 percent year-over-year respectively?exceeded the 62 percent increase in transactions for the U.S. as a whole.
Prime addresses
The Manhattan office sector saw its highest level of investment activity since 2007, with 22 buildings sold and another 21 recapitalized for an overall transaction volume of $30.3 billion, reports commercial real estate services firm Colliers International.
The demand has been coming from everywhere: institutional capital, publicly-traded REITs, private investors, New York?s cadre of homegrown investors and everyone in between. For example, according to a survey administered by the Association of Foreign Investors in Real Estate (AFIRE), a Washington, D.C.-based trade group, New York took the top spot among global cities for foreign investment for 2012.
New York real estate ?provides transparency, stability, long-term growth and significant asset appreciation,? says Helen Hwang, executive vice president for capital markets with the New York office of brokerage firm Cushman & Wakefield. ?In addition, most assets traded in the market thus far offer significant discounts to replacement cost.?
But with so many investors looking to buy in New York, prices on local assets have been reaching vertiginous heights, even with limited improvement in fundamentals to support them. By the end of 2011, prices on Manhattan office buildings averaged $565 per sq. ft., according to Colliers. The average price on class-A buildings reached $659 per sq. ft. (RCA reports the 2011 average on office buildings in all U.S. central business districts was $289 per sq. ft.)
In the multifamily sector, where demand for new apartments remains high, the projected citywide vacancy rate of 2.3 percent can still help the numbers pencil out. But that?s not the case in the office sector, which is still the preferred sector for investment for offshore capital sources, according to Jeffrey W. Baker, executive managing director with Savills, a global real estate services firm.
In the fourth quarter of 2011, the availability rate for Manhattan office properties rose to 11.7 percent, a 30 basis point increase from the third quarter, according to a Colliers report. The availability rate measures currently vacant space along with space that?s likely to come on the market in the near future.
Net absorption in the fourth quarter was negative 1.2 million sq. ft. Also, with the major investment and commercial banks hitting another rough patch in their performance, many are planning rounds of layoffs. Moreover, given continued instability in the global economy, many businesses are wary of expanding in the near future, according to Ronald M. Dickerman, president of Madison International Realty, a global real estate private equity firm based in New York.
In the third quarter of 2011, job growth in New York was flat and in the fourth quarter the city lost 4,900 jobs, according to a report from Eastern Consolidated Inc., a local real estate investment services firm.
Colliers reports that asking rents per sq. ft. for Manhattan office space averaged $54.77 at the end of last year?up 11 percent from $49.37 per sq. ft. in 2010, but only a 13 cent improvement on a quarter-over-quarter basis.
?Rents across the board fell close to 50 percent on a net effective basis peak through trough,? says Andrew Simon, executive managing director with Colliers New York. ?They came back up at better buildings, but never all the way.?
The recovery has also been spread unevenly between various neighborhoods. Office buildings in Midtown and Midtown South have no shortage of prospective tenants. Media companies and technology firms have also started to relocate to Chelsea, the Meatpacking District and the West Village, according to James D. Kuhn, president of real estate services firm Newmark Knight Frank.
On the other hand, several New York-based brokers worry about how the new World Trade Center under construction Downtown will affect the class-B office stock that already exists in the area.
In the fourth quarter of 2011, the availability rate for properties Downtown already stood at 11.6 percent, above the citywide average of 11.1 percent, according to a report from Studley, a tenant advisory firm.
Price is right?
Meanwhile cap rates on office sales in the city in the past 12 months fell to 5.3 percent, a 24 basis point drop from the year prior, according to RCA. By now, some buildings have traded in the 4 percent range, according to Hwang. In the absence of strong rental growth, that makes it difficult for most buyers to bring in a decent return on investment.
?There is no question that New York City is still highly desirable; the problem is the rates of return have gotten really skinny because rents have not been growing and cap rates are getting lower,? says Dickerman.
Francis Greenburger, founder of Time Equities Inc., a New York-based full-service real estate firm, is skeptical as well. ?The cap rates are very low,? he says. ?The only way to justify [them] is if you are very optimistic about rents. A certain amount of optimism may be appropriate, but too much of it will have people out on a limb.?
In 2011, the disconnect between prices and anticipated rental growth meant some trophy office buildings, like 650 Madison Avenue, a 500,000-sq.-ft. class-A building on East 59th Street, took months to trade. Other assets?1211 Avenue of the Americas, 200 West 57th Street?were taken off the market. Eastern Consolidated reports that in the fourth quarter, Manhattan?s commercial sales volume fell 40 percent, to $6.5 billion.
