The Real Deal Miami

Cap rates could reach late-1990s levels

By Roger Drouin | March 03, 2009 12:49PM

When CBRE Investors snatched up West Palm Beach’s signature Esperante office building for $67.6 million in December 2008, it paid $36.4 million less than the building’s previous sale price of three years earlier.

The Class A office building sold at a cap rate, the annual rental income from a building divided by its purchase price, of 9.6 percent. Other South Florida sales are bringing up cap rates significantly from the boom years. Since December, the average cap rate for office transactions was 7.8 percent, compared to cap rates in the range of 5 to 6 percent or lower in 2005, according to market analysts and sales transactions records.

Cap rates will continue to jog upwards as long as purchase prices continue to fall and rents remain relatively flat, analysts said.

“In the late 90s, the average was an 8.5 percent cap, and we could see that again,” said Charles Foschini, vice chairman at CB Richard Ellis. “We will see that again.”

In the current credit crunch, investors rarely get loans based on bullish rent growth projections. A deal could go through with a cap of 3.5 percent in the past and debt at 6 percent, but higher rates are now an integral part of whether financing happens.

“Certain fundamentals were not really looked at over the past few years — especially in places like Miami that don’t have a lot of land. People just expected that property to increase,” said Richard Schuchts, senior vice president at Jones Lang LaSalle who has 12 years experience in the South Florida market. “Now we’re getting back to fundamentals.”

National cap rates for office sales rose 80 basis points since the onset of the credit crunch, and first climbed above 7 percent in mid-2008, according to Real Capital Analytics. It said the average Miami cap rate was 6.4 percent in 2008.

Available office space is scarce in downtown Miami, so Foschini sees both purchase prices and rents increasing once the economy starts to recover. Some buildings with 100 percent occupancy are selling with cap rates above 7 percent. A case in point is the Miller Legg Center, in Hollywood, that sold with a 7.9 percent cap rate in December 2008. Wachovia Financial Center, the 55-story trophy tower in downtown Miami, also changed hands in December, with a 6.9 percent cap rate when Macquarie sold its 50 percent stake.

Buyers such as global real estate investment firm CBRE Investors want to seize the potential for greater returns on investments. The mix of lower purchase prices is offset by having to put more cash down, or in the case of the Esperante deal, pay all cash.

With investors unable to leverage the property the way they would have in 2005, the return on “cash investment” plummets, Schuchts said. Making the deal riskier, buyers also face the prospect of tenants not renewing leases or going bankrupt.

“Investors don’t know how many tenants will leave or go bankrupt,” said Dan Fasulo, managing director at Real Capital Analytics. “So they are looking for higher cap rates to give them a cushion in case the unforeseen happens — understandably so.”

While bidders are active, their bids are coming in as high as 30 percent less than the asking price, Fasulo said.

The dearth of transactions — four office and two apartment sales over the past five months — shows that most sellers are not willing to accept cap rates in the 6 to 8 percent range.

“The buyer thinks it should be at X and the seller thinks it should be at Y,” Fasulo said. “Never have I seen the difference wider.”

Prospective buyers are also looking closely at vacancy rates.

“Two years ago, investors would look at vacant space at an opportunity because they knew [they] could lease it out at a higher rate after they purchased the property,” Foschini said. “Now most people look at vacancy as a problem.”