Fear Factor

Fear Factor

COMMERCIAL REAL ESTATE by Jean Gruss | Editor/Lee-Collier

The commercial real estate investment boom may be topping out as buyers become more cautious. Some investors expect prices to fall in many areas of the Gulf Coast.

Mark Stroud has been traveling up and down Interstate 75 scouting for commercial properties in which to invest.

These days he can afford to be picky.

The credit-market turmoil that began in July has thinned out the ranks of buyers for commercial real estate investments. While no one is ready to predict the end of the commercial real estate investment boom, there are indications prices paid for some types of properties may have reached a peak.

"Some owners are going to have to sit and decide what they're going to do now," says Stroud, president of the Florida region of Davis Marcus Partners. The Boston-based firm acquired buildings in Naples recently and is looking for more investment opportunities in Fort Myers, Sarasota and the Tampa Bay area.

Nationally, prices for commercial buildings have declined about 10%, says Josh Pristaw, managing director for GoldenTree InSite Partners in New York. GoldenTree and Fort Lauderdale-based Cypress Creek Capital bought the 501 East Kennedy building in downtown Tampa in June for nearly $46 million, or $155 per square foot.

"There's definitely a bid-ask spread," Pristaw says. "Sellers are still trying to sell at yesterday's prices."

Pristaw says there's still strong demand for so-called "trophy" properties, or fully leased top-quality buildings in prime locations. But sellers whose buildings don't measure up are starting to discount prices.

Cap rates headed back up

Nationally, commercial-property transactions of all types fell 50% in September, estimates Peter Korpacz, executive managing director of Weiser Realty Advisors of West Palm Beach. Korpacz spoke recently at the Chamber of Southwest Florida's Regional Economic Outlook conference in Fort Myers.

Instead of bidding 98% of the asking price, buyers are low-balling offers 10% to 15% below sellers' asking prices. "They're saying: 'Let's see how much fear is out there'," Korpacz says. "We are going to have re-pricing."

One important measure of value is capitalization rates, or "cap rates" for short. It's a percentage determined by dividing a building's annual net operating income by the purchase price. The lower the cap rate, the more a buyer pays for each dollar of income.

For example, in the Tampa Bay region, the cap rate for office buildings has fallen from nearly 9% in the first quarter of 2003 to 6.6% in the second quarter of 2007, according to Real Capital Analytics. The decline has been similarly sharp in Southwest Florida with office building cap rates falling from nearly 9% to 6.9%.

The run-up in prices for commercial properties may be leveling off, brokers and investors say. Buyers have bid up the price paid for office buildings from about $100 per square foot four years ago to $163 per square foot today in the Tampa area, a 63% increase. In Southwest Florida, buyers pushed the sale price for office buildings from under $150 per square foot four years ago to $185 per square foot today, a 23% increase, according to figures updated to the second quarter of 2007 by Real Capital Analytics.

"Interest rates were falling, which meant investors could accept a lower cap rate," says Jim Tamblyn, a broker with Colliers Arnold in Fort Myers. "Lots of money was chasing a small universe of real estate projects."

Now, with new buildings under construction and demand slowing, cap rates and prices are stabilizing. "The general feeling is that cap rates ought to be a little bit higher and the prices a little lower," Tamblyn says.

But brokers say there's still strong demand for top-quality buildings in excellent locations, particularly in the Tampa Bay region. Private capital, pension funds and real estate investment trusts are still bidding on so-called "trophy" properties. "Capital has not gone away," says Rick Brugge, associate director of capital markets at commercial brokerage Cushman & Wakefield in Tampa.

"Cap rates for the market's best assets have remained stable," says Dale Peterson, senior vice president with commercial brokerage CB Richard Ellis in Tampa.

Underpinning much of the demand is the region's continuing population and job growth, even though that's been more muted lately. "Tampa Bay is still a growth story," Brugge says.

In particular, there is strong demand for warehouses for bulk distribution on the east side of Tampa near Interstate 75. Distribution companies use that area to distribute goods throughout Southwest Florida, fueling low vacancy rates and rising rents.

But financiers have tightened lending standards and have made it more difficult for some investors. "I've got over $14 million worth of medical-office buildings and they keep swimming in and out of contract because of financing issues," says Mark Alexander, a managing director with commercial real estate brokerage Sperry Van Ness in Fort Myers.

Some forms of debt have dried up and lenders are demanding that buyers put up more equity. Brugge says loan-to-value ratios have fallen from as high as 85% to 70% to 75% today. "That limits peoples' ability to lever up their returns," he says.

What's more, lending spreads have widened. Depending on the property, lenders are demanding loan terms of 1.6 to 2 percentage points over the 10-year Treasury note now versus 1 percentage point before the credit-market turmoil began, Brugge says.

A few hot markets

Lately, investors have paid more attention to downtown Tampa. In particular, they're confident that buildings will fill up as more residents move to newly built condos in the central business district.

For example, when GoldenTree and Cypress Capital acquired 501 East Kennedy earlier this year, the building was 70% full. They plan to renovate the building to attract new tenants. What's more, rents downtown are lower than other nearby office markets, including the West Shore Business District near Tampa International Airport.

"Downtown residential has changed the picture for sure," says Brugge. Buildings there are selling for well below replacement cost, another added incentive.Other hot areas include the West Shore Business District, where rents have surpassed the $30 threshold.

Further down the coast, medical-office buildings continue to attract investor attention because of health care's relative immunity to economic swings. "We're close to closing on 150,000 square feet of medical offices in Sarasota," says Stroud of Davis Marcus. "It's an industry that's not going to slow in Florida."

DEAL TRENDS

Here's a snapshot of investment sales in commercial real estate in the Tampa area and Southwest Florida. Data is for the second quarter of 2007 and covers 12 months. Change is over the previous 12 months. Industrial buildings include "flex" and warehouses.

Tampa Office Change

Volume ($mil) $1,188 19%

Avg $/sq. ft. $163 8%

Avg cap rate 6.6% ?46

Tampa Industrial Change

Volume ($mil) $293 ?28%

Avg $/sq. ft. $74 22%

Avg cap rate 6.9% ?7

Southwest Florida Office Change

Volume ($mil) $213 51%

Avg $/sq. ft. $185 11%

Avg cap rate 6.9% ?20

Southwest Florida Industrial Change

Volume ($mil) $81 ?37%

Avg $/sq. ft. $72 17%

Avg cap rate 7.1% 58

Note: Sarasota and Manatee counties are included in Southwest Florida numbers.

Source: Real Capital Analytics