When Tishman Speyer bought Manhattan’s MetLife Building for $1.72 billion last Friday, much of the attention centered on the staggering 10-digit price tag, which translates into more than $660 per sq. ft. That now stands as the loftiest price ever paid for a single Manhattan skyscraper.

But lost in all the hoopla is the downright puny cap rate, estimated at slightly less than 4% by one Manhattan real estate source with close knowledge of the deal. Such a low cap rate could make squeezing profits from the former Pan Am Building a challenge for Tishman.

To be sure, published reports pegged the cap rate at 4.8%, based on 2004 net operating income (NOI) of $81 million. Tishman declined to speak with NREI about the deal, so that $81 million NOI could not be confirmed. Yet, in order for the cap rate to hover below 4%, the building couldn’t have generated more than $69 million in NOI last year.

A sub-4% cap rate is considered extremely low for a healthy, leased-up property in Manhattan. It also represents a huge premium over the 7.1% average cap rate that Real Capital Analytics estimates for similar trophy properties that sold in the first quarter (see chart below).

“They [Tishman Speyer] must really believe that they can boost rents in the building — and fast — in order to pay that price,” says Dan Fasulo, an associate at Manhattan-based Real Capital Analytics.

Easier said than done. Average asking rents in midtown Manhattan were $47.13 per sq. ft. at the close of the first quarter, according to Cushman & Wakefield. A midtown Manhattan leasing broker says that average asking rents in the MetLife Building are around $55 per sq. ft. CoStar Group data shows the building to be 100% occupied, with 5.2% of the space subleased. Lease expirations in the building are staggered over the next 14 years.

Cap-rate compression Yields on stabilized assets have consistently fallen over the past few years as both institutional and private investors have flooded the real estate sector with capital. Two years ago, Macklowe Properties bought the GM Building on Fifth Avenue for $1.39 billion, which, according to Real Capital Analytics, equaled a 4.9% cap rate. The GM Building was 93% occupied when Macklowe bought the property in August 2003. Rents at the GM Building run as high as $125 per sq. ft., which makes it one of Manhattan’s priciest office towers.

The rich valuation of the Tishman Speyer deal does have a certain sense of deja vu. New York real estate execs were stunned in 1980 when the ailing Pan American World Airways sold its headquarters to MetLife for an unheard of $400 million, or $177 per sq. ft. That yielded just 3.4%. What’s more, the building’s cash-on-cash return (meaning cash flow after debt service divided by equity investment) was only 2.4%. But in last week’s sale, MetLife scored a $1.32 billion profit on its investment—and that averages out to $52.8 million worth of appreciation per year since 1980.

Trophy office cap rates by quarter
Q1 2002: 9.2%
Q1 2003: 8.5%
Q1 2004: 7.6%
Q1 2005: 7.1%

Source: Real Capital Analytics