Los Angeles was the nation’s second most active market for real estate investment trust purchases last quarter, according to a new report.
REITs spent $404 million to purchase 18 properties in the L.A. metropolitan area last quarter, up from $218 million spent in the first quarter, according to the Koll National Real Estate Index.
The report’s findings were hardly a surprise to brokers and analysts who have seen REITs come to dominate the local commercial real estate investment market in the past year. It further confirms that Los Angeles has finally shaken off its seven-year-long recession.
“The market has been recovering here for some time, and most Angelenos were waiting for Wall Street and the investment public to notice,” said Richard Klein, a partner at E & Y; Kenneth Leventhal’s Real Estate Group. “(This report) is a general recognition that Los Angeles is a market on the upswing, where occupancy and rents will continue to go up.”
The L.A. market accounted for 7.5 percent of all REIT acquisitions in the United States last quarter, almost double its market share during the first quarter. L.A. placed behind No. 1-ranked Boston, where REITs spent $609 million in the second quarter.
Nationwide, REITs bought $5.4 billion worth of properties in the second quarter, up 8 percent from about $5 billion in the first quarter. The Koll index tracks acquisitions in the 65 largest real estate markets based on data provided by brokers, investors and developers.
Boston-based Beacon Properties set the pace for REIT acquisitions during the second quarter, spending $836 million more than three times as much as the second most active REIT. Beacon accounted for 15.5 percent of all REIT purchases nationwide, although it bought just four properties last quarter including its $99.4 million acquisition of the 10880 Wilshire Blvd. building in Westwood.
Two L.A.-based REITs placed among the top 20 most active REITs, in terms of acquisitions. El Segundo-based Kilroy Realty Corp. ranked 10th, spending $159 million and accounting for 2.9 percent of all REIT purchases. Beverly Hills-based Arden Realty Group Inc. placed 12th, spending $155 million in the second quarter. The bulk of Arden’s purchases about $100 million were made in the Los Angeles office market, where it bought five buildings during the second quarter. Kilroy bought one L.A. property, a Calabasas office building for $11.7 million.
“They’ve both been very active,” said Michael Adler, a partner at the real estate appraisal firm Sommer Adler and Co. “They were buying in the L.A. market before a lot of other REITs would even look out here. Their market timing was very good.”
Although REITs stepped up their activity in L.A. last quarter, the L.A. area’s position as the fourth largest area in terms of REIT holdings remained unchanged from the first quarter. As of the end of the second quarter, REITs had invested about $5.5 billion in 270 L.A.-area properties.
Office properties were the most popular asset type purchased by REITs in the second quarter, accounting for 40 percent of REIT acquisitions naitonwide. In fact, REITs spent as much on U.S. office buildings as they did on U.S. apartments, retail and hotel properties combined in the second quarter.
The Koll report did not break out asset types for individual cities, but Klein said L.A. seems to echo the national trend. Retail REITs were the most active in L.A. in 1992, then apartment and factory outlets followed. Now few of those properties are available because they’ve already been purchased by REITs, he said.
“As we’ve seen the office market strengthen in terms of rent and tenant demand, it’s natural that REITs would begin to acquire them,” he said. Most offices are a value for REITs because they can still be purchased for less than they cost to be constructed, although that’s quickly changing as REIT interest has driven up prices for office buildings, Klein said.
The tendency of certain types of real estate assets to fall in and out of fashion among REITs troubles Allan Kotin, a consultant with KMG Consulting (Kotin Mouchly Group). He said REITs tend to buy heavily into a particular property type, such as office buildings, driving up prices and pushing other investors out. And once Wall Street’s infatuation with office-oriented REITs cools, there’s not enough diversity among investors to cushion the blow to the sector.
“Once that market becomes unfashionable, it becomes very hard to get money to finance new development,” he said. “When it starts to go wrong, it all goes wrong.”
Such has been the case with REITs specializing in factory outlet malls, which have seen their market value decline by 8.6 percent during the first eight months of this year, according to Teleres, a data service company owned by Dow Jones News Service.
Although the heavy REIT investment in L.A. heralds Wall Street’s confidence in the local real estate market, not everyone is happy with the changes that have accompanied the infusion of REIT money.
REITs are by far the most active buyers of office properties, in part because they’ve priced the other investors out of the market. REITs are perceived to have a lower cost of capital than an individual investor, pension fund or opportunity fund that doesn’t have the ability to raise money on Wall Street.
But whether REITs are overpaying, said Klein, remains in question. “The reason they have a lower cost of capitalization is because the stock market continues to perceive that they’ll be the most efficient owners of real estate,” he said.
Adler added that REITs “are now willing to pay higher prices for quality properties,” as they gain confidence that L.A. real estate has recovered and rents will rise.
