Will building buyers bust?

All over Manhattan and this country s urban centers, records are being set for purchases of commercial and residential properties.

A handful of private investors in New York City lead the ranks of envelope-pushing buyers, beating out publicly traded companies and real estate investment trusts with huge and lightning fast bids for marquee properties. But some market watchers (and competitors) wonder what might happen if interest rates start to rise or rents fail to increase or both.

The concern is particularly appropriate in the wake of strong indications by Federal Reserve Board Chairman Alan Greenspan on Feb. 16 that the central bank will keep raising short-term interest rates without any pause in the months ahead. While rates remain “fairly low” even after six consecutive increases, Greenspan said, the Fed s desire to sustain a measured approach to making capital more expensive points to the amount of risk new buyers are assuming.

So will the big-time buyers, who are now big-time landlords, go bust?

“Real estate has always been cyclical,” said real estate lawyer Andrew Herz, a partner with Patterson Belknap Webb & Tyler. “And depending upon what happens to inflation and interest rates, these buyers will either look like fools or geniuses.”

The current flood of capital trying to enter a real estate market marked by very limited supply means many private investors are snapping up commercial buildings with plans to convert their holdings to lucrative residential properties.

Woody Heller, executive managing director and group head in the capital transactions group at Studley, knows what happens if commercial property owners rents can t keep pace with the rising cost of borrowing.

“Who s left holding the bag? The people that own property,” Heller said. “And obviously, people that own property on a more highly-leveraged basis will have more exposure.”

This new class of property magnates may not have the household name recognition of Donald Trump, but developer Joseph Moinian and his sometimes associates, part of a group collectively known as “the New York guys,” are laying out bundles of cash for buildings all over the country. Other members of the small private group include Joseph Chetrit, David Werner, Lloyd Goldman and Jeffrey Feil.

Moinian and Chetrit were part of a group that bought the Sears Tower in Chicago last year, paying $840 million, and Werner and others bought a $400 million, 50 percent stake in the Bank of America building in San Francisco, also in 2004.

Closer to home, the endless list of properties purchased by Moinian alone or with various associates induces envy: 180 Maiden Lane for $355 million; 530 Fifth Avenue for $213 million; 95 Wall Street for $184 million; 1450 Broadway for $124 million; and 17 Battery Place North for $70 million.

Bold purchasing on the part of these mostly foreign-born investors Moinian is a Persian Jew who came to the U.S. in the late 1970s, and the group is linked by religion, if not nationality – has upped the ante and forced other potential buyers, like SL Green Realty Corp., Shorenstein Co. and Chicago magnate Sam Zell s real estate investment trusts, to cough up serious money or retreat to a more watchful stance.

Bruce McLean, a partner in the Milestone Group, a national real estate investment firm which would like to increase its New York holdings, believes a glut of capital aimed at the real estate market, at a time when interest rates remain — as Greenspan reminded the world fairly low, is fueling the feverish pace of buying.

“The low interest rate environment combined with improving fundamentals combined with currency movements and overseas capital movements has created the perfect storm in terms of pushing up real estate values,” he said.

The dominance of private investors has much to do with the free-flowing capital, especially from foreign countries, available in a borrower s market. Lenders are eager to get pieces of real estate transactions.

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Buyers with a healthy borrowing history are finding 100 percent financing for many properties, courtesy of primary lenders such as Washington Mutual and Fannie Mae, as well as private banks like First Boston and Wachovia with the assistance of daring mezzanine lenders who will provide a secondary mortgage. Traditional financing covers about 75 percent of these types of purchases.

“The lenders being the most aggressive are the mezzanine lenders, and because the interest rates on the first mortgages are so low, the mezzanine lenders can make a lot of money on the spread,” Herz said. “Some of them also would not mind it if they ended up owning the property.”

Private investors like Moinian can settle for a capitalization rate on properties cap rate being annual income expressed as a percentage of the purchase price that is much lower than that typically desired by real estate firms seeking to satisfy stockholders.

“You can t roll the dice when you have shareholders, or you will get sued,” Herz said.

But bidding wars have even driven down the cap rate historically sought by real estate investment trusts from 7 percent to 8 percent down to the 5 percent acceptable to private investors.

“I think that has come down,” McLean said. “REITs have become more aggressive as well. But they re not as aggressive as some of the private capital.”

Are high-flying private investors living on borrowed time? Some observers have raised questions about whether underlying rents will be able to support these exorbitant purchase prices. Others anticipate rents continuing to rise at a pace faster than interest rates.

“I think the influence of rents rising will have a more profound influence on the change in values than the impact of interest rates,” said Heller.

But some developers operating a move ahead on the chess board may be gambling on the fact that all those conversions may eventually lead to a demand for more office space.

“I would categorize the good investor as buying today s property in tomorrow s market,” said Asher Alcobi, founding president of brokerage Peter Ashe Inc. “The one that has the vision, and the one that can bring something to the table, would not hesitate to pay a little bit more at the prices of tomorrow to sell hopefully at the prices of next week.”

But if lenders lose their enthusiasm for real estate investments, that could shake up private investors. But that doesn t seem likely, experts said. The one thing to worry about is a correction to the market, said to be inevitable but always difficult to predict in terms of timing, perhaps spurred by some catastrophic event, along the lines of the 2001 terrorist attacks

“If alternative investments or asset classes suddenly became more appealing that would have a pronounced impact on values and pricing,” Heller said. “But at the moment, that doesn t seem to be the case.”

Nonetheless, some investors are waiting and hoping to swoop in on properties should the big buyers run into trouble.

“I don t know that we re necessarily poised as a kind of vulture,” said McLean of Milestone, referring to his firm s desire to make purchases in New York. “We have been aggressively looking to buy things, but we re typically outbid by people who apparently have more aggressive assumptions than we do.”

TRD

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