By GARY STACHE
A number of factors are influencing investor demand for low-rise office buildings.
The yield on the 10-year Treasury bond is at 4.6%, which means investors can get loans at good terms and use positive leverage.
Meanwhile, the average rent for garden office buildings is expected to continue climbing, which will boost a buyer’s yield.
Overall vacancy for low-rise buildings has fallen more than 33% versus a year ago. As rents for class A office buildings increase, tenants now are being forced to consider cheaper low-rise alternatives.
Office employment has continued to grow and leasing activity has picked up.
During the past year, cap rates have dropped to between 6.5% and 7.5%, depending on the quality of the building, its location and tenancies. Cap, or capitalization, rates are a measure of the income a property generates compared to its sale price. Higher prices mean lower capitalization rates, or yields, on real estate investments.
Even at a 6.75% cap rate, garden office buildings still offer the largest spread between cap rates and interest rates: Seventy percent loans are available at 5.9% fixed with three-year interest only due in 10 years.
Sellers, on the other hand, are looking to take advantage of record-low cap rates for garden office buildings. Cap rate increases will follow the rise in interest rates, which will negatively impact property values.
The only way to recover the loss in value associated with the move in cap rates would be to wait for an increase in lease rates. The potential impact of a 100 basis point swing in the cap rate would be a $1.25 million reduction for a property with a $10-million value.
Long-term investors can look forward to rents increasing during the next couple of years.
For shorter-term investors who are considering a sale during the next five years, now may be the time to take advantage of an overheated investment market.
About 80% of private client group transactions involve 1031-exchange buyers who are paying premiums for properties.
Research firm Torto Wheaton is projecting 10-year Treasury bonds to be at 6% by the end of 2006.
A number of individuals are selling here and moving into markets in other states that are producing much higher yields.
Areas such as Phoenix, Denver, Las Vegas and Houston are similar to OC’s market two to four years ago in terms of vacancies, and the buying opportunities and yields are much better there.
Other investors are saying that with the current federal deficit and the lowest long-term capital gains rate in history, now is the time to take profits, wait for the market to adjust, and then buy into a better yielding market.
Stache is an executive vice president with the Private Client Group in the Newport Beach office of CB Richard Ellis Group Inc.
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