Vol. 23, Number 1 page 2 : < previous page (p1)

Commercial Real Estate Market

Reflecting the strength of the US economy and rising demand for space in offices and industrial buildings, pricing in the commercial real estate market continued on a steady upward trajectory as 2013 came to a close. One of the broadest measures of pricing for US commercial properties, the CoStar Group’s US Composite Index, rose by 7.8% during the past year. Space absorption in 2013 proceeded at the fastest pace since 2007, with tenants occupying an additional 380 million square feet of office, retail and industrial space throughout the U.S. The investment grade, or top tier segment of the market, continued to dominate in space absorption. However, there has been some indication that the recovery is accelerating in the secondary and tertiary markets.

The commercial real estate market is, of course, being aided by the availability of adequate credit at very low interest rates. Investors should recognize that the ability to buy investment grade properties at attractive capitalization rates and finance those purchases with very low, fixed rate mortgages will not last forever. We are continuing to see excellent properties in prime markets that can be bought on a 6% cap rate with financing of 5%, leading to a current income return of 7% to 8%. As the economy continues to grow, it is inevitable that the Fed will let interest rates move up and this type of opportunity will disappear.

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Attractive Markets

Falcon is seeing attractive investment opportunities in a great many markets in the United States. We always look at the underlying fundamentals of a geographic market and its longer-term growth prospects before recommending a specific property in that market. Some of the markets that we are considering today include the following:

  1. Dade County, Florida – Miami is a global magnet for international business and the epicenter of the South Florida market, which is home to 5.6 million people. The Miami-Dade County office market experienced significant improvement during 2013, with nearly 2 million square feet of positive absorption since 2012, pushing vacancy down to the current 16.8% from a high of 19.2% in 2011. A specific property we are considering in Miami is the Waterford Center, which we believe can be purchased for approximately $26 million, equal to a 6.7% initial capitalization rate to provide a 7.3% ten-year average cash yield and a 12.5% IRR.
  2. Wall Street Market, New York City – Downtown New York has undergone the most extraordinary transformation of any CBD in the country. The area has been energized with new infrastructure, transportation, parks, schools, and hotels. The Downtown labor pool has continued to attract new tenants catering to media, publishing, technology, healthcare and education, such as Condé Nast and Harper Collins. These new tenants will join the financial giants that are already headquartered Downtown including Goldman Sachs, AIG, American Express, and Merrill Lynch. We are analyzing a joint venture for the purchase of a 50% interest in a property in this market — 77 Water Street, a 26-story, Class A office building that is currently 100% net leased to Goldman Sachs. We believe that a $100 million investment in this property could be made on a 7.5% capitalization rate to provide an average 10-year IRR of 8.6%.
  3. Northern New Jersey — The warehouse/industrial market in Northern New Jersey is the third largest in the nation with a total of 744 million square feet of space. The specific property we are considering in this market is a data center, and the New Jersey/New York data center market ranks as the largest data center market in the world. Data center proximity to Manhattan is a “must” for New York City’s financial institutions and media firms from a technical standpoint as well as for access to the area’s robust electric and fiber sources and human capital. The property we are recommending is 755 Secaucus Road, which is 100% leased to Equinix for another 22 years through September 2036. This location is irreplaceable given its proximity to Manhattan, mass transit and the surrounding transportation infrastructure. We believe that this property can be purchased for about $63 million, equal to a 6.2% capitalization rate. At this price the investment will provide a pre-tax average yield of 7% and an IRR of 7.5%.

Additional information can be obtained on these properties and others by contacting Kenneth Lorman — klorman@falconreal.com .

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Conclusion

Ten years ago, Falcon was recommending investments in China and in the growing countries of Latin America where we thought that the commercial real estate markets were relatively attractive. Today, we see no economy or commercial real estate market in any country in the world as attractive as those of the United States.

About Falcon Real Estate Investment Management, Ltd. — Falcon is a specialized U.S. real estate advisory and asset management firm that provides a full range of advisory services for non-U.S. investors.  Falcon has four regional offices throughout the U.S., providing localized acquisition and asset management expertise. The firm has completed over $7 billion of transactions since its inception in 1991 and has provided real estate advisory services to institutional and private high net worth investors in all asset classes and in all major and secondary markets across the United States.  For more information about Falcon, please visit our website at www.falconreal.com

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Profile
Quarterly Market Commentary

January 2014