Little Guys Buying as REITS Await Change
By MATHEW PADILLA
Orange County’s slumping commercial real estate market has spurred a lot of buying in the past two years. The twist is in who’s buying.
Real estate investment trusts are out. In are the little guys and pension fund investors seeking refuge from Wall Street.
Low interest rates and a lackluster stock market have brought out smaller buyers and institutional investors. They often don’t expect fantastic returns, according to brokers. They just want more for their money than can be had with stocks or interest on savings accounts.
That’s not enticing enough for the big guys. Real estate investment trusts, such as Chicago-based Equity Office Properties Trust and New Jersey’s Mack-Cali Realty Corp., are sitting on the sidelines. Why? In a nutshell, there’s no money to be made for them.
Smaller and institutional investors have pushed up prices for some buildings even as rents languish. The scenario works for them because the low returns still are better than what Wall Street is offering these days. And, for individual buyers, there are tax benefits.
Many recent buyers are so-called 1031 exchange investors who are putting proceeds from sales of other real estate into new buildings to avoid capital gains taxes.
But the economics of today’s market don’t pencil out for real estate investment trusts. They need rents that cover the cost of owning a building and then some, as they’re required to turn profits over to shareholders as dividends.
For now, Equity Office isn’t buying anything in OC, said Bert Dezzutti, the company’s top Southern California executive.
In fact, Equity has sold some buildings in San Diego and is shopping some in the Inland Empire and elsewhere. The proceeds are going to buy back the company’s shares, Dezzutti said.
That’s the opposite of what Equity did during OC’s more severe real estate downtown in the early 1990s, when chairman Samuel Zell grabbed up buildings here at depressed prices.
But after buying Spieker Properties Inc. in 2001, Equity’s focus now is on controlling costs by combining property management offices and getting tenants for empty space, Dezzutti said (see related item, page 25).
Don’t look for Equity and others to start buying before interest rates go up. Private investors typically use more debt than real estate trusts, making interest rates critical for them. A rise in interest rates stands to clear some smaller buyers from the market, observers say.
The flight of money from Wall Street into real estate may be hitting a critical mass. Capitalization rates, a key investment indicator, are hitting record lows, especially for retail and industrial investments. Capitalization rates are a ratio of operating income from a property to its sale price.
Even with low capitalization rates, private investors are buying buildings now because mortgage interest is even lower.
There still are risks for buyers, said Mike Randall, senior vice president in the Newport Beach office of Grubb & Ellis Co. He said he believes rents haven’t hit the floor yet with the still sluggish economy.
But that’s not causing pause for individual investors. They’re even going after bigger buys.
A group of them are teaming with Santa Ana’s Triple Net Properties LLC in a $59 million bid for Xerox Centre in Santa Ana (see related story, page 1).
“Almost any office, industrial or retail property with BBB-or-better credit tenant on at least a 10-year net lease will achieve a premium price in this market,” said Kenneth Barry, vice president with the Anaheim office of CB Richard Ellis Inc.
On the retail side, Santa Ana-based Passco Real Estate Enterprises Inc. pooled together 32 investors to buy Puente Hills Mall in Industry for $148 million.
Among private buyers of OC office buildings in the first quarter, about 60% are 1031 exchange buyers, according to Gary Stache of CB Richard Ellis. 1031 buyers make up 80% of industrial investment buys and 80% of retail investment deals.
