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U.S. Real Estate May Slow in 2003 After Outperforming 3 Years
By Elizabeth Hayes - Bloomberg
January 1, 2003 - U.S. commercial real estate, after outpacing stocks the past three years, may be poised for a slowdown in 2003, hurting shares of developers such as Boston
Properties Inc. and Simon Property Group Inc., some investors said.
Investors, seeking an alternative to a stock market that has slumped 43 percent since March 2000, have flocked to everything from malls to shares of developers, pushing a Morgan Stanley index of real estate companies up 44 percent over the past three years.
Prices for Manhattan skyscrapers set a record in 2002.
Now, some big investors including Chicago billionaire Sam Zell, insurer MetLife Inc. and investment bank Blackstone Group Inc., are selling property amid signs values have peaked with vacancies at the highest level since 1995. Earnings for public
real estate companies may fall 1.1 percent this year, the biggest drop since at least 1993, according to Salomon Smith Barney.
Prices may have gotten "a little ahead of the underlying'' vacancies and rents, said Zell, chairman of Equity Office Properties Trust, the U.S.'s largest owner of office buildings, and Equity Residential, the largest apartment company.
Zell's companies have sold about $1 billion of properties since 2001, and more sales are planned this year, analysts said. MetLife sold two office towers for $258 million last month, including the 38-story landmark Fred F. French Building on New York's Fifth Avenue, as part of a goal of selling $2 billion of real estate. Blackstone, led by former U.S. commerce secretary Peter Peterson, also has $2 billion of its properties on the
block, executives said in November.
Less Money
Sellers will find buyers with less money to spend. About $7 billion to $10 billion will go into private real estate funds this year, about half the $17 billion to $20 billion last year, said Debbie Levinson, a partner at Ernst & Young LLP's real estate practice.
Steve Sakwa, a real estate analyst at Merrill Lynch & Co., said he's been surprised by "the resiliency of asset values over the past 12 to 18 months. At some point, will the fundamentals catch up with values or will values follow cash flows down?''
Prices for buildings have remained high even as landlords reduce earnings estimates amid a doubling in the office vacancy rate in the past two years to 16.4 percent. The average price of a Manhattan office tower hit a record $388 a square foot in 2002, according to property broker Insigna/ESG.
Some investors who have bought property in the past few months said the 12 interest rate cuts by the Federal Reserve since January 2001 have allowed buyers to pay higher prices and still make money.
"Low interest rates enable people to buy at lower yields,'' said Mortimer Zuckerman, chairman of Boston-based Boston Properties. "The reason we're still buying is because we're realizing long-term values.''
Rising Prices
Boston Properties paid $1.06 billion in September for Citigroup Inc.'s New York headquarters on Park Avenue, or $630 a square foot, a near record price for a Manhattan skyscraper.
General Growth Properties Inc. last month paid $415 million for the Glendale Galleria mall near Los Angeles, translating into an initial annual return of 6.5 percent based on net operating income, analysts estimate. Two years ago, similar malls sold for
initial returns of more than 8 percent.
Zell, Zuckerman and other investors point out that unlike the real estate slump of the early 1990s, there is no overbuilding today, giving investors hope for a speedier recovery once demand for space returns.
There were six million square feet of office building starts in the third quarter, down from 35 million to 40 million square feet of starts in one quarter in 2000, according to property research firm Torto Wheaton Research.
Trophy Bubble
If there is a "bubble'' in real estate prices, it is limited to so-called "trophy'' properties such the Citigroup headquarters that typically stay full under all economic conditions, said Bob White, president of Real Capital Analytics.
Low borrowing rates also means returns investors can generate from real estate are about five percentage points above the benchmark 10-year Treasury note, he said.
"Real returns for office properties are pretty much at an all-time high,'' White said. "Aggressive bidders feel low interest rates can't last for long so if they're going to buy real estate, they feel they better buy sooner rather than later.''
There are signs that prices may be cooling. San Francisco-based Shorenstein Co. recently agreed to buy Grosvenor USA Ltd.'s U.S. Bank Plaza in Sacramento for $113 million after another buyer's $122 million initial bid fell through.
"A number of deals have blown up,'' said Chief Executive Douglas Shorenstein. "Capital gets frothy and the price is bid up and it gets tied up by buyers who get ahead of themselves, and when they step back and look at the underlying fundamentals, they
negotiate the price down.''
Morgan Stanley expects shares of REITs, or publicly traded developers, to deliver a total return of dividends plus price appreciation of 5 percent to 8 percent next year, compared with 10 percent to 15 percent for the S&P 500.
"I wouldn't be surprised if estimates continue to come down,'' said Darren Rabenou, who helps manage $400 million in REIT securities at J.P. Morgan Fleming Asset Management.
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