In the case of 200 West 57th Street, the owner, The Feil Organization, reportedly decided to wait because company executives thought they would get a better price on the almost fully leased building a few months down the road. Feil originally valued the 180,000-sq.-ft. property at $145 million.
But 1211 Avenue of the Americas spent at least six months on the market. Its owner, Beacon Partners Inc., reportedly expected to sell the building for about $1.9 billion, including the assumption of $950 million in debt. The 1.9 million-sq.-ft. building was built in 1973.
?A lot of the anticipated activity [in the second half of 2011] was brought back to earth because of still existing difficulty in financing,? says Colliers? Simon. ?Ever since the downturn, there?s been a little bit of a disconnect between anticipated pricing on the sale and what buyers are willing to pay. People on the bigger deals still had to come up with large chunks of equity, so you saw some properties that were put on the market mid-year or in the third quarter that didn?t receive the type of pricing owners anticipated and were pulled back.?
Given office leasing?s muted outlook, cap rates on commercial property sales in New York won?t drop lower this year, but neither should they rise, says Kuhn. That would create an ongoing challenge for investors looking for properties here.
But it won?t mean people will turn away from New York. Instead, investors are getting creative?teaming up in joint ventures, doing recapitalizations instead of outright acquisitions and picking up lower-level retail condominiums rather than buying office towers wholesale. These strategies help minimize risk but still allow buyers to capitalize on New York real estate?s inherent strengths.
Recaps rising
Madison International Realty, for instance, recently purchased a 25 percent interest in 655 Madison Avenue, a 300,000-sq.-ft. class-A office building in Midtown Manhattan. Loews Corp. leases approximately 50 percent of the office space at the property, with a lease that won?t expire until 2020, and Donna Karan operates its flagship store there.
Madison paid about $35 million for its stake in the building. ?We worked with the existing sponsors to replace the investor who wanted to exit the deal and we invested to support the existing management?s plan?the retail lease is expected to roll in the next few years and we think it?s an irreplaceable location,? says Dickerman. ?From a rate of return standpoint, the property is very low-levered, there is no risk of mortgage default and it pays a low dividend yield which we can harvest during our holding period.?
Other recent recapitalizations include Century Plaza purchasing a 50 percent stake in 650 Madison Avenue, a 600,000-sq.-ft. office building that houses Columbia Presbyterian Health Systems and the Ralph Lauren/Polo store; Vornado Realty Trust?s acquisition of a 50 percent stake in 666 Fifth Avenue, a 1.4-million-sq.-ft. office building owned by Kushner Co.; and SL Green Realty?s purchase of a 50 percent interest in 180 Maiden Lane, a 1-million-sq.-ft. Downtown office building, from the Moinian Group.
Tenants at 180 Maiden Lane include AIG and Goldman Sachs. SL Green recapitalized the property at a cap rate of 7.1 percent, an almost unheard of number in today?s market. The New York-based REIT has been among the most active buyers of Manhattan assets in recent months. RCA estimates that over the past two years, SL Green acquired 16 commercial properties in New York, valued at approximately $4.2 billion.
SL Green is in a very strong position for investing in New York: Its status as a publicly traded REIT gives it easy access to capital and its longtime New York connections and familiarity with the market allow it to move quickly to close transactions, say Jeff Baker and Andrew Simon.
?Guys coming into the city for their first acquisition won?t be able to compete like that,? Simon says. For instance, SL Green closes many of its acquisitions through off-market transactions; because its executives know the city well, they aren?t limited to core assets in Midtown.
?We have a multi-tiered strategy, a combination of buying core stabilized assets, but also buying assets for repositioning,? says David Schonbraun, co-chief investment officer with SL Green. ?There are no set criteria: We?ve bought everything from vacant buildings to fully occupied properties. We are predominantly Midtown, but we have purchased some properties Downtown and are probably more opportunistic there.?
In addition to the recapitalization of 180 Maiden Lane, in recent months SL Green also bought 51 East 42nd Street, a 160,482-sq.-ft. office building, and 10 East 53rd Street, a 388,000-sq.-ft. office building, among other assets.
Investors trying to enter the New York market for the first time would do well to partner with companies like SL Green and Vornado on recapitalization deals rather than try to complete acquisitions themselves, says Hwang. If they try to go it alone, they would most likely have to overpay in order to compete against local players. They might also find themselves in over their heads when it comes to the intricacies of managing commercial properties in the city.
