Investors Ramp Up Real Estate Allocations and Eye Bay Area Real Estate

Bay Area, Real Estate, real estate investment, commercial real estate, San Francisco, Preqin, Colliers International, Greenlaw Partners, Walnut Creek

Bay Area, Real Estate, real estate investment, commercial real estate, San Francisco, Preqin, Colliers International, Greenlaw Partners, Walnut CreekBy Joe Gose

Institutional investors are increasing their appetite for commercial real estate as they increase their real estate allocations versus other asset classes. They also continue to pour money into the San Francisco Bay Area, making it one of the top investment geographies in the world.

[contextly_sidebar id=”XkThOsEyFtYS1ANDsLlbPh7Qha4kl8ZV”]Pension funds, private equity, insurance companies, sovereign wealth funds and other institutional investors around the world want real estate to account for an average of 9.7 percent of fund assets, up from an average of 9.1 percent in 2011, according to a recent report by Preqin, a firm that tracks the alternative asset industry.

But investors still have a long way to go before they meet those targets. On average, real estate makes up only about 7.6 percent of fund assets today, an increase of 90 basis points from 2011.

Recent transactions indicate that a decent chunk of those allocated dollars are flowing into the Bay Area, which is already enjoying one of most active sales periods in recent history.

The San Francisco office of brokerage Colliers International predicts that office investment sales will surpass $5 billion by the end of the year, for example, well above the city’s historical average of around $2 billion to $3 billion seen over the past 14 years, according to the firm’s third quarter office report. Through the first nine months of the year, some 38 office properties changed hands for more than $4.5 billion, the brokerage added.

Meanwhile, prices for San Francisco Class A properties have climbed to an average of $593 a square foot in the third quarter, a year-over-year spike of 27 percent, Colliers International reported.

Among recent Bay Area deals, in August Miami-based Rialto Capital Management, a division of homebuilder Lennar Corp., acquired the 12-building, 423,458-square-foot Walnut Creek Executive Park in the East Bay for $48.6 million from a venture that included Greenlaw Partners.

Rialto bought the asset for its Rialto Real Estate Fund II, which it closed late last year after attracting $1.3 billion in commitments from pension funds, endowments, foundations, overseas funds, insurance companies and other investors. That was 35 percent more than Rialto had originally planned to raise.

RREF II primarily targets distressed assets and commercial real estate debt. The office park was 75 percent leased when Rialto acquired it, and an official with JLL, who represented the sellers, noted that the fund was able to buy the sizable project at a “significant” discount to replacement cost in a tightening market, according to a statement announcing the sale.

In September, TIAA-CREF and joint venture partner Norges Bank Investment Management (NBIM), which oversees the $887 billion Norwegian government pension fund, purchased the 521,555-square-foot Orrick Building at 405 Howard St. in the South Financial District. NBIM said that it paid $139.7 million for 49.9 percent of the building and valued the asset at $390 million.

The acquisition followed an NBIM restructuring in August, part of which included establishing a separate real estate leadership group to help the sovereign wealth fund increase its property investments to 5 percent from 1.2 percent.

Despite the market’s booming economy, some investment experts are beginning to wonder if San Francisco’s real estate market is approaching a top. Robert Stamm, an executive managing director with the cross border investment division of Savills Studley in Orange County, a niche investment advisory for international clients, said that his group had become a little hesitant about pursuing deals in San Francisco, particularly in the office sector.

Technology tenants moving from Silicon Valley to San Francisco are contributing to confidence in an already robust economic environment, he acknowledged. Not only are technology companies moving closer to major capital sources, but good wage earners working in the tech industry are also locating in the city to take advantage of the urban lifestyle, which continues to drive residential demand, he adds.

Yet Stamm suggests that buyers and sellers have already “baked” those elements into transactions, as evidenced by rising property prices. The average office direct rental rate in San Francisco has grown by an average of roughly 18 percent a year over the last five years to nearly $61 a square foot, according to JLL. Meanwhile, the average vacancy in the market is 10.4 percent, and nearly 3.5 million square feet of new supply is under construction, 63 percent of which is pre-leased, the brokerage said in a recent report.

Stamm maintains that buyers today in many cases must assume that rent growth will remain healthy for the foreseeable future to justify paying lofty prices and to realize upside on the back end of their investments. But the market can’t sustain such heady year-over-year rent increases over the long term, he argues, and a softening market could sting investors that have five- to 10-year hold periods.

“It seems like our competitors have forgotten a little bit about real estate cycles, which concerns us,” Stamm said. “If I buy now, my best case is that my underwriting will be proved by the market.”

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