(Bloomberg News) Minneapolis, Dallas and Denver are enticing U.S. commercial-property investors as a rebound in demand spreads from prime markets along the U.S. coasts.
The cities had three of the four biggest gains in sales by dollar volume among major metropolitan areas outside the coasts in the first quarter, according to CoStar Group Inc. (CSGP), a Washington-based property-research firm. Sales rose 127 percent from a year earlier in Minneapolis, 108 percent in Dallas and 89 percent in Denver. Nationally, the increase was 47 percent.
Investors are turning to secondary markets as credit availability improves and surging demand for properties in New York, Washington and San Francisco boosts prices and reduces returns in those areas. Cities such as Dallas and Houston are attracting real estate buyers because of the prospects for job and population growth, according to Robert Bach, chief economist for Grubb & Ellis Co., a Santa Ana, California-based broker.
"It's a story of investors gradually embracing risk," Bach said in a telephone interview. "They're looking at other markets to deploy cash."
Buyers have included Hines Global REIT Inc., a non-traded real estate investment trust sponsored by Houston-based developer Hines. It acquired Fifty South Sixth, a 29-story office tower in downtown Minneapolis, late last year for $180 million. Invesco Ltd. (IVZ) of Atlanta purchased a 22-story Denver tower for $213 million in February on behalf of a client. That was the highest sale price ever for an office building in the city's downtown, according to broker Newmark Knight Frank Frederick Ross.
New York, Washington
Metropolitan areas on the coasts are leading the recovery in commercial real estate as buyers are attracted to well-leased, income-producing properties in desirable locations. Prices for offices, the biggest part of the market, climbed 33 percent in New York and 21 percent in Washington in the fourth quarter from a year earlier, according to Moody's Investors Service. That compared with a 1.7 percent gain nationally.
Rising demand pushed down capitalization rates, a measure of real estate returns, in Manhattan, Washington and San Francisco. Cap rates are net operating income divided by the sales price, so they go down as values rise.
The average cap rate for Manhattan office transactions in the 12 months through March was 5.6 percent, compared with a recent peak of 6.5 percent in June 2010, according to Real Capital Analytics Inc., a property-research firm in New York. In Washington, the rate fell to 6.1 percent in March from 7.7 percent a year earlier. The San Francisco rate dropped to 6.8 percent from 7.7 percent in March 2010.
Extra Yield
The yield available outside the coasts is higher. Office- property cap rates were 7.8 percent in Dallas, 8.2 percent in Minneapolis and 8.4 percent in Denver as of March, Real Capital data show.
"People are looking for extra yield," Janice Stanton, senior managing director of capital markets for brokerage Cushman & Wakefield Inc., said in a phone interview. "You'll see a move to the secondary markets because there's a higher yield there and also lending is coming back in those markets."
Property investors are attracted to cities with population or job increases or both, according to Christopher Macke, senior real estate strategist at CoStar. Dallas and Denver benefit from an influx of people and San Francisco, Seattle and Boston are boosted by strength in the technology industry, Macke said.
"These are all markets that have performed better on the employment side," Macke said.
Minnesota Demand
The jobs outlook is one of the reasons real estate investors are turning to the Minneapolis-St. Paul area, said Whitney Peyton, senior managing director for broker CB Richard Ellis Group Inc. The region has gone from "out of interest" to in demand for buyers seeking higher returns, he said.
"They're getting the yields that they want and the properties are good and the communities are good," said Peyton, who is based in Minneapolis. "It's a flight to pricing."
The area's roster of Fortune 500 companies, which include Target Corp. (TGT) and Best Buy Co., and its well-educated workforce make it attractive to real estate investors, he said. The Minneapolis-St. Paul area's unemployment rate was 6.8 percent in March, below the national rate of 8.8 percent that month.
Texas properties are luring investors because of the state's prospects for economic growth, said Bach of Grubb & Ellis. There is no state income tax and housing is less expensive than other areas of the country. About 251,000 non- farm jobs were added in the 12 months through March, according to the Texas Workforce Commission.
Oil Benefit
Every metropolitan area in the state is increasing jobs and "commercial real estate seems to have stabilized," said Mark Dotzour, chief economist of the Real Estate Center at Texas A&M University in College Station.
