Building Buyers Go Bridge And Tunnel

Manhattan’s institutional investors are becoming part of the bridge-and-tunnel crowd.

Low interest rates and a scarcity of buildings for sale in Manhattan’s high-priced office districts are driving some buyers to the outer boroughs to try and cash in on the hot investment sales market.

Other investors are trying to get a slice of the action in Manhattan by structuring creative deals for smaller stakes in buildings or turning to class B properties.

Not that buyers still aren’t holding out for assets like the General Motors Building. The 50-story office building, one of the best in New York, sold for a record-breaking $1.4 billion last year.

“Those buildings will continue to be the asset class of choice,” said investment sales broker Richard Baxter of Cushman & Wakefield. “They are eminently able to be financed, and they are very sought after.”

Because there are so many buyers and so few buildings, many investors are looking to the outer boroughs, including some unexpected players.

“It’s a classic reaction to scarcity,” said Woody Heller, head of the capital transactions group at Studley. “Geography, deal size and deal type are the factors that change in an environment like this.”

Recently, Morgan Stanley and the Fisher Brothers formed an investment fund that specifically targets all of New York, not just Manhattan, Heller said.

“That includes small deals in all the five boroughs,” he said. “It’s unusual for an investor of that type to do deals in non-institutional areas.”

Heller said one of the main issues investors will have to examine in the outer boroughs, like everywhere else, is the tenants in a given building. “You want good tenant profiles,” he said. “The question is, what risk do people tolerate in this market versus another market?”

Bill Shanahan, an investment sales broker at CB Richard Ellis, said Brooklyn is especially hot right now. Plans by developer Bruce Ratner to build an arena to house the Nets basketball team in downtown Brooklyn, rezoning by the city and residential development are all fueling interest.

“There is a big focus on Brooklyn for both residential and commercial,” Shanahan said. “You really have to give some credit to Bruce Ratner. The sky is the limit if they get a stadium there.”

Shanahan also said new residential buildings in Brooklyn are hot properties because they are much needed in a borough dominated by brownstones, which can often be limiting in terms of layout. “Brooklyn has such a huge demand for modern apartments,” he said.

Shanahan cited several new high-rise apartment buildings being constructed on Fourth Avenue on the edge of Park Slope as indicative of the kinds of new development that could serve as potential investment opportunities.

However, not every investor is comfortable leaving Manhattan for Brooklyn, according to Baxter. “I think there are buyers for every market segment,” he said. “Some of the foreign investors have very strict acquisition criteria” and limit themselves to between 42nd and 59th Streets, from Park Avenue to Sixth Avenue, he said. Baxter is also currently marketing a building at 86 Chambers which is primarily leased by government tenants and might appeal to a foreign buyer, he said.

Robert Knakal, chairman of Massey Knakal, which has offices in Brooklyn and Queens and is opening an office in the Bronx this year, expects the outer boroughs to explode in terms of investment sales in 2004.

“We anticipate a tremendous flight of capital from Manhattan to the outer boroughs,” he predicted. “In the second half of 2003 we saw a dramatic increase in the number of transactions in Brooklyn, Queens and the Bronx and many of the buyers of these properties have traditionally been Manhattan buyers.”

The outer boroughs can often provide a positive cash-on-cash return for buyers of apartment buildings, Knakal said, which isn’t necessarily the case in Manhattan.

“We believe that capitalization rates on multi-family properties will continue to hover only slightly above fixed-rate lending rates, which will provide little cash-on-cash return. This is particularly true in Manhattan,” said Knakal.

By contrast, “in the outer boroughs, where cap rates are above lending rates, positive cash-on-cash returns can be realized,” Knakal said.

Other funds have also been formed to acquire “less glamorous” properties. Myron Berman, a principal of the recently formed BP Real Estate Fund, is targeting midsize income-producing Class B and C properties in the Northeast, including industrial, retail, office, multifamily and hotel assets.

“They may not be the shiniest and prettiest assets,” he said, “but they present exceptional opportunities to generate significant value. And the competition for these properties isn’t nearly as fierce because they usually fall below the radar screen of institutional investors.”

“There are many office buildings with leases that are about to run out that won’t be replaced because the space is either vacant, not being used, or rents are too high,” he added. “Those properties will surface on the market very soon.”

Shanahan said that in Manhattan, some buyers are looking at class B properties because there is more room for rental rate rises. He cited an example, saying that a $5 rise in rent on a $25 per square foot space in a B building would make for a better return than a $5 rise in rent on a $50 per square foot space found in a class A building. He added, however, that class B rental rates usually increase after class A rates during an upturn in the economy.

Buyers in Manhattan are also getting creative in how they are buying into class A office buildings given the current scarcity of inventory, brokers said.

Heller said Vornado’s investment of $200 million in the General Motors building as a mezzanine loan to buyer Harry Macklowe was one such example. “They would usually be the buyer in the deal,” Heller said.

Another deal, S.L Green Realty Corp.’s purchase of 45 percent ownership in the 2.6 million square foot McGraw Hill Building at 1221 Ave. of the Americas in December, was also an uncharacteristic buy because the REIT assumed a non-operating position in the building. SL Green bought the stake for $450 million, in a deal in which McGraw Hill was represented by Heller and his team as well as Steve Siegel of Heller’s old company, CB Richard Ellis.

“SL Green would typically look for management and leasing opportunities, and there they got neither,” said Shanahan. “So we’re seeing creativity on the investment side.”

Investors are also continuing to look downtown, where the hot trend has been residential conversions, with thousands of units in the works. Baxter doesn’t see the trend abating anytime soon. “Demand continues for property suitable to residential,” he said.

Development sites are also hot right now, but only for residential. “It depends on the zoning,” Baxter said. “We’re seeing record prices for FAR (floor-area-ratio). But if it’s not where residential is permissible, we’re not seeing the same demand.”

Recent development site deals include another transaction handled by Heller, who has had a hot hand lately. Central Parking System sold the air rights to 10 West 48th Street and two small adjacent buildings to Jules Demchick’s J.D. Carlisle Development Corp. for $23 million. The site will likely house a new 131,500 square foot residential condo or hotel.

In other deals, developer Ratner recently bought a much coveted parking lot near City Hall for an undisclosed price where a residential tower can be built. The Related Cos. also purchased a 18,000 square foot parking lot at 26 Astor Place where it plans to build apartments.

Going forward, the direction of the investment sales market will depend largely on interest rates.

Shanahan said that prices will be affected by the improving economy and its effect on rental rates and interest rates. “As the economy improves, rental rates will improve, which will have a positive effect on pricing,” he said.

But an improving economy could also boost interest rates, which would offset that trend. “It will sort of be a potential race between interest rates and rental rates if the economy improves,” Shanahan said.

Baxter said he foresees an interest rate rise, but nothing dramatic. “It won’t be more than a 1 to 1 1/2 percent rise, and I’d be surprised if it rose that high.”

According to figures provided by Massey Knakal, building prices in New York City appreciated by 8.4 percent in 2003. The company also concluded there was a 16 percent drop in sales volume in 2003, as the amount of building turnover dropped from 1.9 percent in 2002 to 1.6 percent in 2003.