Zeev's Turnips Patch-No Politics (ZEEV)

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Commercial Real Estate
Billionaires Bet On Buildings
Stephane Fitch, 10.21.02, 12:00 PM ET

Some property magnates know a few things that most property investors don't. When they act on them, they can unleash horrified gasps from the unknowing.

These magnates have been buying skyscrapers around the U.S. for record prices (see table below)--as in 50% to 100% more than it costs to build new office space or buy other used property. They are doing this just when rents around the country are off 10% to 20% from a year ago and headed lower.

To Peter Korpacz, a real estate researcher for PricewaterhouseCoopers, it doesn't add up. He recently declared in The Wall Street Journal: "There is a bubble in the commercial real estate market."

Puhleeze.

Look closer at some of the folks doing the buying: Forbes World's Richest People member Mortimer Zuckerman of Boston Properties (nyse: BXP - news - people ), Forbes 400 Richest Americans member Neil Bluhm of Walton St. Capital and Forbes 400 member John E. Anderson of Topa Equities, a Forbes 500 Largest Privates company. Not exactly flash-in-the-pan types.



Sky-High Buildings And Prices
Buyer City Yield* (%) Price ($mil) Price/Square Feet
Generali/Lend Lease** San Francisco 9% $117 $388
Broadway Real Estate Greenwich, Conn. 8.5 115 483
Deutsche Bank/RREEF Chicago 8.5 400 309
Boston Properties New York 8.2 1,060 631
Challenger International Boston 7.7 109 416
John E. Anderson Los Angeles 7.9 182 305
Blue Capital Investments Washington, D.C. 7.9 78 388
Walton Street Capital New York 7.4 270 620
Taconic Partners/New York State New York 6.5 158 552

Sources: Commercial Real Estate Direct. *Net operating income for next 12 months as percentage of purchase price. **Purchase was of a partial interest; yield and price per square foot are calculated accordingly.


All three men got an alarmingly close look at the real estate collapse of the early 1990s--the worst in living memory--and survived. Don't bet they'd be buying if it didn't make some sense. Even Bluhm, who did take a thrashing in the last downturn, has restored his reputation as a shrewd buyer whose investments in the 1980s held up far, far better in the long run than anybody expected.

So what do these seasoned buyers see? First, they're looking at the initial yields on their purchases, around 8%. That's a 4% "spread" over the less-risky 10-year U.S. Treasury bond, which is as wide a spread as has existed in years, says Orest Mandzy of Newtown, Pa.-based Commercial Real Estate Direct, a real estate data and news service.

Sounds good, but here's something better. Even as beaten down as the S&P 500 is, its earnings yield (the inverse of its price-to-earnings ratio) is stuck way down at 6%. Normally, you'd expect it to be higher, not lower, than commercial real estate yields. Read: No bubble here.

Second, Zuckerman and his cohorts are looking at the fundamentals. Scott Latham, of New York City-based real estate services firm Cushman & Wakefield, says they are wagering this year's drop in rents is only temporary.

"Sounds familiar, doesn't it? Optimism is a character trait in our industry," he says. This time, Latham says, the optimism is warranted.

There's no glut of empty space on the market. For example, vacancy in New York City is 11% now, compared with 18% a decade ago. And most of the vacant space isn't being put on the market by either of the two nightmare sources: overeager developers or busted tenants. Rather, Latham says, it's from healthy companies just looking to clear out space they'd "inventoried" in order to anticipate growth when times were good.

That means no fire sales. The sublease crowd is asking for relatively high rents and getting them. Average rents are $25 per square foot in Los Angeles, $30 in Boston, Chicago and San Francisco, $40 in Washington, D.C., and nearly $60 in New York City, according to New York brokerage Julien J. Studley. All these rents are two or three times typical operating costs.

Talk to Scott Lawler, who runs Broadway Real Estate Partners. He says the office complex in Greenwich, Conn., that his investment firm purchased for $500 a square foot, called Pickwick Plaza, is so tightly leased, tenants desperate for space must beg existing tenants for sublease space. He ought to know. Broadway is one of the sub-lessees that had to get on bended knee.

Finally, seasoned real estate buyers usually think far into the future. There's no recovery now, but there will be. The buyers should be able to improve their returns when older tenants' leases are rolled over at higher rates.

Bubble? No. Smart? Quite likely.

http://www.forbes.com/2002/10/21/1021fm_realestate.html