Stunning price tags for Manhattan properties, such as the recent $7 billion purchase of eight buildings by Harry Macklowe, are even more impressive when one factors in the number of years it could take for the deals to actually become profitable.
Historically, investors have looked to hold on to a building for at least five to 10 years. In that time, they would often make improvements and raise rents in order to increase cash flow and fetch a higher price when they were ready to sell. More recently, that’s changed: Buyers are tossing the conventional timeline out the window.
The sale of both 230 and 280 Park Avenue last month by Dubai firm Istithmar (a buyer better known for paying record prices for office towers), shows that other buyers are willing to pay prices that might require them to forgo profits for a long time. Monday Properties, Goldman Sachs and Broadway Partners are among those with a seemingly long time horizon for their investments. Or perhaps these investors are banking on the thesis that the commercial market is due for still more price increases, despite a heady run-up in values over the past several years.
Monday and Goldman paid $1.15 billion last month to buy 230 Park Avenue, approaching $1,000 a square foot, for the property Istithmar bought for $705 million two years ago. Broadway Partners — a New York-based real-estate investment firm, which has been on a buying spree lately in the city — agreed to pay a little more than $1.2 billion for 280 Park, or more than $1,000 a square foot, according to the New York Observer.
Istithmar purchased the building in June for a flat $1.2 billion.
Caviar prices
In the Macklowe deal, the buildings were acquired in February from the Blackstone Group. The purchase included the Park Avenue Tower at 65 East 55th Street and 1301 Avenue of the Americas, which Blackstone had just acquired from Equity Office Properties.
Dan Fasulo, director of market analysis for Real Capital Analytics, a New York research company, said the purchase price — an average of $1,142 per square foot — was the highest ever for a single portfolio. That figure is topped only by the $1,200-a-square-foot price for 666 Fifth Avenue at the end of 2006.
Some of the bigger deals are said to have had capitalization rates as low as 3.5 percent. At that rate, the buyers must believe that they can make the buildings profitable through raising rents, “or else are willing to sit with low returns for a long period of time,” Fasulo said.
“If you are willing to accept that initial rate of return on a property, it’s based on expectations of future rent growth,” he said. “If not, why would you buy at 3.5 percent when you could buy U.S. treasury bonds at 5 percent?”
The sales price of office space in Midtown currently averages $674 per square foot, up 50 percent from $449 per square foot in 2005 and up 85 percent from $364 per square foot in 2002, according to Real Capital Analytics. Cap rates for many Midtown office buildings are below 5 percent — and are sometimes in the 2.5 to 4 percent range.
“There is a gigantic pool of money that wants to be in real estate no matter what the cost,” said Peter Hauspurg, chairman and CEO of Eastern Consolidated. “We thought the last run-up was going to be the end, but then the office market took off and people keep projecting increases. In a way, they are buying futures at $1,000 a foot.”
Gulf buyers
Middle Eastern buyers in addition to Istithmar have figured prominently in the rising price of Manhattan buildings. In one example, Fosterlane, the Atlanta-based investment arm of the government of Kuwait, paid Vornado Realty Trust $542 million, or $1,007 per square foot, for 350 Park Avenue at the end of 2006.
“Middle Eastern buyers have an abundance of cash,” said Craig Evans, senior managing director and member of the investment services group at Colliers ABR. “They are looking out a generation; that’s when they are going to want income from those investments. They don’t need a current return.”
But in a surprise to the New York real estate community, Istithmar’s sale of 230 and 280 Park Avenue was a change of course for a company that had made a half-dozen huge acquisitions in the city in the past two years, including twice setting records for the priciest hotel purchase in city history — first with its buy of the W Hotel in Union Square, and later with the purchase of a stake in the Mandarin Oriental in the Time Warner Center.
Rising rents
How long it takes for investors like Macklowe to benefit from rising rents of course depends on how quickly rents go up. Where the market is going is hard to pin down, but the recent trajectory of rent increases may justify their bets.
From the first quarter of 2006 to the first quarter of 2007, average office rents in Manhattan have increased 23.7 percent to $53.43 per square foot, according to Cushman & Wakefield. Class A Manhattan office rents reached an all-time high of $70.77 a square foot, according to the firm.
“When they are putting together pro forma estimates on future value of properties, they are forecasting increases in rents to justify their acquisitions,” Fasulo said. Although in certain cases the forecast may be a tad too bullish, buyers who are most familiar with the Manhattan market will probably do well. Macklowe, in particular, is well-positioned to make the sky-high numbers work, Fasulo said. Macklowe bought the GM Building from Conseco in 2003, for $1.4 billion, which was the highest price paid for a building in North America. Since then, rents in the building have risen as high as $175 a square foot.
“I think Macklowe is in a very unique position to capture added value,” Fasulo said. “There’s no one writing as many $100-a-square-foot leases as Macklowe.”
Business drivers
Prices in Manhattan are benefiting from age-old supply-and-demand issues, as well as the fact that New York is increasingly being put in the same basket as other cities where there is little room for new development, such as London, Paris and Tokyo.
“There is strong demand and little supply coming online in Manhattan,” said Steven Kohn, president of Sonnenblick-Goldman LLC. “The only pockets of new construction are in Downtown — with the redevelopment of the World Trade Center site — and in the Times Square area. In addition, replacement costs have skyrocketed, providing further comfort to owners of existing buildings. Global investors are attracted to these market conditions.”
Of course, if something changes that makes buying in Manhattan less attractive, investors who wanted to take advantage of quickly escalating values might have a more traditional wait for strong returns.
“If the market went south and people had purchased predicated on the expectation of future [rent] growth,” said Woody Heller, executive managing director and group head of the capital transactions group at Studley, “they’ll need to wait until this cycle is over before being in a position to recognize the returns they had projected.”