Experts discussed the state of the commercial real estate market during a panel held last week at Brandeis University in Waltham. From left are Jonathan Davis, chief executive officer of Davis Marcus Partners; John Usdan, president of Midwood Management Corp.; Brandeis professor Edward Bayone, moderator of the event; Earle W. Kazis, president of Earle W. Kazis Assoc.; and Gene Kohn, an architect with Kohn Pedersen Fox Assoc.
Single-digit yields are not deterring investors from pouring billions of dollars into commercial real estate, according to a panel held last week at Brandeis University in Waltham.
“I’m not buying at these cap rates,” said Earle W. Kazis, president of Earle W. Kazis Assoc., a New York-based real estate investment and development company, referring to the ratio used to estimate the value of income-producing properties. “But there are risk takers who have proven to be very successful at it.”
Four experts provided their take on “Real Estate Markets in Transition: Sea Change or Cycle?” to a standing-room-only crowd at the university’s International Business School.
With capitalization rates below 5 percent, Brandeis professor Edward Bayone, the moderator of the panel, asked whether low returns are symbolic of a new paradigm for the industry or simply reflect a temporary blip in an industry accustomed to 10-year cycles.
John Usdan, president of Midwood Management Corp., a New York-based developer, said there’s no simple answer to the question of whether commercial real estate is in the midst of a dramatic transformation or a cycle change.
“It’s an old story with a different twist,” he said. “Everyone must understand that it’s not a tale of two cities, but it’s a tale of many cities. Each location has its own economy and there are profoundly different things happening in the cities across the [United States].”
To illustrate the point, Usdan noted that while New York and Boston are seeing office vacancies decline and rents rise, Hartford, Conn.’s office rents are lower than they were 20 years ago. In many cities, he said, there is no demand for office space.
“You can make a different argument for each city,” he said. “These imbalances have created a land rush in places like New York, where the replacement cost of office buildings has increased from $400 to $1,000 per square foot in the last few years. This will pass, not withstanding the tremendous difficulty of building in New York. The city’s economy will change and that will free up lots of space, and rents will drop.”
If there are doubters, Usdan said, consider that when he entered the real estate business in the 1980s, certificates of deposit fetched 21 percent interest while mortgage rates hovered at 15 percent.
‘The Cycle Continues’
Jonathan Davis, chief executive officer of Boston-based developer Davis Marcus Partners, argued that many investors considered the stock market dangerous because it’s overvalued. As a result, he said, lots of money migrated to real estate, driving prices up.
“Real estate is overpriced and that has reinforced the ‘buy’ decision,” he said. “We are in a situation where the people who overpaid for property three years ago by any traditional measure are now cashing in and making huge fortunes, so the cycle continues.”
Still, Usdan said he is reluctant to buy office buildings with cap rates in the low single-digits or facilities with leases in place for 20 years. Before buying, he noted, he prefers to see a big disparity between today’s rents at the property and what he estimates the rent could reach at a later date.
“I have not been a buyer of office buildings at 4 percent because I am not interested in making 4 to 5 percent or less for two decades,” he said. “But I am buying retail properties at 4 to 5 percent if the cash flow is 50 percent of what I think they will be when leases turn over.”
Kazis, however, noted that the General Motors Building in New York sold for $1.4 billion in 2003 and is now worth nearly three times that amount. He said when the 1.9 million-square-foot building fetched $1,000 per square foot, it was considered a “crazy” number. But it was recently refinanced at $2,000 per square foot and has been appraised at $3,000 per square foot, he said.
“People have proven that the market is growing, that rents are rising and if you’re creative you can find ways to grow rents in these buildings by finding space that has not been occupied properly,” Kazis said. “The reality is that there are risk takers who have been successful and their success is causing enthusiasm.”
Kazis also noted that much of the investment for the nation’s real estate markets stem from outside the United States. “Foreign investors are putting their money here because they consider us to be more stable than their own country,” he said. “We are in a period of globalization where much of the world is interconnected.”
Still, some U.S. companies are investing their real estate dollars overseas. Gene Kohn, an architect with New York-based Kohn Pedersen Fox Assoc., has joined Gale International, POSCO Engineering & Construction Co. and the city of Incheon, South Korea, as the principal designer for the master-planned development of Songdo City.
Built on 1,500 acres of reclaimed land and soon to be connected to Incheon International Airport via a new bridge, Songdo City is perhaps the most ambitious undertaking of its kind. Under construction and expected to be completed over the next 15 years, the master-planned city will include a 100-acre park, an international school, a hospital, an aquarium and a museum.
The city’s plan calls for 50 million square feet of office space, including a landmark 65-story tower and convention center; 30 million square feet of residential space; 10 million square feet of retail; 10 million square feet of green space; and 5 million square feet of hotel facilities.
“In a word, it’s extraordinary,” said Kohn. “The first 2,500 units of housing sold out in a day.”
