I Star Financial recently set a New Jersey record when it paid $194 million — $336 per sq. ft. — for Harborside Financial Plaza 10, a 19-story office building in Jersey City. But the steep price hardly shocked veteran investors. For several years now, buyers have been lining up to acquire prime offices around the country.

And in Manhattan — a ferry ride away from Jersey City — the average price for offices is $329 per sq. ft. “A lot of people are still rushing to invest in fully leased buildings,” says Mitchell Hersh, CEO of Mack-Cali Realty Corp., which manages the Jersey City building and was a former owner.

With REITs and private investors bidding furiously, sales of offices in CBDs totaled $5.7 billion in the first quarter of 2004, up 38% from a year ago, reports Real Capital Analytics. Since 2003, some of the biggest companies have taken advantage of high prices and trimmed their portfolios.

Mack-Cali, ranked No. 6 on NREI's list of top office owners, cut its holdings by 1 million sq. ft. to 27.8 million sq. ft. The portfolio of Equity Office Properties Trust, the No. 1 ranked office owner, also declined from 124.6 million sq. ft. in the 2003 survey to 122.3 million sq. ft. this year.

Falling Cap Rates

While some big companies have been selling, there is no shortage of private investors and REITs scouring the market for acquisitions. As prices continue to climb for office product across the country, the average capitalization rate has dropped from 9.1% in the first quarter of 2003 to 7.4% this year.

Trophy properties can command higher prices. Manhattan's General Motors Building sold in June 2003 for a cap rate of less than 5%, says Woody Heller, executive managing director of New York brokerage Studley. The Bank of New York Building at 530 Fifth Avenue sold in February 2004 for a cap rate of less than 6%. “People are paying high prices for well-known properties that can deliver reliable yields,” says Heller.

While buyers face strong prices, office market fundamentals remain soft. The national office vacancy rate registered 14.8% in the first quarter of 2004, up from 14.4% a year ago, reports CoStar Group. Vacancy rates remain above 18% in areas that have suffered serious job losses, such as Silicon Valley. Annual net rental rates averaged $21.94 per sq. ft. nationally, down from $22.70 a year ago, according to CoStar.

Still, there are reasons for cautious optimism, says Jay Spivey, director of analytics for CoStar. After three years of rising vacancy rates, the numbers appear to be stabilizing, he says. As the economy expands, new jobs are being created, including many in white-collar office sectors.

The Department of Labor reported that non-farm payrolls increased by 248,000 in May, the third consecutive month of big gains. That is helping some markets to absorb space. Rents should start rising soon, Spivey says. “We are bumping along the bottom of the office cycle, and some markets are starting to turn up.”

Bargain Properties Available

Buildings with vacancy problems still sell at sizable discounts to core properties. That could present unusual opportunities, say bargain-hunting investors. “If you are willing to take on leasing risk, you can buy solid properties at good prices,” says John Guinee, executive vice president of Duke Realty Corp.

Last year, Duke Realty paid $25 million for Millenia Lakes, a 200,448 sq. ft. Class-A suburban property in Orlando with only 17% occupancy. Duke thought the property had upside potential because of its location near an interstate and Orlando International Airport. So far, the investment appears promising. With the company intensifying marketing efforts, the occupancy rate has climbed to 60%.

Faced with sizable vacancy rates, few developers are building new properties — except in strong markets or when significant pre-leasing is in place.

CarrAmerica Realty has broken ground on a 124,000 sq. ft. office building in Irving, Texas, that will cost $15.9 million. The building is already leased to Washington Mutual. Simultaneously, CarrAmerica is selling properties in softer markets, including Atlanta and Portland, Ore. The company will build and acquire in areas with stronger demand, most notably Washington, D.C., and Southern California. CarrAmerica recently teamed up with Beacon Capital Partners in a joint venture that paid $190 million for 10 Universal City Plaza in Los Angeles.

The 35-story, Class-A building measures 774,240 sq. ft. and is ideally situated near the Hollywood Freeway. “We want to focus on high-quality assets that are in markets where the capacity is constrained,” says Philip Hawkins, president of CarrAmerica.