Seller’s Market for Area’s Commercial Real Estate
Investment dollars have been flowing into Southern California’s commercial real estate market this year, giving sellers reason to celebrate.
Offices, shopping centers, industrial buildings and apartments have been rapidly changing hands as institutional investors needing a dose of real estate in their portfolios bid against investment trusts, foreign investors and wealthy individuals looking for a tax break.
The pressure on some investors to buy real estate has created a market that favors sellers. Many of them are eager to cash out of properties they bought during the economic downturn that followed the collapse of the late-1990s tech boom and the 2001 terrorist attacks.
“Now is the time to take that profit and reinvest in other deals,” said C. Frederick Wehba, chairman of private investment firm BentleyForbes. “It’s such a great time to be selling.”
Los Angeles-based BentleyForbes, which is operated by the Wehba family, has just made $30 million on the $130-million sale of 21st Century Plaza in Woodland Hills to J.P. Morgan Fleming Asset Management, Wehba said. His firm bought the two office towers -- primarily occupied by 21st Century Insurance Group -- in 2001.
Odds are that the profit from the sale will be reinvested out of state.
“We love California,” Wehba said. “We just can’t find as much [real estate] as we would like because so many other people have the same idea.”
Although full-year numbers for the region aren’t available, analysts cite demand for L.A. County office buildings -- one of the most sought-after investments -- as evidence that the local commercial real estate market is doing well. Buyers will have spent more than $4.2 billion on office buildings in the county this year, twice as much as in 2001 and 6% more than last year, according to preliminary figures from real estate brokerage Cushman & Wakefield.
They’re paying more for them too. The average price per foot rose to $196 this year from $156 in 2003. Some of the highest prices have been paid for office buildings in downtown Los Angeles, where values hit $350 a foot this year. Woodland Hills has been the other popular neighborhood for office transactions.
The market’s fundamentals don’t necessarily justify the higher prices, some experts contend. Although office vacancy rates in downtown Los Angeles fell 2 percentage points to 17.3% in the third quarter, that’s still well above the 10% level that the industry considers an equilibrium. That is also true of L.A. County as a whole, where vacancy rates came down 2 percentage points to 15.5%.
The decline in vacancy rates wasn’t enough to boost office rents, which remained flat countywide.
One investor in office buildings who asked not to be identified called downtown L.A. “a sucker bet” because he didn’t believe buyers would be able to raise rents enough in the years ahead to justify current prices.
A lender’s representative evaluating the regional investment market put it more diplomatically.
“I would say the market is overvalued, based on historical comparisons of prices per square foot,” said Wayne M. Brandt, managing director of real estate finance for RBS Greenwich Capital in Los Angeles. Rental income is improving, he said, “but these cash flows are being overvalued by investors who have an abundance of capital to invest.”
Not everyone agrees. This month Broadreach Capital Partners paid ING Realty Partners $21 million for a five-story office building at 3330 Cahuenga Blvd. near Universal City that is less than two-thirds occupied. It was the third acquisition in Southern California in the last six months for the Palo Alto-based company, which opened a Los Angeles office this year.
“We are finding opportunities to invest in older office projects that we have been redeveloping,” said David Simon, Broadreach’s managing director for Southern California. “We’re able to do that at a much lower cost than building new construction.”
The local economy is on the upswing, Simon said, and investors like him want to be poised to take advantage of an improving business climate. He said Broadreach had $315 million to invest primarily on behalf of endowments for large universities and private foundations.
“Southern California is the driver in the West,” Simon said. “Clearly a regional fund in the Western U.S. has to have equity invested in Southern California.”
What Broadreach is doing is part of a trend among advisors for pension funds and endowments based in other cities to set up shop in L.A. County, said Richard Plummer, a senior director at Cushman & Wakefield. Other newcomers include San Francisco-based McMorgan & Co. and New York’s J.P. Morgan.
“There is a bigger pipeline of capital focused on Southern California now,” Plummer said. “And they have pressure to get the dollars out.”
Brisk real estate sales will continue as long as interest rates stay low, Brandt predicted, but he expects at least some institutional investors and real estate investment trusts to back away from the high-priced market. He thinks they’ll be replaced by wealthy individuals looking for group purchases or taking advantage of tax breaks that allow sellers to avoid capital gains taxes if they reinvest in other real estate quickly.
A national survey of commercial real estate investors by Marcus & Millichap Real Estate Investment Brokerage Co. found that nearly two-thirds of commercial real estate investors expected the economy to be stronger a year from now, compared with 37% who felt that way a year ago. Nearly three-fourths of them plan to boost their investment over the next 12 months by a median of 17%, compared with 13% in last year’s survey.
Commercial real estate remains in high demand despite uncertainties related to the slow economic recovery, trade deficits and turmoil in the Middle East.
“Those variables are actually encouraging the flow of capital into real estate,” said Harvey E. Green, chief executive of Marcus & Millichap.
