Marvin Davis, Roy Disney and several other savvy investors are putting their Westside trophy properties up for sale, suggesting that the torrid run-up in that area’s property values may be subsiding.
The moves come as technology-related tenants, which have been largely responsible for fueling the frenzy, suffer downturns in their stock prices and pullbacks in their venture capital backing.
“We’re definitely hitting a peak,” said Ian Strano, a veteran Westside broker and senior vice president at First Property Realty Corp. “The people who are disposing of these assets have maximized the value of the buildings and are smart to move on.”
The crown jewel of properties hitting the auction block is Fox Plaza, which the Davis Cos. hopes to sell for $325 million (more than $400 per square foot) $75 million more than Davis paid in late 1997.
Other properties on the market include Raleigh Studios Manhattan Beach, which Disney’s private investment firm, Shamrock Holdings Inc., hopes to unload for $130 million; and The Tower in Westwood, which Tishman Speyer Properties expects to sell for $300 per square foot, or in the high-$50 million range, industry sources said.
Not all industry observers agree that the selloff reflects a peak in the Westside market.
“I’m not sure a decision to sell signals anything with respect to the state of the market, as much as it signals something with respect to the asset,” said William J. Chadwick, a principal in Chadwick, Saylor & Co. Inc., a West L.A. real estate investment bank. “For the next couple years, you’re going to continue to see a very strong Westside market because demand is far stronger than existing supply there.”
Among the most likely buyers of the Westside trophies are pension funds and their advisors. Most real estate investment trusts remain sidelined. Among the names mentioned as potential suitors for Fox Plaza are Douglas Emmett & Co. and two German companies, TMW and Jamestown (although German companies have been hurt recently by weakness in the euro).
Rate hike immunity
Such well-heeled investors with lots of equity and strong credit lines remain relatively unaffected by the recent interest rate hikes because they are not heavily leveraged, and their strong relationships with banks enable them to borrow below the prime rate.
“It’s predicated on the asset type, the quality and size,” said Bob Safai, principal at brokerage Madison Partners. “It’s easier to borrow $100 million than $1 million.”
But at some point, higher interest rates impact everyone, even the big boys. In general, as interest rates go up, the price a building can fetch goes down.
“It affects the pricing. Everyone has a threshold and needs a certain cash-on-cash return,” Safai said. “With interest rates going up, there’s going to be caution. It’s going to make it a lot more difficult for value-added players to be active (buyers). Deals are harder to find and make work.”
“Value-added players” are entrepreneurial investors, like Davis, who snatch up undervalued buildings, renovate them, re-lease them at higher rents and then sell them at a hefty profit all in a relatively short period of time, typically three to five years.
Indeed, one reason several properties are now up for sale is that they were bought by these value-added investors about five years ago, when prices were still depressed, then renovated and leased up at higher rental rates.
Those buyers always planned to cash out in a few years, as the market improved. That’s especially true if the buyer had guaranteed its investors a high return each year, which becomes tougher to achieve as the real estate cycle matures.
“None of it is panic selling,” said David Doup & #233;, executive managing director at Insignia/ESG’s Capital Advisors Group. “A lot of it was bought two to five years ago with business plans that envisioned that, once rents rolled and stabilized, they would sell.”
So what will these savvy value-added investors do with their sales proceeds?
Davis and Disney did not return phone calls last week.
But several investment experts said those two mega-investors and similar value-added types will most likely buy other undervalued assets in emerging markets elsewhere, or they’ll shift into developing new buildings from scratch.
“These guys are merely repositioning their portfolios to have cash ready to jump on opportunities in the future,” said Strano. “Guys like Davis and Tishman (Speyer) will start to develop again, and as development comes back, you need cash.”
Other destinations for the sales proceeds are offshore.
“As opportunistic investors like Davis take their money out of Fox Plaza, they’re going to re-deploy it globally, wherever they see opportunities,” said Chadwick. “And the money people are now seeing better opportunities outside the United States. The U.S. is entering a more stable phase, where finding 35 percent (annual) returns is proving very difficult.”
As a result, such investors are diverting much more money to Asia and Europe, he said.
“If you were to look at the big investors Whitehall, Colony, DLJ and compare the percentage of their capital in the U.S. vs. abroad in 1998, 1999 and the first five months of 2000, you’d see that the line drops like a rock from left to right from probably 70 (percent U.S. assets in 1998), to 50 (percent in 1999) to 30 (percent today).”
Meanwhile, buying the Westside trophy properties makes perfect economic sense to pension funds and other big institutional investors, industry observers said. That’s because they’re happy with far lower returns than those demanded by value-added investors. Also, their investment horizons are much longer.
In addition, some pension funds had actually made so much money in stocks before the recent decline that they found themselves under-allocated in real estate. Pension funds typically allocate 5 percent to 10 percent of their portfolios to real estate.
“There’s a lot of money that wants to get into real estate and out of the stock market,” said Steve Silk, a principal with Secured Capital Corp.
Also, the fundamentals remain strong, with rents rising throughout the L.A. area and vacancies decreasing.
“Plays are being made not based on interest rates but on the scarcity and barriers to entry,” said Peter Best, a principal at Trammell Crow Co. “It’s difficult to get anything entitled in the city.”
But there’s no shortage of L.A.-area commercial properties up for sale right now.
In addition to the Westside trophy properties, TrizecHahn Corp. is trying to sell its holdings at 15760 and 15910 Ventura Blvd. in Sherman Oaks, which are expected to fetch around $80 million.
Several smaller deals but still in the eight-figure range are being offered in Torrance, El Segundo, Long Beach, Culver City, the Conejo Valley, Glendale, Pasadena, downtown and Mid-Wilshire, industry sources said.
But there’s actually less property on the market in the L.A. area than in other markets around the country. In San Francisco, for example, $1.9 billion worth of property is on the market, about two times the amount sold there each year over the past three years, Doup & #233; said.
Meanwhile, he said, there are 20 percent to 30 percent fewer serious buyers today than there were earlier this year, because many groups have already achieved their real estate allocations, “so they don’t need to run after every deal.”
Commercial real estate investors at this late stage in the cycle will tend to be longer-term investors who are seeking slow, steady returns.
“The buyer today is going to be fairly passive,” Strano said. “Real estate is now a commodity. It’s a vehicle for placing money and achieving return, like a CD in a bank. The days of getting rich on real estate by flipping it in 30, 60 or 90 days are gone.”
Possibly so, at least on the Westside. But if history is any indicator, those days will return.