While those in the industry have been relieved to see the New York City commercial real estate market bounce back over the past year, the resulting price increases have prompted many investors and developers to look elsewhere for deals.
Instead of searching for properties to buy in the Big Apple, they are, in many cases, turning to other markets — from prime locations like San Francisco and Los Angeles to secondary markets like Austin, Tex.
“People need to realize that the number of assets truly available for a sales price that makes sense is very few in New York City,” said Daniel Alpert, managing partner of Westwood Capital, a Manhattan-based real estate investment bank. “There are an enormous number of people chasing [deals] to the point that there’s been overpayment, enticing people to look elsewhere.”
As of Jan. 31, prices for office building sales in New York City had risen 32.9 percent from their 2009 low, according to Moody’s/REAL commercial property indices. That gain more than tripled the 9.7 percent increase for national office building sales prices from their 2009 low.
“With prices as high as they are, it’s difficult for a lot of real estate investors to be able to buy in New York and earn the returns they need to stay in business,” said Jahn Brodwin, senior managing director at FTI Schonbraun McCann Group, a Manhattan-based real estate consulting firm.
“The high-octane money is finding that even a 10 percent return is kind of tough to pencil out when you are buying properties with 4 and 5 percent caps, financing at 6 percent, and can only borrow 50 percent of your investment,” Brodwin added.
Dan Fasulo, managing director of real estate research firm Real Capital Analytics, concurred, saying New York’s high prices have sparked interest in secondary markets nationwide. The spread in prices between primary and secondary markets has reached an almost 10-year high, he said.
“When that spread opens up wide, it always encourages investors to go out more on the risk spectrum for superior yields,” Fasulo said. “Non-tradable REITs promise investors 6 to 7 percent returns a year. Now you can’t buy in Manhattan, because cap rates are about 5 percent again. So you have no choice but to look for greener pastures.”
The pilgrimage to other cities encompasses all different kinds of investors.
“Look no further than Blackstone,” Fasulo said, referring to the mammoth private equity firm.
Fasulo cited the company’s February purchase of 588 shopping centers around the U.S. from Centro Properties for $9.4 billion. Last October, meanwhile, Blackstone joined Paulson & Co. and Centerbridge Partners to purchase the Extended Stay America hotel chain, with 685 properties nationwide, for more than $3.9 billion. Sources have said in the past that they expected Blackstone to look for investments outside of New York in this economic environment.
Meanwhile, companies like Square Mile Capital, which launched in 2006 and had been doing deals almost exclusively in New York, also have been looking elsewhere.
Executives at the company were quoted in The Real Deal last month, saying their investors are looking for more aggressive returns that can only be achieved in less competitive markets than New York. The company has recently been involved in deals in Atlanta, Tampa and elsewhere.
Westwood’s Alpert said he’s seeing investor interest in Dallas and Houston, thanks to the surge in oil prices, which always fuels (no pun intended) interest in those cities. “Until three months ago, they were dirty words,” he said, referring to Dallas and Houston.
Other experts, such as Spencer Levy, executive managing director of CB Richard Ellis Capital Markets, said the interest in Texas extends to Austin, which has built itself into something of a technology hub.
Simon Ziff, president of New York real estate advisory firm Ackman-Ziff, said he’s seeing investor interest in multifamily properties in the San Francisco and Los Angeles areas. His firm’s customers are also investing in the hospitality sector in those two areas, as well as South Florida and Washington, D.C., in addition to New York.
The multifamily investments in California are mostly restructurings, Ziff said. “Two things are driving it: Financing is available and valuations are high. Cap rates are still very low, so different tranches are able to accomplish some recovery,” he said.
He added: “A lot of it is the result of overleveraged assets.”
Investors also are returning to cities and regions that were poster children for the real estate bust — Phoenix and Las Vegas, in addition to South Florida.
“Long-term demographics and job growth look strong there,” CBRE’s Levy said. The Carolinas, like Texas, draw interest for their low taxes, he added.
Investors are also hunting overseas rather than putting all of their investment eggs in the New York basket. As The Real Deal also noted last month, Tishman Speyer bought two office buildings in Paris last year for about $378 million.
And investors are increasingly moving into emerging markets as well, FTI Schonbraun McCann’s Brodwin said. Economies in some of those countries suffered less from the credit crisis than the U.S. and Western Europe, and their prices are generally lower than New York’s.
“Brazil’s hot — Rio and São Paulo,” Brodwin said. “Brazil is relatively stable, with massive amounts of resources. There’s a lot of industry to be built, and money to be made.”
Sam Zell’s Equity International announced in February that it has invested $58 million for a majority stake in GuardeAqui, a privately owned self-storage company based in São Paulo.
Turkey is also attracting attention, Brodwin said. “It’s a moderate country with a stable government for that region.”
For U.S. investors, the move outside New York will continue, experts said. “The secondary market will be the biggest story of 2011,” Fasulo said. “Barring an economic collapse, or something blowing up, we see capital flowing there this year.”
Westwood’s Alpert said the jury’s still out on whether these investments will turn out to be wise. Given the tepid economic recovery, investors throughout the country may not be able to stomach rising rents, he said.
“One of the chief risks today is that the ultimate users need to be able to afford the rent,” Alpert said. “There is still a considerable backlog of assets underwater.”
If more of these troubled assets come to market in primary cities like New York, that will put a damper on prices in those locations, keeping investors away from secondary cities, Alpert said.
“Will we suffer a 20-year drought in secondary cities, like [those in] Japan?” That, he said, is an open question.