Good Deals in the 2005 U.S. Real Estate Market

As we go into the second half of 2005, there is still a tremendous amount of capital trying to find investments in the U.S. real estate market. Mortgage money remains plentiful and mortgage interest rates have remained at historically attractive levels, actually declining again in recent weeks. As a result, cash-on-cash yields to investors continue to exceed the yields available from other asset classes. At the beginning of the year we had expected that gradually increasing interest rates would put upward pressure on capitalization rates and downward pressure on real estate prices. However, this has not yet happened, and our experience in the market place at this time indicates that competition for good properties remains as intense as ever. As long as the U.S. economy continues to stay strong, it would appear that the real estate market will also remain strong.

Falcon Real Estate believes that the best investment opportunities in the real estate market today lie in those properties that have some characteristics that are slightly out of the mainstream. The properties could entail a small amount of credit or leasing risk; they could be in a less well-know geographic market; or they could be relatively unexciting from an architectural viewpoint. We have selected the following four properties that we would currently recommend as being examples of excellent long-term investments available in the U.S. real estate market at this time:

1. 1. Underwood Johnson Corporate Park, Redmond, Washington
2. 2. Verizon Building, Las Colinas, Dallas, Texas
3. 3. Sephora Distribution Facility, Baltimore, Maryland
4. 4. FedEx Call Center, Fort Lauderdale, Florida

Detailed descriptions of these properties follow.

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Underwood Johnson Corporate Park:

The Underwood Johnson Corporate Park is a three building, 418,388 square foot (38,883 square meter) industrial property that was constructed in 1997. The property is considered to be among the most efficient and highest quality industrial facilities in its market and has benefited from significant capital investments made by the tenant and the current landlord. The Underwood Johnson Corporate Center is located in the City of Redmond, part of Seattle, Washington’s Eastside Market, which is connected via two floating bridges across Lake Washington with Downtown Seattle just 18 miles to the west.

The property is leased to a wholly-owned subsidiary of Terex Industries, although Terex does not formally guarantee the lease. There are twelve years remaining on an original twenty-year lease. We believe that this property can be purchased at a price of $43 million, equal to a going-in capitalization rate of 6.3% and a price per square foot of $103. The initial cash-on-cash yield would be only 6.8% in Years 1 and 2, since the rental rate being paid by the tenant is considerably below market. However, in 2008 the rent adjusts to market, at which time we estimate that the yield would increase to 11%. Since the lease provides for rental increases every 30 months thereafter at the greater of 6.25% or the consumer's price index for Seattle, the cash-on cash yield moves up to 12.7% in Year 5. The negatives in this situation include the lack of an investment grade credit rating for the tenant, and the low cash-on-cash yield in the first two years of ownership. However, Falcon believes that the lease terms are very positive for the investor, and that the quality of the property and its location combine to make this a very attractive long-term investment.

Verizon Building, Las Colinas, Dallas, Texas

This is a 250,000 square foot (23,226 square meter) six-story office building located in the Las Colinas development, adjacent to the Dallas/Ft. Worth International Airport. Las Colinas is considered to be one of the premiere master-planned, mixed-use real estate developments in the United States. Since its construction in 2003, the property has been leased to Verizon Communications, one of the largest and strongest telephone companies in the country. There is only one problem with the property – and it is also the opportunity – and that is that there are only three years remaining on the lease to Verizon. Many investors in the market today are not willing to take leasing risk and therefore it is possible that this property could be acquired at a price of $46 million, which would be equal to a going-in capitalization rate of 9%. It would also be equal to $184 per square foot, which is below replacement cost. The building would be held for three years until Verizon renewed their lease, and then it could be sold at what we anticipate would be a significant capital gain.

If the property could be sold at an 8% capitalization rate three years from now, the IRR during the holding period would be 15.4%. We believe that this is a conservative estimate, since this property, with a new 5-year lease to Verizon would sell at about a 7% cap rate today, and maybe even lower. If it were to sell at a 7.5% cap rate three years from now, the IRR would be 21.8%. So the big question is: will Verizon renew? That is, of course, the risk in the situation. However, this property is part of the company's Dallas regional headquarters, and the company has occupied space in this relatively new building for only a few years. Admittedly, there is risk, but that is why the IRR can be projected in a range starting at 15% and going up from there.

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