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THE YEAR IN DEALS

THE YEAR IN DEALS

Mortgage Boom Played Out in Commercial Real Estate in 2003

By MATHEW PADILLA

In a twist, 2003 may come to be known as the year the hot housing market dominated commercial real estate.

Homebuilders, companies that sell to homebuilders and mortgage lenders accounted for several of the biggest leases and sales last year.

In the following pages, the Business Journal has published several lists of the top sales and leases of 2003 in office, industrial and retail markets. Apartment sales also are included.

Data was provided by CoStar Group Inc. and by local brokerages. Sales are ranked by dollar value and lease deals are ranked by square footage.

Before analyzing the lists, it’s important to note something they don’t show: how popular the sales of smaller office and industrial buildings were last year. While small sales were big in number, they weren’t large enough to make our lists.

Spurred by low interest rates, owners of small companies have been trading in their leases for an opportunity to buy a small building, typically under 10,000 square feet, and use it to house their business.

Kurt Strasmann, who heads Grubb & Ellis Co. in Orange County, said his company had a 40% increase in volume in 2003 here versus the prior year, mostly as a result of sales. Grubb’s Newport Beach office did nearly $1 billion worth of deals last year, he said.

“(Sales) drove a lot of revenue for brokerages,” Strasmann said.

Low interest rates fueled demand for buying office properties, according to Steve Economos, a sales broker with NAI Capital Commercial in Newport Beach.

“Rents softened all through last year, yet it’s definitely true that sales prices went up,” Economos said.

He and his father, George Economos, sold 20 office buildings in 2003.

Tile mogul Larry Bedrosian’s big industrial buy is evidence of how big an impact the housing market had on commercial real estate last year.

In one of last year’s biggest industrial sales, Bedrosian paid $27 million for a 500,000-square-foot building in Tustin from Woodland Hills-based The Voit Cos. The building is part of the former Steelcase Inc. campus.

Bedrosian’s company, which bares his name, is occupying the space. Bedrosians sells granite slabs and tiles to homebuilders and designers, as well as to Home Depot Inc.’s Expo Design Center.

“We have a lot more space now, and it is a growing business,” Bedrosian said last year.

The deal closed in the summer.

Homebuilder Takes Top Lease

On the leasing side, residential-related companies accounted for the top three office deals last year.

Last year’s biggest office lease, at 137,000 square feet, was signed by the California unit of Miami-based homebuilder Lennar Corp. The builder is set to move from Mission Viejo to the Summit Office Campus in Aliso Viejo.

The November deal consolidated and expanded Lennar’s operation in the county.

Lennar’s lease was not only a boon to Summit owners Parker Properties LLC and Cigna Corp. but also help the Aliso Viejo submarket, according to W. William Gaboury, chief executive of Shea Properties, a unit of Walnut-based J.F. Shea Co.

Shea Properties’ Vantis project has been competing with Summit for office tenants in Aliso Viejo. Gaboury said the Lennar deal takes a big chunk of office space off the market in that city, which is good for all office landlords.

Orange-based Ameriquest Mortgage Co. signed the No. 2 lease deal last year, taking 128,000 square feet at a Trammell Crow Co. project in Anaheim.

Ameriquest is a subprime lender,it specializes in loans to people with less than perfect credit. The company also is expanding into other types of mortgages.

And Encore Credit Corp., another specialty mortgage lender, took the No. 3 office lease, with 127,718 square feet at 1833 Alton Parkway in Irvine.

A slew of mortgage companies have nearly dominated office leasing for the past couple years,something the Business Journal often has reported on.

But after interest rates hit rock bottom in mid-June, a bust in home loan refinances contributed to the closing of Irvine’s Instafi.com. That sent some shock waves through the office leasing market, with some worried other companies soon would follow. So far that hasn’t happened.

In any case, leasing activity by mortgage companies and homebuilders helped solidify the office leasing market last year, especially since there was a dearth of new construction, sources said.

Total office absorption in 2003 hit a sizeable 3 million square feet, the highest total since 3.5 million square feet in 2000, according to Voit Commercial Brokerage.

That means a big chunk of empty space was taken off the market last year. CB Richard Ellis Inc. noted a drop in office vacancy in the fourth quarter to 14.1%, compared to 15.9% at the end of 2002.

Many brokers expect rental rates to start ticking upward, perhaps as early as the second half of this year, as the economy improves.

Unlike other commercial markets, the buying and selling of trophy office properties last year wasn’t much affected by the hot housing market.

Still, last year was unusual in terms of who was buying. 2003 witnessed the growth of companies that group together wealthy private investors on real estate buys.

These companies specialize in tenant-in-common deals, industry lingo for when several private investors share ownership in a property.

In of the biggest office sales last year, Santa Ana-based Triple Net Properties paid about $60 million for Xerox Centre, one of Santa Ana’s most high-profile office towers. Triple Net teamed 17 private investors who put up about $20 million in cash,with the remainder debt,to buy the 15-story building.

Many tenant-in-common buyers active last year took advantage of a portion of the tax code, known as 1031, to avoid paying capital gains taxes on prior real estate sales. To avoid being taxed, investors must buy an income-producing property within a certain period of selling one.

“1031 exchange investors defined the marketplace,” said Gary Stache, senior vice president with the private client group of CB Richard Ellis.

Bob Smith of CB Richard Ellis brokered the Xerox deal, with seller New York-based pension fund adviser DRA Adivsors Inc. Smith’s team at CB accounted for nearly half of the top office sales last year.

Smith said last year private investors were active buyers of real estate in part because the stock market crash of 2001 turned some investors away from seeking only capital appreciation in their investments.

Instead, they are looking for cash flow, he said.

Amid today’s low interest rates, cash flow from real estate has become an attractive alternative to dividends on stocks and yields on bonds, he said.

“Real estate has grown up to become an asset class over the last five years,” Smith said.

Some brokers are concerned that so much of what happened in 2003 was dependent on low interest rates.

Low rates helped drive sales for homebuilders and mortgage companies who in turn leased commercial space. And low interest rates drove sales of commercial buildings.

So far this year, interest rates are back down again after rising slightly in the second half of last year.

On March 1 the yield on a 10-year treasury note, a highly watched rate, dipped below 4%. With elections in November, most economic pundits don’t expect rates to start going up until late this year or next year.

The major cloud on the horizon is government debt.

Federal and state governments are deep in the red, and no one is sure exactly how that will affect debt markets. But most agree those deficits will put upward pressure on rates.

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