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As seen in
January 10, 1999
Commercial Property
After a Roller-Coaster Year, Optimism
for 1999
Fundamentals strong, executives say, and
'99 outlook is good.
by JOHN HOLUSHA
Real estate executives used words like "frothy", and
"giddy" and "frenzy" to describe the investment
market in the New York area during the first half of last year.
Fueled by a seemingly unlimited amount of capital from Wall
Street, real estate investment trusts and private operators
bid against each other for available properties, driving up
prices.
Today, the froth has flattened and nobody is feeling very giddy.
At the same time there is little gloom.
Although the capital markets took the industry on a roller-coaster
ride last year, the fundamentals of the commercial real estate
business remain strong and most executives are optimistic about
the coming year.
"We are at the top end of a real estate cycle, so 1999
should be a good year, but not a spectacularly good one,"
said Dennis Yeskey, Managing Director of the real-estate services
group at Deloitte & Touche, the accounting and consulting
company.
Michael T. Cohen, President of Williams Real Estate, said that
"what we saw last year was a historic disconnect between
the rental and sales markets." Mr. Cohen said that commercial
rents remained strong even as the prices of properties fluctuated
in response to activity in financial markets.
"The good news," said Raymond G. Torto, a principal
in Torto Wheaton Research, an economic analysis firm specializing
in real estate, "is that real estate has made it in capital
markets," allowing financing to be raised by public stock
and bond offerings.
"That is also the bad news," he added, noting that
events in foreign countries can affect projects and prices in
the United States, regardless of local market conditions.
Real estate investment trusts, known as REIT's, were the first
to feel the market's sting, as disenchanted investors drove
the prices of their shares down, preventing the REIT's from
selling more shares to finance a continuation of their buying
binge. The overall stock market also took a sharp lurch downward
in August, raising fears of layoffs in financial-services companies.
Those worries have not entirely evaporated despite the market's
strong showing in recent months.
"We saw that public markets for real estate are quick to
go down and slow to recover," said John I. Bralower, the
President of Sonnenblick-Goldman, a real-estate finance company.
"The underlying market for the properties did not go down
as much as the stocks."
Meanwhile, recessions in Asia, currency problems in Russia and
the near-collapse of a huge American hedge fund shook up the
bond market in this country, leaving Wall Street firms unable
to convert the mortgage loans they had already purchased into
securities.
With the widespread uncertainty about the future pricing of
mortgage-backed securities, liquidity dried up and sales ground
to a halt.
Properties that had been for sale were withdrawn from the market
because of uncertainty and declining bids. According to Insignia/ESG,
a real estate brokerage and service company, properties that
were pulled off the market included the 1.5 million-square-foot
building at 450 West 33rd Street, the 1.1 million-square-foot
structure at 237 Park Avenue at 45th Street, and the million-square-foot
building at 450 Lexington Avenue, at 45th Street.
One transaction that did close reflects the abrupt drop in pricing.
The Witkoff Group acquired the Woolworth Building, at 233 Broadway,
for $133 million after having successfully reduced its original
- and accepted - bid of $157 million. The seller was Venator
Group, the successor to the old Woolworth Corporation.
All the time the capital markets were churning, most of the
real estate fundaments were strong, with office vacancies low
and rents stable or climbing. According to a year-end report
prepared by CB Richard Ellis, a brokerage company, the overall
office vacancy rate for Manhattan was 5 percent, with the Midtown
North subdistrict, generally defined as 32nd to 59th Street,
river to river, down to 3.2 percent availability.
Asking annual rents for all classes of multi-tenanted commercial
buildings in Manhattan reached $36.60 a square foot in the fourth
quarter, according to the report, compared to $29.96 at the
end of 1997. Brokers reported that some prime buildings in key
locations, such as 9 West 57th Street and the General Motors
building at 767 Fifth Avenue, were fetching as much as $70 to
$75 a square foot.
Because of these strong fundamentals, most real estate leaders
say they are cautiously optimistic as they head into 1999. The
relative lack of new construction in Manhattan will keep office
rents high, they say, although builders in New Jersey are betting
those rates will drive some companies to their developments
along the Hudson River waterfront.
Meanwhile, new industries, most of them computer-related, are
growing in Manhattan and injecting new life into what had been
declining post-industrial neighborhoods, such as the garment
manufacturing buildings in the teens between Fifth and Sixth
Avenues and the old printing buildings near Hudson Square on
the west side.
The companies in these new industries are contributing to the
numbers and pace at which new leases are being signed. "Leasing
velocity over the last two years has been 25 to 30 percent better
than the best years in the past," said Stephen B. Siegel,
the President of Insignia/ESG.
Mr. Siegel said he expected the pace to decline somewhat in
1999, but added that some large space users, including the NASDAQ
stock trading operation and the German-based publishing company
Bertelsmann, are actively looking for new quarters.
