Earlier this year, market watchers speculated that rising interest rates would throw a wet blanket on the property-flipping party that has been raging in the office sector. The assumption was that higher financing costs would curb demand, forcing investors to hold onto office towers, rather than reselling quickly. Many experts also expected that rising rates would slow fundraising for office investment.
So much for the conventional wisdom. While interest rates have crept upwards — the 10-year Treasury was yielding 5.23% at midday, up from roughly 4.5% in January — there is no sign that capital is shifting away from the office market. Indeed, just last week, Blackstone Real Estate partners announced that it has closed a record-breaking $5.25 billion fund.
What’s more, the data from the first half shows no sign that investors are holding onto buildings longer than they have in the recent past. According to Real Capital Analytics, roughly 35% of all office properties (valued at $5 million or more) that were put up for sale this year had been acquired within the past four years. During full-year 2005, roughly 26% of all office properties that were sold were held for roughly four years.
Fund investors, who sold more than $1 billion in office assets last year, were the leading office buyers during the first five months of this year.
This phenomenon is more pronounced in metro markets like Boston and Phoenix, where 60% of all recent office offerings were also bought within the past four years. That’s a pretty short holding period, too, when 8- to 12-year holds have been the norm for most of the past two decades.
Dan Fasulo, national director of market analysis at Real Capital Analytics, believes that there’s more to this story than just flipping activity by owners. Despite high prices and rising financing costs, there is still strong demand: “I don't get the sense from our clients that pricing has topped out and this is certainly evident when through [year to date] private investors are net buyers again,” he says.
Capital flows have clearly shifted during the past several months. For example, the major funds and smaller-scale local investors alike have switched from being net sellers last year to once again accumulating office properties. This investor class gobbled up more than $20 billion in office properties during the first five months of this year (which represents roughly half of the total $40.5 billion in office sales during that period).
One overriding message from these deals is simply: Why wait? One of the largest deals was the March sale of Bank of America Center for $1.05 billion to a joint venture. The San Francisco office tower had been purchased in September 2004 for $825 million by a joint venture between IPC, a REIT, and private investor David Warner. Their 18-month hold yielded a tidy $225 million gross profit.
Another notable flip in the first half was February’s $185 million sale of 75 Wall Street. JP Morgan Chase had bought the office tower in July 2005 for $150 million. That’s a 23% return in seven months—or about 39% on an annualized basis.
Parting Shot: Meanwhile, office REITs are showing no signs of fatigue either. According to SNL Financial’s Real Estate Securities Daily report, office REITs were up 24.63% (total return) during the 52-week period that ended on Monday. Equity REITs in general posted a 19.63% return during that period.
Two of last quarter’s top five performing REITs were in the office sector, too. Merrill Lynch analyst Steve Sakwa says that both Equity Office Properties Trust (EOP) and SL Green (SLG) have benefited from investor optimism that the office market will continue to tighten over the next 12 to 24 months. EOP gained 8.7% during the second quarter, followed by SL Green, which posted a 7.9% gain (total return).
Another factoid: None of the worst performing REIT stocks in the second quarter hailed from the office sector.