?If it?s a first-time buyer entering the market, it?s very difficult to buy in the core arena and it?s too much of a risk to reposition an asset,? says Hwang. ?It?s best to get into a joint venture with someone who?s very solid in New York City, so that they are not taking up all that risk and at the same time are investing in a good opportunity and not competing against institutions and REITs who have a very low cost of capital.?
Another strategy investors have been employing in order to minimize risk involves putting money into retail condominiums. For example, in January, a joint venture of SL Green, Stonehenge Partners and Jeff Sutton bought the 16,468-sq.-ft. retail condominium housing the Giorgio Armani store at 760 Madison Ave. The joint venture paid $3,198 per sq. ft. for the condo.
Also in January, Yucaipa Cos. and Midtown Equities paid $956 per sq. ft. for Soho House, a retail property at 29-35 Ninth Avenue housing Spice Market and Soho House New York. The transaction reportedly closed at a cap rate of 2.9 percent.
?My investor clients have an appetite for more risk with retail condos because the return is based on the quality and credit-worthiness of the tenants,? says Daniel T. Altman, partner with real estate law firm Belkin, Burden, Wenig & Goldman LLP. ?New York City is one of the best locations to own a retail condominium and you are able to achieve higher returns because you are taking on more risk. They are easier to manage [than office buildings] too, because you only have one or two tenants.?
Finally, some New York-based firms have been focusing on new development, as the return on investment compared to acquisitions tends to be much higher.
For instance, global real estate services firm Hines is building 7 Bryant Park, a 474,000-sq.-ft. boutique office building at 40th Street and Sixth Avenue. Hines is comfortable investing in new development in the area because it sees strong demand at nearby office properties, says Tommy Craig, senior vice president in Hines? New York office. He projects that initial rents at 7 Bryant Park will be close to the $100-per-sq.-ft. mark.
?We?ve seen the demand by investors and users for post 1990s projects and it?s very high,? Craig says. ?A big part of the story at 7 Bryant Park could be described as a build-to-core strategy. We think that the return on that is especially attractive given the positive spread between the return we expect and cap rates on trades on existing buildings.?
Meanwhile, Taconic Investment Partners, Thor Equities and Square Mile Capital plan to start construction on 837 Washington Street, a 55,000-sq.-ft. office/retail building in the Meatpacking District. ?My speculation is that there will be certain areas of the city that will experience rental growth, and then there will be other areas that will remain stable,? says Charles Bendit, co-CEO of Taconic Investment Partners. ?I think the West Chelsea/Meatpacking area will see rental growth; I can see rental growth in the Park Avenue South/Flatiron area, Madison Square Park and Soho.?
Along with its development initiative, Taconic has a $220 million fund committed to acquiring New York properties, set to seek value-added or opportunistic investments offering returns in the high teens or low 20s, Bendit says. ?
Sidebar: Multifamily Rules the Day
While the office sector still presents certain challenges for investors looking for commercial real estate in New York City, multifamily and retail properties have been picking up steam. The multifamily market is particularly strong, with steady demand and limited new product on the market. Marcus & Millichap Real Estate Investment Services, an Encino, Calif.-based real estate services firm, predicts that in 2012 vacancy at market-rate apartment complexes in New York will fall to 2.3 percent. Effective rents will likely rise 7 percent, to $3,052 per sq. ft.
As a result, cap rates on sales of multifamily properties have dropped into the sub-4 percent range, says Cushman & Wakefield?s Helen Hwang.
?Multifamily is on fire, especially in the core arena, and probably has been the most competitive [sector] so far, along with core office,? she says. ?Most of the deals have been snatched by REITs or institutions backed by pension funds or foreign money.?
In the past six months, 127 apartment complexes sold in Manhattan, for a total dollar volume of $3.119 billion, according to Real Capital Analytics (RCA).
Meanwhile, cap rates on sales of retail properties in the city averaged 4 percent in the first quarter of 2012, RCA reports. Average price per sq. ft. was $1,297.
In the past 12 months, the volume of retail sales here shot up 115 percent on a year-over-year basis, to $1.99 billion.
?Urban retail is great,? notes Hwang. ?It?s much more bite-size, typically, because it tends to be ground floor, so it yields higher return than office or residential. And some of the fundamentals of that market are better than peak.?
Plus, ?the beautiful thing about investing in retail assets is there is no limit on capital expenditures.?
Marcus & Millichap forecasts that this year, retail vacancy in New York City will fall 50 basis points, to 7.5 percent. Asking rents should rise 3.1 percent, to $68.64 per sq. ft.
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