Go to charts: Tallying up the deals
Developer Harry Macklowe ceded his prized General Motors Building to lenders after defaulting on a loan for a $7 billion purchase secured with just $50 million down, a defeat that made him the poster boy for the hazards of exorbitant debt in a credit crunch.
Real estate analysts believe he won’t be the last to lose a Manhattan trophy tower purchased in the heady days of 2006 and 2007.
Although many indicators used in commercial real estate, such as vacancies and asking rents, are often seen as lagging indicators of the overall economy, investment sales, as illustrated by the Macklowe trades, provide a more sensitive indicator of market conditions.
Recent CB Richard Ellis data showed office vacancies remained low at 5.8 percent and asking rents stayed near all-time highs at above $71.
But investment sales for the year through Sept. 1 plunged by more than 60 percent from the year-ago period, according to data from Real Capital Analytics. In that time the easy money provided by private funds retreated by 80 percent and the average capitalization rate on office buildings — the expected annual rate of return on the investment — began rising for the first time in four years, the data showed.
To understand the effect of the altered credit landscape on investment sales in Manhattan, The Real Deal analyzed data provided by Real Capital Analytics covering the first eight months of 2008 and compared it to the same period in the years 2004 to 2007. The data do not include the recent Wall Street turmoil of September and October, when the market effectively seized up for investment sales greater than $50 million.
Although the Wall Street credit market essentially shut down in September for large deals following the bankruptcy of Lehman Brothers, borrowing had begun to freeze up more than a year earlier in mid-2007, the data showed.
The top buyer in 2007 was the top seller, of sorts, in 2008. Harry Macklowe lost the GM Building at 767 Fifth Avenue, which he had used as collateral for his highly leveraged purchase of seven Equity Office Properties buildings for $7 billion. To pay off lender Deutsche Bank, he sold off six buildings that ranked among the top 10 sales of the year, including the GM Building, the Credit Lyonnais Building and Two Grand Central Tower.
Peter Hauspurg, chairman and chief executive officer of Eastern Consolidated, said additional properties owned by other companies that bought them with a great deal of leverage will likely be sold under duress over the next year.
“We have known Harry for 25 or 30 years, and he is a gunslinger. He has always had remarkable success … but timing can kill you. He got caught when the music ended and he did not have a seat,” Hauspurg said. “He is the poster child, but anyone who bought highly leveraged” would face similar pressure, he said.
One clear effect of the credit squeeze was the 63 percent drop in office building sales this year. The data showed a steady rise in sales from $8.03 billion in 2004 to $11.48 billion in 2006, followed by a surge of 176 percent to $31.69 billion in 2007. This year, sales fell back to $11.59 billion.
The number of Manhattan buildings worth more than $5 million traded this year also declined from last year, from 116 to 69, the lowest number in at least four years.
The volume of investment sales in all classes of property types was off around 60 percent, down from $42.97 billion in the first eight months of 2007 to $17.2 billion this year.
Jeff Baker, executive managing director at investment banking firm Savills US, said sales declined in large part because of the scarcity of debt and the collapse of the commercial mortgage-backed securities market. He expected the slow sales to continue.
“The decrease was somewhat exacerbated in the second half of the year,” he said, adding that a wide spread remains between bid and ask prices. “We are seeing buyers and sellers pretty much sitting on the sidelines unless they are forced to do something.”
Another change was a shift in buyer profiles. In 2007, funds such as Fortress Investment Group and City Investment Fund accounted for more than a third of the total $42.97 billion spent on all property types. But this year fund spending declined by 80 percent to $2.78 billion, making up 16 percent of the purchasing power. In 2008, it was real estate investment trusts (REITs) that have spent the most money on sales, accounting for $4.1 billion.
Foreign buyers, such as the Abu Dhabi Investment Council, which bought a stake in the Chrysler Building for $888 million this July, had the smallest decline year over year, dropping just 18 percent to $3.92 billion.
It will be individual, veteran investors who do the bulk of the buying in the next cycle, said Hauspurg.
“Individual investors who have been here 20 or 25 years, private local guys, maybe foreign [buyers]. Those guys are starting to look and say, ‘These prices are starting to return to something I can understand,'” he said.
But Robert Knakal, chairman of commercial brokerage Massey Knakal Realty Services, did not see overseas investors playing as significant a role now.
“There is a big misconception … that foreigners are driving the market. Foreign economies are worse than ours. We see foreigners, but in a much more limited way than in the past few years,” he said.
Craig Evans, senior managing director of institutional sales at Colliers ABR, said pension funds might have to sell some real estate because of statutory regulations setting an upper limit on such holdings. As the value of the equity portfolio declines, the real estate portion may grow higher than the cap.
Within the New York State Common Retirement Fund, real estate makes up about 6 percent of the portfolio but is part of a group of so-called alternative investments that can make up to 25 percent of the total, said a spokesman for the state Comptroller’s Office, which manages the fund. He said no move has been taken to sell real estate assets, despite an estimated 20 percent decrease in the fund’s overall value since April, according to figures reported last month.
Although the majority of money invested in Manhattan real estate is in office properties, the percentage has fluctuated widely since 2006. That year, some 56 percent of the total $20.67 billion spent was to buy office buildings. The following year, 74 percent of the money invested in Manhattan property was in office buildings, totaling $31.68 billion. Last year the share declined to 67 percent, while apartment buildings and retail properties attracted relatively more dollars.
The percentage of building sales valued above $500 million grew steadily from 11 percent in 2004 to 44 percent in 2008. But trades in that range have nearly halted in the fourth quarter as financing dried up, experts said. Trades below $50 million have continued at a reduced pace.
Relatively more money was spent on sales under $50 million in 2008 compared to 2007, although sales in the range fell by 45 percent to $3.8 billion.
Knakal attributed the relative strength of the lower-end market to regional banks that keep loans on their balance sheets, known as portfolio lenders.
“A big part is that portfolio lenders have a high comfort level up to $35 million,” which would allow a loan-to-value ratio in the 60 percent range, where most lenders are today, he said.
While lenders were demanding lower loan-to-value ratios this year, another metric, capitalization rates, was creeping up. Cap rates, the net operating income of the property divided by its value, in office properties had fallen from 7.2 percent in 2004 to 4.9 percent in 2007, reflecting a more optimistic valuation of future rents and overall property values. That view changed this year, and the average cap rate rose to 5.1 percent.
Brad Gordon, senior project director in asset management and acquisitions at real estate owner and manager Time Equities, said his firm was demanding even higher cap rates in order to make an investment, a shift undertaken in the past six months.
“Whereas before it was mid-5 [percent range], now it’s the mid-6 to low 7 [percent range]. It is increased risk and increased cost of debt,” he said, explaining the recent rise.