National and international economic weakness is contributing to rising concern among bankers and institutional real estate investors about the durability of the economic recovery and its effects on real estate. But if safe haven exists, the Bay Area is as close as you can get.
Acquisition executives for AREA Property Partners and GLL Real Estate Partners, and a Comerica Bank honcho, told an East Bay audience Oct. 6 that while conditions locally still seem robust, others in their organizations located elsewhere in the United States are less sanguine. “It still feels pretty good here, but depending on where your investment committee sits, they may feel differently,” said Daniel K. Cushing, a senior vice president and head of West Coast asset management for AREA Property Partners.
Steve Burich, a senior vice president for Comerica Bank who manages the San Jose Commercial Real Estate Finance Group, agreed, saying the Dallas-based bank, which has $60 billion in assets, has ratcheted up its lending in Northern California after two extremely quiet years. But activity would be even more robust if the world news didn’t include Greek sovereign debt default and inflation in China.
Burich’s lending group did $50 million in loan originations in all of 2009 and 2010, compared to a more normal $500 million to $600 million annually, he said. Not only was the bank out of the market, so were borrowers. So far this year, it has closed on $195 million in new loans and has another $300 million in the pipeline. “If we weren’t so concerned, we would be doing more,” Burich said. “There is a lot of bad news out there.”
Burich, Cushing and Christopher E. Quiett, a senior vice president for GLL, spoke at a market forum hosted by GLL and the Northern California Chapter of CCIM, a global commercial real estate network of professional people who have earned the certified commercial investment member designation.
Bay Area loan demand has escalated rapidly in the last six months, Burich said. Comerica is entertaining requests for construction financing for several for-sale housing projects, apartments and more than one new ground-up office development in Mountain View, where Google Inc.’s rapacious leasing has left other tenants with limited recourse.
Investor demand for Bay Area assets has reached such a pitch that Quiett said his company is considering putting properties on the market. “We are looking at taking some money off the table,” Quiett said. “Nothing has really changed a lot in the last 18 months but because of cap-rate compression, it is a good time to sell, and it is hard to believe that cap rates are going to go any lower.”
The capitalization rate measures investor yield. If cap rates are falling, it means building values are rising, assuming the income flow from a property is unchanged.
New York City-based AREA, the former Apollo Real Estate Advisors, has eschewed office investment in this cycle because it feared the anemic jobs recovery. Instead, it has focused on industrial and multifamily properties, Cushing said, turning to rent-controlled and government-subsidized units in neighborhoods such as San Francisco’s Tenderloin where competing investors feared to tread. This summer, the company paid $59.6 million in cash for a 422-unit San Francisco apartment portfolio, much of which is in the Tenderloin. It was the international real estate fund manager’s first-ever Bay Area apartment acquisition. The rent-regulated units were priced at a bit more than $141,000 apiece.
AREA also owns 1.2 million square feet of San Francisco offices, including 201 California St., 60 Spear St., 188 Embarcadero, One Post St. and 400 Howard St., for which it had been the lender. In 2009, when it acquired the five, it chose to keep them rather than sell because it believed, based on the region’s economic resilience, that it would fare better by holding and waiting for better days ahead.
Cushing has been with AREA since 2009 and is responsible for new investments and investment management.
Quiett does asset management and asset acquisitions in the western half of the United States for GLL Real Estate Partners Inc., the U.S. acquisitions, development, property management and asset management subsidiary of GLL Real Estate Partners GmbH, a Munich-based real estate fund management company formed in 2000. The company’s funds under management exceed $5.37 billion, according to its Web site. The company owns 199 Fremont St. in the South of Market area of San Francisco.
Pricing in markets such as Seattle and Portland is as high as in the Bay Area, to his surprise, Quiett said. “We expected a greater differential.” His company is no longer considering either market for investment as a consequence. GLL will do business in so-called second-tier markets, such as Phoenix, to capture yield, he said. But 24-hour cities across the country are generally in line with one another with regard to pricing, Cushing said.
LEED certification is evolving to become a given for most buildings, but is not really a major driver of tenant and landlord behavior, Cushing and Quiett said. At GLL, the goal is operational efficiency and has been for some time, which means that LEED typically translates into a documentation of existing business practices. A new term he is hearing in the market is “LEED-able,” Quiett said, where owners wants to indicate that a building could attain some level of LEED certification but they are unwilling to pay the tens of thousands of dollars necessary to complete the process. “[Tenants] are more value- and location-driven,” Cushing said. “If you are LEED certified, great, but it is at the bottom of the list.”
The dominant characteristic of the Bay Area market is the level of competition for the assets that become available to buy, all three speakers agreed. The mismatch between supply and demand is driving pricing, rather than simply fundamentals. Comerica has seen a surge of loan demand to finance the acquisition of offices where buyers are pursuing a value-add strategy, Burich said. The opportunity seems viable, given that many institutional owners including pension funds, hedge funds, life companies and banks have assets that they wish to sell. In many cases the buildings have been poorly managed and undercapitalized because the owners were unwilling to invest fresh capital for tenant improvements and brokers often stopped showing the properties because owners were unresponsive.
At Comerica, the bank has chosen to stick with most owners rather than foreclose, throughout the recession, believing results would be better using a ride-it-out strategy even if the bank still lost money in the end, Burich said. That has largely proven a good approach.
Still, the Bay Area’s renowned resilience is not enough to assure everyone, particularly now: “The nervousness is starting to creep back into the market. Clients are going into permanent financing because they are worried,” Burich said. “We are seeing more payoffs and conversions to permanent loans because of interest rate fears.”
Comerica specializes in construction and acquisition loans. It does no permanent loans or non-recourse lending.