Southland Office Sales Up 60% Over 1996

With Wall Street-backed real estate investment trusts and institutional investors leading the way, real estate investment activity skyrocketed in Southern California last year as buyers poured about $3.2 billion into office property acquisitions in Los Angeles and Orange counties--nearly 60% more than in 1996.

Not only are investors acquiring more Southland office properties, they’re also buying bigger buildings and paying more for them, according to a survey just released by brokerage Cushman & Wakefield Inc.

“We’re finally in that rare ‘sweet spot’ in the [real estate] investment market cycle where buyers are comfortable that values will continue to rise, while many owners think the market is near its peak and are willing to sell,” said Richard J. Plummer, a veteran Los Angeles office investment broker who compiled the survey.

The survey examined sales of office buildings with 50,000 or more square feet that didn’t trade hands through “sister company” transactions or in large, multi-property portfolio sales.

By far the sweetest spot for office building sales is the Westside, where rents have recovered sharply as strong tenant demand has absorbed much of the space emptied during the early-1990s recession. Investors snapped up 39 Westside buildings, spending $1.75 billion--more than half the total spent in Los Angeles and Orange counties.

Also attractive to investors were Orange County and the San Fernando Valley, which are experiencing relatively strong recoveries. But the still-struggling downtown L.A. financial district saw only two major buildings trade hands last year, a reflection of stubbornly depressed rents.

Plummer said he expects to see more activity downtown this year, as illustrated by the expected sale of the Figueroa Plaza complex. He said he is surprised by the dearth of sales in the low-vacancy Burbank and Glendale areas, which saw only a handful of office buildings trade hands last year.

Also slow was Long Beach, where suburban buildings proved more popular than the city’s downtown district, which continues to recover from its early-’90s slump.

But the sheer volume of activity was noteworthy. As the local economy pulled out of the recession and real estate capital markets opened up again after several sleepy years, commercial real estate investment activity in the L.A. area began taking off in 1995.

Office acquisitions had remained remarkably slow during most of the 1990s, with aggregate sales in L.A. County typically totaling well below $500 million annually from 1991 to 1994. The pace began to pick up substantially in the middle of the decade, with activity nearly doubling in 1995 and again the following year, before jumping by about another $1 billion to approximately $2.76 billion last year. In Orange County, investors spent $485 million, doubling the previous year’s total.

Buyers are apparently focusing on large buildings, Plummer said. Although the number of L.A. County office buildings sold rose only 5% last year over 1996, the aggregate dollar amount spent jumped about 57%.

Sales of certain major properties--including two of Century City’s most visible landmarks--highlight the movement toward larger transactions. Institutional investors advised by a J.P. Morgan & Co. affiliate bought the twin Century Plaza Towers complex for about $485 million in early April. And late in the year, a group headed by financier Marvin Davis, one of the towers’ original developers, acquired nearby Fox Plaza for $253 million.

Property values are rising too. Over the course of 1997, prices that local Class A buildings fetched--on a per-square-foot basis--rose between 15% and 25% for downtown L.A. high-rises to as much as 40% for top Westside and Orange County properties.

Driving sales is the fact that investors--with some exceptions--can still acquire regional office buildings at prices below what it would cost to develop them today. However, Plummer noted that some trophy-type buildings in top locations have actually fetched prices beyond those so-called replacement costs.

Nationwide statistics indicate that property is appreciating faster here than in other large metropolitan areas. The recently released CB Commercial National Real Estate Index notes that the prices for Class A office properties in central business districts around the country typically rose by 12.4% last year, with rents rising an average of 11.6%. For Class A suburban commercial buildings, the sales price gains averaged 14.3%, with rents typically climbing 9.6%.

Profiles of property buyers reflect a national trend. The C&W; survey clearly illustrates Wall Street’s aggressive push into commercial real estate in the Southland. Publicly traded REITs--cash-flush real estate investment trusts in particular--were by far the most active buyers, snatching up more than a third of the buildings sold last year as they invested about $1.3 billion in L.A. and Orange counties.

As Plummer and others noted, Beverly Hills-based Arden Realty led the REIT charge with several noteworthy single-property and portfolio acquisitions. Menlo Park, Calif.-based Spieker Properties also staged a major assault on the Pasadena marketplace, Orange County and the Westside, while El Segundo’s Kilroy Realty closed a number of acquisitions stretching from Orange County to Calabasas.

On the national level, REITs, which are thought to have been involved in about half of all income-property sales last year, acquired $15.6 billion worth of office buildings during 1997, according to the latest Investment Property & Real Estate Capital Markets Report, published by Institutional Real Estate Inc. Nearly a third of the REIT investment activity was in office buildings.

