Office buildings in top U.S. markets are getting so expensive that landlords are choosing to build rather than buy, spurring the most development by real estate investment trusts in at least a decade.

Office REITs, led by Boston Properties Inc., Vornado Realty Trust and Kilroy Realty Corp., are planning to plow almost $11 billion into new projects, triple the amount just two years ago and the most in data going back to 2004, according to research firm Green Street Advisors Inc. Much of that is focused on the coasts, including San Francisco and New York, the areas with the most demand from both tenants and investors.

Prices for office buildings in major markets have surged past peak levels, lifted in part by sovereign-wealth funds and pensions willing to accept lower yields than other investors because they are seeking safe investments. For REITs, which have to answer to shareholders seeking higher returns, building is often a better option than competing with institutional buyers.

“They’re selling assets and they’re developing,” said Michael Knott, a managing director at Green Street in Newport Beach, Calif. “They’re going out the risk-reward spectrum by starting more developments rather than buying.”

Projects in the works include Boston Properties’ $1.13 billion tower in San Francisco that will be the headquarters of Inc. and the city’s tallest building. SL Green Realty Corp. plans on constructing a 1,200 foot (366 meter) skyscraper in Midtown Manhattan. Cousins Properties Inc. and Brandywine Realty Trust are developing offices in Austin, Texas.

Prices for central business district office properties in six major markets––Boston, New York, San Francisco, Chicago, Los Angeles and Washington––were 16% above the 2007 peak as of April, according to data from Moody’s Investors Service and Real Capital Analytics Inc.

Capitalization rates, a measure of returns derived by dividing a property’s net operating income by its purchase price, have tumbled as a result. The average cap rate for Manhattan office buildings was 4.5% in the first three months of the year, close to the low of 4.4% in the second quarter of 2008, according to Real Capital. It reached as high as 6.6% as the property market cratered in 2010.

In San Francisco, cap rates were 5.4% in the first quarter, down from 7.8% in the second quarter of 2010. They hit a low of 5% in 2009.

Ian Goltra, a money manager overseeing real estate funds at Forward Management LLC in San Francisco, and who manages funds that own shares in REITs including Boston Properties, Vornado and SL Green, said he’d rather see publicly traded office owners construct new properties than buy a building for a cap rate under 5%.

“That’s why the public REITs are left to build buildings,” said Goltra, whose firm manages about $5 billion.

While returns vary depending on the development, they’re generally averaging around 7% for Boston Properties projects under way, the company said.
Investors have so far rewarded the company’s strategy, with shares up 13% in the past year, compared with an 8.3% gain in the Bloomberg REIT Index. Vornado has jumped 25%, while Kilroy is up 16%.