The 2009 sale of Boston’s John Hancock Tower whetted investors’ appetites for an expected fire sale of commercial properties in 2010 that never materialized, while the 2010 sale of the iconic tower at a significant premium foreshadows a likely trend for 2011.
The sale of the Back Bay skyscraper in early 2009, when Normandy Real Estate Partners and Five Mile Capital Partners purchased the property for $660.6 million, half of its 2006 sales price,an early sign of what investors anticipated would be a wave of overleveraged commercial properties to flood the market in 2009 and 2010. During 2009, institutional investors, such as REITS and large pension funds, and well-heeled foreign investors began building up reserves in anticipation of a flood of bargain basement deals.
But the flood never hit. Instead, banks chose to “extend and amend” their commercial real estate loans rather than put them in default. Investors with deep pockets that were looking to snatch up turnaround properties changed tactics, focused on trophy properties and bid up their values. The $930 million sale of the John Hancock Tower closed in the final week in December.
Trophy properties, considered the best buildings in the most desirable locations, are stable income-producing assets. They don’t carry the huge risk of turnaround projects. They are coveted by tenants, and lenders are still willing to lend on them. Furthermore, with interest rates as low as they are, investors who haven’t been able to deploy their war-chests on turn-around properties can still earn a higher return on their investment in trophy properties (despite at higher prices) than they can get elsewhere.
In 2011, the high-end market will continue to be active. But investors won’t find 2009 Hancock-type bargains on Class A buildings easily. There are no indications that an avalanche of distressed properties will hit the market anytime soon, although there are some rumblings that foreign banks may be looking to offload their U.S. holdings in 2011. Accordingly, the prime properties being brought to the market in 2011 will come from owners like those who turned around the Hancock Tower – experienced real estate managers who have stable properties that are well-maintained and boast strong occupancy rates.
Rising Rents
Certainly, there’s more optimism in the commercial real estate market than a year ago, particularly in select cities (including Boston, New York and Washington D.C.). Rents for premium office space have risen during the last two quarters in Boston, up to an average of $48.62 per square foot compared with $47.31 at the end of 2009, according to the real estate services firm Richards Barry Joyce & Partners. Furthermore, most experts believe that the worst is probably over and that a double-dip recession is increasingly unlikely.
Still, the job market – the main driver of office leasing — continues to struggle. The national vacancy rate was 17.6 percent during the third quarter, up from 16.6 percent in the same quarter in 2009, according to Reis, a New York research company.
There is also bound to be more activity among stable Class B assets as the bidding rises among trophy properties and more investors are priced out of them and turn to other asset classes.
Sure to have continued problems are properties in smaller and suburban markets. While big banks and institutional lenders were able to fortify their balance sheets in 2010, community banks financed a disproportionate percentage of underperforming suburban office buildings. They haven’t been able to rebuild their balance sheets as quickly as the national banks. As a result, they can’t afford to write down their assets or put loans in default. The affected properties are left in limbo with borrowers struggling to make debt service payments and cutting back on capital investments, causing the properties to lose even more value.
One bellwether for the Boston market will be the former Filene’s department store building in Boston’s Downtown Crossing, once a prized property whose owners are looking to sell. Now blighted and dormant for more than two years, how soon that property is sold and what combination of office, retail or residential it ultimately includes could indicate the direction of the Boston market.
The John Hancock Tower sold two years ago at what now looks like a fire sale price to savvy and experienced real estate investors willing to take on the risk, who had the skills necessary to manage and stabilize the property. In Boston and elsewhere, the deep discount deals will be hard to find in 2011, but properties that are stable and well-maintained will continue to be in demand.
John Steiner is a partner in the REIT and Real Estate Practice Groups of the law firm Sullivan & Worcester in Boston. E-mail: jsteiner@sandw.com
