Buildings trade at a discount

Despite a few rosy reports, brokers say building prices hitting up to 25% lower than asking price

Mar.March 04, 2008 07:51 PM

After the credit crisis of late 2007, investment sales brokers worried that Manhattan office building prices might plummet, and were left to await the grim numbers.

But the data is in — and it paints a picture that appears too rosy. Brokers are saying their anecdotal experience leads them to believe that prices have fallen 5 to 10 percent since the credit crunch hit last June. In some deals, sales prices came in 25 percent lower than asking prices.

However, according to 2007 statistics provided by Real Capital Analytics, the price of office buildings rose more than 20 percent from the previous year, with a second-half increase — following the credit debacle — pushing the average up to $704.90 a square foot.

Dan Fasulo, a managing director at Real Capital Analytics, said the data may be misleading, since it doesn’t reflect the buildings that couldn’t sell in a softening market.

“When there’s uncertainty in the market, there’s always a flight to quality, and then only the good buildings continue to trade, and the lower-quality offerings sit there,” Fasulo said. “These are all market averages, so if we’re only getting data points on the top end of the spectrum and the lower-quality buildings aren’t selling, it can artificially hold up prices.”

One broker was closely watching prices in the offerings of 120 Park Avenue, 31 West 52nd Street and 1177 Sixth Avenue. All three high-profile office buildings came on the market after Labor Day, said Nat Rockett, a senior vice president with the commercial brokerage Jones Lang LaSalle. All sold within the past couple of months, he said.

While 1177 Sixth Avenue apparently brought in a windfall for its sellers, the other two properties sold for significantly less than their asking prices. Rockett said he was still optimistic.

“I think the overall message to be taken from these sales is that people still love New York, and they’re still excited about buying quality assets, and they’re still willing to pay up for them,” he said.

When the 47-story, 1 million-square-foot building at 1177 Sixth Avenue near Rockefeller Center went on the market in early fall, it was pegged as the first $1 billion office tower sale since the credit crisis.

In December, a joint venture between Silverstein Properties and the California State Teachers’ Retirement System announced it was purchasing the granite tower, represented by Eastdil Secured, for more than $1 billion from Paramount Group.

While the other two deals didn’t get near those numbers, Rockett said the deals were still strong ones.

The Altria Group headquarters at 120 Park Avenue, with only 500 Altria employees working in it and no other tenants, was represented by CB Richard Ellis, and sold in November to Global Holdings for about $525 million, or about $816 a square foot.

“They had been talking initially about $1,000 a foot, but they came in close to $800,” Rockett said. “Still, I think in the context of a building that is not quite entirely, but very nearly, vacant, with no real retail presence or real ability to create a retail presence, it was a strong number.”

Jones Lang LaSalle represented 31 West 52nd Street, located just west of Fifth Avenue and formerly owned by Deutsche Bank, which, according to published reports in November, was being marketed for $1,100 a foot. The 30-story, granite-clad office tower built in 1986 is well-stabilized, with no leases expiring any time soon, Rockett said. Paramount Group bought it in December for $595 million, or about $816 a foot.

Commercial brokers said discrepancies of more than 25 percent between asking prices and sales prices could be caused by many factors. One could be the buyer receiving less than anticipated on a lease for a large tenant — but that the smaller price tags were significant.

“There probably is an effect on value because of the changes in the debt market,” Rockett conceded, “But it’s impossible for us to quantify what these buildings would have been worth in June 2007, since we didn’t market them then.”

Some buildings sold immediately after the tumult in the debt markets. Somerset Partners purchased 450 Park Avenue in late June for about $510 million, or $1,589 a square foot, which was believed to be the most ever paid for a U.S. office building.

But the pace of sales soon slowed to a trickle.

“We had a tremendous run-up in pricing between 2005 and 2007, and every six months, a lot of buyers were just flipping their properties,” Fasulo said. “But the second half of 2007, properties stopped flipping, because price appreciation tempered.”

While some properties that have come on the market since Labor Day have sold at lower than expected prices, such as 31 West 52nd Street, there have been some notable sales figures. In January, two towers at 388 Greenwich Street sold for $1.575 billion, or $598 per square foot, in the fourth largest building sale in U.S. history.

“In some areas, prices really have appreciated,” said Robert Von Ancken, an appraiser and executive managing director with Grubb & Ellis. “It’s still pretty mind-boggling what overall sales are.”

Still, Von Ancken agreed that, on average, prices for prime properties are down 5 to 10 percent, “probably closer to 10 percent,” he said. “For the major buildings, the initial capitalization rates are up because the costs of financing are up, which is impacting the overall value of the properties, and reducing the value.”

Buyers are no longer able to finance 85 or 90 percent of their building purchase, but have to put in at least 25 to 30 percent equity, he said. Also, current rates for mortgages on commercial properties are at least 6.5 percent, whereas prior to June 2007, they were 5 or 5.5 percent. Even more importantly, lenders are no longer financing based on a building’s future income.

“Before, say, June 2007, lending was based on an expectation that the office rents would continue to increase, and at this point, they’re probably static going forward,” Von Ancken said. “Lenders are basing their lending on what the return is on the property today.”

Stanley Conway, a managing director with Coldwell Banker Commercial Properties Unlimited, agreed that leasing is slowing. “You have leasing possibly slowing down, and that changes the income of the building, and that changes the final value of the building,” he said. “The economic turmoil changes how tenants budget for leasing and what they want to spend in rent. There’s always a top, powerful layer that will spend $140 a foot, but there’s always the people who are running a service business who say, ‘Should we be spending $60 a foot, or can we get away with spending $45?'”

Conway said he doesn’t believe prices have hit bottom, and anticipates they could fall another 5 to 10 percent by mid- to late-2008. They may even continue to fall into 2009, he said.

“As the economy starts to suck wind, and rentals decrease for a variety of reasons, you’re going to see that the income generated by buildings will be less, capitalization rates will rise a tiny bit and prices will change,” he said.

Fasulo said capitalization rates are already up 25 to 50 basis points, one-quarter to half a percentage point, but the news is not all bad. The overall sales volume in dollar value in Manhattan for 2007 was $40.9 million, up 132 percent over the previous year. The number of properties sold was 194, an increase of 24 percent over 2006, a total fed largely by activity in the beginning of the year, though not totally.

“We actually had a tremendous fourth-quarter 2007 in Manhattan, which has been an anomaly post-credit crunch compared to other markets in the country, where we’ve seen a 30 to 40 percent decrease in sales volume,” Fasulo said. “We haven’t really seen that yet in Manhattan.”

Tempered prices have brought out two groups of buyers that haven’t been active in the Manhattan office market for several years: the institutional buyers and real estate investment trusts, although major New York City-based REITs SL Green and Vornado have been exceptions.

In January, TIAA-CREF, the teachers’ retirement fund, closed on 470 Park Avenue South, for which it reportedly paid $157 million in cash to SL Green. The last purchase made by TIAA-CREF, 780 Third Avenue, was in 1999.

“A pension fund would have been outbid for this type of asset pre-credit crunch,” Fasulo said. “This property definitely would have sold to a private investor or an equity fund earlier in 2007.”

Foreign buyers, many of whom were outbid for years by equity funds and private investors, have also become bigger players in the Manhattan market since the credit crisis.

“A guy in Chelsea who has an office building he wants to sell said to me, ‘The price is so high; do you have a European buyer?'” Conway said. “I’ve had other people say, ‘Don’t go to anybody domestic with this, because you’re just going to waste your time. Just go to an overseas buyer.'”

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