In fact, the two most active buyers of office buildings nationwide in 1997--together investing about $4.4 billion--were a pair of REITs that recently merged, Chicago investor Sam Zell’s Equity Office Properties and Boston-based Beacon Properties. Both were active in the Los Angeles area last year, with Equity Office acquiring downtown’s 550 S. Hope high-rise and Beacon acquiring Westwood’s Oppenheimer Plaza after purchasing its sister Saban Plaza late the previous year. With the merger, Equity Office also assumed Beacon’s ownership of the $150-million Media Center office complex, which local developer J.H. Snyder Co. is developing in the Burbank Media District.

Two other investor categories accounted for the bulk of last year’s purchases, with each acquiring more than $900 million worth of local office buildings. Private real estate companies and entrepreneurial investors spent nearly $970 million, while institutional investors such as pension funds and insurance companies followed at just under $920 million.

Pension funds were also active buyers around the U.S., choosing office buildings for 43% of the $9.9 billion they spent on property acquisitions in 1997, according to Institutional Real Estate Inc.

Plummer said he found the absence of two types of investors in the 1997 survey particularly noteworthy. After a period in which Asian investors snapped up several local office buildings and hotels, offshore buyers acquired just two substantial local office properties last year--probably reflecting the economic troubles back home, Plummer suggested.

And “users”--or building tenants--represented less than 1% of the activity last year. During the deepest years of the recession, several users took advantage of depressed values and bought properties for their own use and investments, Plummer said.

Even though the vast bulk of local offices are trading at prices below the cost of developing a similar property today, the aggressive investment activity does entail risk--particularly considering that office rents in some parts of L.A. might not increase as much as investors are anticipating.

Los Angeles wasn’t among the top 10 markets measured by the CB Commercial index of overall rent and value escalation in office, retail, industrial and apartments in 1997. Nor does L.A. rank among the top 10 performing office markets cited in E&Y; Kenneth Leventhal’s recently released study, which is based on expectations for the next five years.

But California’s other big markets--San Francisco, San Diego, San Jose-Silicon Valley and Orange County--made both top 10 lists.

Some buyers appear to have greater expectations than others about prospects for higher rents, said Steve Solomon, a vice president with commercial real estate brokerage Seeley Co. who has negotiated several large local office building sales over the last two years.

An institutional investor’s recent acquisition of a Brentwood office tower for $325 per square foot “doesn’t make a lot of sense” unless rents in that district keep climbing until they reach $3.50 or $4 per square foot monthly rental value, which is far from assured, Solomon said. However, Marvin Davis’ acquisition of Fox Plaza in Century City at closer to $340 per foot may be something of a bargain considering that monthly rents in top Century City high-rises are already approaching the $4-per-square-foot mark, he added.

But although some investors are clearly buying on the basis of anticipated, rather than current, rent levels, some locations are already surpassing expectations, Solomon said. Some of the better buildings in the El Segundo and Marina del Rey areas, for example, have seen rents jump 20% to 30% over the last year.

But as investment broker Bob Safai of Madison Partners in Santa Monica noted, a surge in development or an upward spike in interest rates could significantly reduce the returns investors are now seeing on their local office building acquisitions.

Santa Monica alone may see as much as 1 million square feet of new offices developed over the next year or two, potentially dragging down rents in competing buildings. And, as unlikely as an interest rate hike seems today, REITs and other investors would see their returns diminish and probably reduce their acquisitions activity if one does occur, Safai said.

But the most active buyers will probably continue buying up L.A. offices and other income properties for at least another year or two, targeting locations they’ve previously avoided, now that opportunities in the favored districts are drying up.

“Central business districts aren’t in the mission statements of most REITs, but I think downtown is probably the next wave for the more opportunistic buyers,” Safai said. “And they’ll probably also be active in tertiary markets like Hollywood and other areas east of Beverly Hills.”

Solomon also senses that investor interest in the region remains high.

“I get calls every week from institutional-type buyers from outside California who want to get into the market here,” he said.

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Real Growth

Investors, led by real estate investment trusts, spent $3.2 billion last year on office properties in Los Angeles and Orange counties. The breakdown by investment source:

REIT’s: $1.3 billion

Investors: $976.1 million

Realty advisors: $918.1 million

Users: $25.7 million

A Real Jump in REIT Investing

The $3.2 billion spent last year on office properties in Los Angeles and Orange counties reflects a nearly 60% increase over 1996 and a huge increase over the recessionary early 1990s. Office buildings on Los Angeles’ Westside were the most sought-after.

1997 Investment Activity (in billions)

Downtown Los Angeles / Mid-Wilsher / Hollywood

Westside

Southbay

San Fernando and San Gabriel valleys

Orange County

Note: Inestment by users of the real estate occured in all segements but never exceeded 2.6% of total investments in that area.

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1997 Sales in Los Angeles County

Aggregate Sales (in billions)

1997: $2.76 billion

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Number of Transactions

1997: 110

Source: Cushman & Wakefield