11/20/08

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Office sales breaking the bank in Manhattan

5 Times Square

Earlier this year, when there were only two deals for major Manhattan office buildings priced above $1,000 per square foot, they might have been flukes. No longer.

The market has now seen six such transactions in 2006, including a $1,009-per-square-foot deal for 350 Park Avenue and the record $1.28 billion -- or $1,163-per-square-foot -- deal for 5 Times Square just last month. Manhattan's roaring investment sales market has clearly established an eye-popping new high. Capitalization rates, used to measure income streams in commercial properties, are now hitting record lows of under 4 percent.

The smashing of the $1,000 ceiling for major properties kicked off in June when Boston Properties sold a 1.18-million-square-foot office tower at 280 Park Avenue to the Dubai-based investment holding company Istithmar for $1.2 billion, or $1,018 per square foot. Also in June, Istithmar announced a $300 million, or $1,007-per-square-foot, purchase of 6 Times Square, former site of the Knickerbocker Hotel.

"Prior to the purchase by Istithmar of 280 Park, no large, previously leased office building had sold at a cap rate below 4 percent or a price above $1,000 per square foot," notes Woody Heller, executive managing director at Studley. "Now we have a new trend."

In other circumstances, these numbers would signal that the market was reaching a peak. Only three years ago, the General Motors Building became the most expensive skyscraper in America at the time, crossing the then-stratospheric $800-per-square-foot mark in a $1.4 billion deal by Macklowe Properties.

The sentiment at the time was that such gonzo growth levels were unsustainable, especially against the backdrop of an expected slowdown in returns on real estate nationwide.

Instead, many investors and brokers expect sales of trophy office buildings in Manhattan to continue at these levels and even to achieve new heights. Market watchers point to a host of factors that sustain buyer appetites for the best Class A office buildings. The high cost of construction, low vacancy rates and, most importantly, high rents all point to a longer boom.

The average asking rent for Midtown Class A available space was $73.95 a square foot in October, a 5.2 percent gain from the prior month -- and an increase from the previous record reached in August, according to Colliers ABR. For all of Manhattan, October average asking rents for Class A space also reached record levels, hitting $63.26 per square foot, the highest month-over-month gain in at least 15 years. Meanwhile, Class A vacancies in Midtown fell to their lowest levels since March 2001, according Colliers.

"Most investors perceive the office rental market as still having a lot of growth prospects," says Steve Kohn, president of real estate investment bank Sonnenblick-Goldman. "Low debt costs combined with a rising rental market means you end up with the prices we're seeing."

Despite widespread expectations of further growth in sale prices and rents, some insiders sound notes of caution. A recession or stock market slump could crimp business expansion plans, derailing demand for office space. In addition, some observers feel that the prices of recent office deals have simply gotten too rich.

"The market looks too frothy and probably nears a peak," says the section on New York City in Emerging Real Estate Trends 2007, a recent report by the Urban Land Institute and PricewaterhouseCoopers. Based on a survey of more than 600 industry experts, including developers and investors, the report forecasts an overall slowing of the American commercial and multifamily real estate market next year.

Some sellers are looking at these sky-high prices and are being inspired to lock in profits and cash out now.

In the second most expensive U.S. sale of a single building, Jamestown, a real estate investment fund, sold 1211 Avenue of the Americas earlier this year to Boston Properties for more than $1.5 billion, or $817 a square foot.

Jamestown acquired the office tower in 2000 for $560 million, expecting to hold it through 2010, delivering an 8 percent return and about 125 to 130 percent of the original invested capital back to investors. Instead, Jamestown was able to deliver 8 percent and more than 200 percent of the invested capital four years ahead of schedule.

"You weigh the risk in four or five years from now of the market not being as strong, against the opportunity to capitalize on the current robust market," says Jeffrey Ackemann, managing director of Atlanta-based Jamestown. "For our [expectations], it made perfect sense to sell."