For a year now, industry insiders have worried about the possibility of a bubble in the commercial real estate market, amid rapidly rising prices for trophy properties.
A number of recent purchases, including Harry Macklowe’s $255 million pending acquisition of 737 Park Avenue, have raised eyebrows for their high prices and low cap rates. And yet, experts still seem divided on whether or not the market is overly frothy. Some say investors anxious to deploy capital are driving up prices by overpaying for questionable assets. But others argue that, so far at least, still-tight lending guidelines and other restraining factors are preventing a repeat of the mid-2000s bubble.
Peter Hauspurg, chief executive of the Manhattan-based real estate investment services firm Eastern Consolidated, said his company is about to ink a deal for the sale of a Bryant Park development site for more than $400 per square foot — twice as much as much as the owners paid a year ago.
“Our view is, how much further can you go up in price?” Hauspurg said. “Cap rates and interest rates can’t get any lower. This points to a bubble.”
Real estate mogul Richard LeFrak, owner of the legendary LeFrak City apartment complex in Queens, also sees a bubble on the horizon for elite Manhattan office buildings.
When it comes to trophy properties, “there’s a wall of money chasing that stuff,” LeFrak told CNBC in May. But not even he knows for sure if Manhattan is risking a true bubble, or if the market is simply recovering.
“We may be going back into a bubble,” he said, “or maybe the reality is that we have low interest rates, and this is what people will pay for these properties.”
Bubble on the horizon?
Macklowe’s acquisition of 737 Park will be the most expensive residential building purchased for a condo conversion since the Apthorp in 2007. And several other recent deals indicate frothiness in the market.
In May, for example, Manhattan-based real estate investment firm Zar Property reportedly purchased 1450 Broadway in Midtown for $204 million. That translates to $567 per square foot for the 43-story building. That’s some 42 percent higher than the price CB Richard Ellis paid for the property just two years ago.
Also in May, Kuwaiti investment firm Fosterlane Management bought 750 Seventh Avenue for $485 million. That puts the price at $845 a square foot, with a quoted cap rate of 4 percent, according to research firm Real Capital Analytics. Experts say that’s close to the prices paid for similar properties at the height of the market in 2007.
Low interest rates are fueling much of this activity, Hauspurg said, noting that buyers can still borrow at rates of 4.5 to 6 percent for office and retail property.
The rebound of the commercial mortgage-backed securities market, which started in 2010 and has picked up steam this year, also has sparked sales. CMBS will likely account for 15 to 20 percent of commercial real estate transactions in the nation this year, compared to almost none during the recession, according to Dan Fasulo, managing director of Real Capital Analytics.
“As soon as the CMBS market opened up again, everyone wanted prime assets,” said Dan Alpert, managing director of Westwood Capital, an investment bank based in Manhattan.
Meanwhile, real estate investment fund managers are eager to deploy their capital — as they’ve been itching to do for a while now. “They were on the sidelines thinking prices would go down further, and now they see them moving in the opposite direction,” Hauspurg said. “So they want to jump in before they have to give money back [to investors], or prices increase even further.”
There is indeed talk of higher prices to come. According to the New York Post, a seller at the Seagram Building at 375 Park Avenue is reportedly trying to unload a 49 percent stake for $2,000 a square foot, substantially higher than the record price per square foot for an office building, set at $1,585 in 2007 with the sale of 450 Park Avenue.
Skeptics weigh in
Still, some industry insiders predicted that current market factors will prevent a true real estate bubble from forming anytime soon. Alpert called the current market activity “over-exuberance.”
He said investors may be paying too much for deals now, but that’s only because so few assets have hit the market; the surplus of building supply currently being held on banks’ balance sheets will soon put an end to that.
“There are only a small portion of assets available … and too much money is chasing them,” Alpert said. “But there is a huge pile of assets behind that.”
Plus, the still-shaky economy and slow job growth can’t support further price increases, he said.
“Doesn’t anyone [paying high prices for buildings] put two plus two together?” he wondered aloud, adding: “Let’s hope they don’t lose their shirts.”
Marisa Manley, president of Commercial Tenant Real Estate Representation in Manhattan, agreed. “I see a great number of restraining factors,” Manley said, noting that the city’s unemployment rate still stands at a troubling 8.6 percent. “At this point, I don’t see the factors likely to continue driving property values higher.”
Another limiting factor is the continuing scarcity of credit. “The key for a bubble is reliance on credit and financing and overleveraging,” said Susan Wachter, a professor of real estate at University of Pennsylvania’s Wharton School. “Leverage isn’t at unsustainable levels now.”
Loan-to-value ratios are hovering between 60 and 70 percent, down from a peak of 80 to 100 percent at the zenith of the real estate boom in 2007.
These ratios “are starting to creep up,” said Fasulo of Real Capital Analytics. “We have seen some in the 70s during the last couple quarters.”
Still, “at least this time investors are using some of their own money,” he said. “I don’t think lenders will let it get crazy again.”