Liquidity will return to the market, real estate executives
say, as Wall Street firms sell their portfolios of existing
loans and start looking for new business. "People talked
about a capital crisis," said John D. Lyons, Chief Executive
of Granite Partners, a real estate financing firm. "People
were not lending because they did not know what price to lend
at."
He said that one result of the crunch is that money is more
expensive for acquirers and developers than it was. He said
that interest rates are 2 to 2.5 percent above Treasury securities
with a similar maturity, compared to 0.8 to 1.0 percent above
during the summer. But he said that was still more favorable
than the 3 to 3.5 percent premiums that prevailed three years
ago as the market was developing.
At the height of the crunch in October, he said, lenders were
demanding rates of up to 7.50 percent, regardless of how low
the rates on Treasury securities fell.
Higher interest rates and the need for buyers to put up more
equity capital means that the prices paid for property are expected
to be somewhat lower than the first half on 1998.
"The return on equity is higher than debt," said Barry
Gosin, the Chief Executive of Newmark & Company Real Estate,
explaining that stockholders want more income for their greater
risk than the relatively more secure bondholders.
Mr. Gosin said if a purchaser has to put up 30 to 40 percent
equity - rather than the 5 or 10 percent that was sufficient
when money was flowing out of Wall Street - it limits the ability
to bid. "You have to pay less for properties," he
said. "It's that simple."
Mr. Gosin said that prices appeared to be down 10 to 20 percent,
although not many transactions have closed since the bond market
crunch began in the Fall.
Some real estate executives say the markets have functioned
as they are supposed to, cutting off funding before too many
people joined the party. "The capital markets exerted discipline
and prevented overbuilding," said Mitchell Hersh, the President
of Mack-Cali Realty, a New Jersey-based REIT. "It is usually
supply that puts markets out of balance."
The furious pace of the first half of 1998 may have contributed
to the slowdown in the later months, said Thomas L. Benneville,
Managing Director of LaSalle Partners' investment banking group.
"A lot of guys in my business had the year in the bag by
July," he said. "So when the markets got hit, they
had no reason to move quickly."
But he predicted that sales activity would pick up quickly this
year. "The real estate fundamentals are still good,"
he said, "and you have to eat in '99, too."
Others agreed. Darcy Stacom, an investment sales specialist
at the Cushman & Wakefield brokerage company, said that
the Wall Street firms started getting back in the market late
last year and that she expected sales to be brisk early in the
year. "We are going to see a lot of product for sale in
the first quarter," she said.
One sale that closed late in the year was that of Exchange Place
Center, a 700,000-square-foot waterfront office tower in Jersey
City for $175 million. The building was purchased by BBV U.S.
Real Estate Fund III, a German investment group, from Prudential
Real Estate Investors.
In the leasing market, brokers say they expect the landlords
in New York to continue to have the upper hand, but few are
predicting sharp increases in rent.
"There have been better times
to be a tenant," said James Meiskin, the President of Plymouth
Partners Ltd., a tenant's representative. "Rents will go
up marginally, but you will see less free rent, less work and
tougher lease terms," he said, referring to provisions
that give tenants a period of no rent and require landlords
to contribute to renovation costs.
But some brokers say that summer's dips
in the stock market have cooled the demand for space. "During
the summer there was an intense frenzy for every piece of space,"
said Mitchell Steir, an Executive Vice President of the Julien
J. Studley brokerage company. "That has leveled off. Now
the landlords do not have two backup deals for every bit of
space."
Although the decline in the price of REIT shares sharply slowed
their pace of acquisition, it did not prevent Reckson Associates
Realty Corporation from becoming the second of the suburban-based
REIT's to enter the Manhattan office market. The first was Vornado
Realty Trust, which acquired the Mendik Company's midtown portfolio
in early 1997.
Reckson reached agreement to acquire Tower Realty, a Manhattan-based
REIT with seven buildings totaling 2.3 million square feet,
including Tower 45 at 12 West 45th Street.
The original plan was for Reckson to be an equal partner with
Crescent Real Estate in an acquisition vehicle called Metropolitan
Partners. But when Crescent pulled back, Reckson went ahead
with the acquisition for a total of $680 million in cash, stock
and assumption of debt, with Crescent remaining as a passive
investor.
Scott Rechler, the President of Reckson, described the acquisition
as a strategic one for the company, which already has properties
on Long Island, in New Jersey and in the area north of New York
City.
A report by CIBC Oppenheimer, a securities brokerage and research
firm, on the deal said that "with Reckson having established
a dominant position as an owner/operator of office and industrial
real estate in the suburban New York market, the Tower acquisition
appears to be a natural extension to fill a geographic void
in its portfolio." But it warned that Reckson needed to
find managers for the Tower properties who are both savvy about
the Manhattan market and able to participate smoothly in a suburban-oriented
company.
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