Thursday, August 27, 2009

Betting on troubled US commercial property

Considering it a prime buying opportunity, some cash-rich investors are entering the market

(CANTON, Massachusetts) This year, US commercial property sales are down by about 90 per cent from their peak in 2007, but a handful of cash-rich investors see this troubled market as a prime buying opportunity.

A few years ago, the market was characterised by inflated appraisals, heavy reliance on debt and almost instant resale of buildings. Today's buyers pick properties more carefully, pay low prices in cash and plan to hold the buildings for years.

But high-quality properties aren't very easy to find, since many owners are hoping for prices to rebound before they are willing to sell.

In this environment, even a relatively mundane structure like the red brick building at 250 Royall St here was in demand. In June, the fully leased 182,000-square-foot four-storey suburban office building sold for US$62 million. A few years ago, the same building sold for US$68.8 million.

The buyer was G Joseph Cosenza, president of Inland Real Estate Acquisitions of Oak Brook, Illinois. His company is the largest buyer of US commercial real estate so far this year, according to research firm Real Capital Analytics.

The Canton site is among dozens of offices, shopping centres, apartment buildings and industrial structures that Mr Cosenza has purchased across the country since the beginning of last year. After paying out US$3 billion in 2008, he has spent US$1 billion this year.

He is happy to be swimming against the tide - buying while others watch from the sidelines. 'I say to them, 'thank goodness and just get out of my way',' Mr Cosenza said. 'We're not looking for trophies; we're buying solid income-producing real estate that is not in default.'

Some observers say that Mr Cosenza and other intrepid investors stand to profit handsomely.

'For the opportunity fund with the resources, it's time to make a killing,' said David L Funk, director of the Cornell University Program in Real Estate, a master's degree curriculum. 'In 10 years, people will look back at 2009 as the year fortunes were made.'

Other professionals are not so sure. 'There's always a risk being first on the frontier,' said Raymond G Torto, global chief economist for CB Richard Ellis Group.

Indeed, investors may face losses because they jumped the gun, some say. 'It's too early to buy, except from really distressed sellers,' said William F McCall Jr, president of McCall & Almy, a Boston-based real estate adviser. 'The market has a significant way to fall.'

Values may decline further as owners who need capital to improve buildings or refinance debt are pressured to sell or take partners.

But if they are unable to raise funds in a tight credit market, 'banks may take back some properties and sell at bargain- basement prices', said Arthur I Segel, a professor of management at Harvard Business School.

Meanwhile, the weak economy continues to exert more downward pressure on values, said Karl E Case, a professor of economics at Wellesley College and co-creator of the Case-Shiller home price index. 'Every office job lost knocks off demand for 180 square feet. With 6.7 million jobs gone - many in the service sector - a lot of demand has evaporated.'

While clearly a contrarian these days, Mr Cosenza is not alone in thinking that this is the time to act. With trillions in mortgages coming due, said Neil Bluhm, a partner at Walton Street Capital LLC, a private equity real estate investment firm, 'there's potential to buy or joint venture at attractive prices, and unlike last summer, it doesn't look like we'll have a financial crisis'.

After a year without a deal, he plans to spend US$1.5 billion in the next few years on buildings or debt in Boston, New York, Los Angeles and San Francisco, and he is aiming for annual returns of 20 per cent.

In Boston in July, Dietmar Georg, chairman of US operations for Munich- based GLL Real Estate Partners, an institutional real estate investment management firm with a US$5 billion fund under management, bought his third downtown office building there. He has spent US$224 million in the city since last fall.

Battered by the recession, Boston area commercial property values are down 30-70 per cent, depending on location, according to Robert E Griffin Jr, New England regional president for Cushman & Wakefield; 15.8 per cent of the offices are available for lease or sublease, up from 11 per cent a year ago and average annual asking rents have sunk to US$31 per sq ft, from US$39.54. But he added that the downtown Boston market, the region's hub, was still among the strongest in the nation.

Mr Cosenza says he thinks he knows a good deal when he sees it.

In the real estate recession of the early 1990s, he bought 11,000 acres (4,452 hectares) of vacant farmland for Inland. It was subdivided with little or no improvement and sold to residential developers. Some parcels purchased for US$3,870 an acre sold for US$69,000 an acre, he recalled.

Soon Inland started private real estate investment trusts (Reits), which are sold through brokers and financial advisers but are not listed on public exchanges. In 2000, it formed the Inland Retail Real Estate Trust Inc with US$4.4 billion in assets, and sold it in 2007 for US$6.2 billion to Developers Diversified Realty Corp.

In 2009, he's often buying at 2000 prices, Mr Cosenza said. 'We pay cash, keep them on the books and when the credit market changes, we'll finance,' he said.

Recently, he has bought 2,000 rental apartments near Houston; the US office of the European drugmaker Sanofi- Aventis in Bridgewater, New Jersey; and several shopping centres anchored by supermarkets in Georgia, Florida and South Carolina.

As for his purchase in Canton, it is a five-year-old building near Route 128, a major regional beltway, and its sole tenant - financial services firm Computershare Ltd - has 10 years to go on its lease.

He knows the property because he bought it in 2005 for the seller: Inland Western Real Estate Trust Inc, another member of the Inland conglomerate.

Of the US$4 billion in recent purchases, no others were within the Inland family, Mr Cosenza noted.

He says he intends to keep buying. 'I have another 6-8 months when people will be frozen in their tracks,' he said, 'and I'll have a clear field.' - NYT

Source: Business Times, 27 Aug 2009

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