The economy is benefiting from rising oil prices, he said. Crude futures jumped about 45 percent in the past two years and reached $113.93 a barrel on April 29, the highest since 2008.
"It's amazing what $100 oil does for the Texas economy," Dotzour said.
The energy industry is helping to boost demand in Houston, said Dennis Friedrich, president of U.S. commercial operations for New York-based Brookfield Office Properties Inc. Sales in the largest Texas city rose 55 percent in the first quarter, according to CoStar.
'Reasonable' Prices
Unilev Capital Corp. in February paid $176 million for three office towers in Houston and is interested in buying more properties in the city, said Daniel Levy, president of the Beverly Hills, California-based company. It owns office and retail properties in several submarkets of Houston, including One and Three Riverway, a complex that has about 880,000 square feet (81,750 square meters) of rentable office space.
"We are looking to even grow more in Houston," Levy said in a telephone interview. "The prices are very reasonable compared to the other parts of the country."
In Denver, KBS Real Estate Investment Trust II purchased Granite Tower, a 31-story downtown property, in December for $149 million, the biggest office transaction in the city last year. The building is about 95 percent leased, with tenants including Anadarko Petroleum Corp.
The tower is near Coors Field, where Major League Baseball's Colorado Rockies play, and the redeveloped Union Station. The location is at the edge of the city's lower downtown historic neighborhood, which has a mix of residential buildings, bars, restaurants and shopping.
Denver Growth
KBS is attracted to Denver in part because of its diversified economy, said Christopher Aust, senior vice president and director of acquisitions for the southwest region. The population is also increasing, climbing 8.2 percent from 2000 to 2010, according to the U.S. Census Bureau.
"I see it as an opportunity to be in the path of growth," said Aust, whose company is based in Newport Beach, California.
Among interior cities, only Phoenix had a bigger increase in sales by dollar volume in the first quarter than Minneapolis, Dallas and Denver, according to CoStar. Some of those may have been driven by distressed deals. The area has the third-highest percentage of commercial properties seized by banks among the top 25 U.S. metropolitan areas, according to data compiled by Bloomberg based on loans that were packaged into securities.
San Francisco led the biggest markets in the first quarter as deals more than tripled from a year earlier in dollar value, according to CoStar. The data are based on 23 U.S. metro areas.
Las Vegas Slump
The recovery may take longer elsewhere as a national unemployment rate of 9 percent and an oversupply of distressed properties reduce values. Las Vegas commercial-real estate transactions slumped 67 percent in the first quarter from a year earlier as the housing bust hurt the local economy, CoStar data show. Nevada had the highest U.S. unemployment rate, 13.2 percent, as of March, according to the Labor Department.
In cities such as Detroit and Cleveland, which have seen population declines in the past 60 years, the market is dominated by local buyers and not institutional investors who make more deals, said Ben Thypin, an analyst at Real Capital.
Secondary markets carry risk because building values and rental rates don't appreciate as fast as land-constrained coastal markets such as New York or San Francisco, Bach of Grubb & Ellis said.
"On balance investors would rather have supply constraints and barriers to entry than they would fast growth," he said. "A fast-growing market also means lots of construction and rental rates that don't go up very fast."
Loan Delinquencies
Loan delinquencies after a more than 40 percent plunge in property values since 2007 also may limit a rebound. About 5 percent of Dallas metropolitan-area loans that were packaged and sold in commercial mortgage-backed securities were 90 days late or more as of this month, the eighth-highest in the U.S. among the 25 largest metro regions, according to data compiled by Bloomberg. Houston was 13th.
Increasing availability of credit, including CMBS, is boosting demand in smaller markets. The amount of commercial and apartment-building mortgage origination volume surged 44 percent to $118.8 billion in 2010 from the previous year, according to an April 25 report by the Washington-based Mortgage Bankers Association.
Wall Street has sold $8.6 billion of bonds tied to property loans in 2011, compared with $11.5 billion in all of last year, according to data compiled by Bloomberg.
Helping Smaller Markets
"The return of the CMBS market certainly helps the secondary and tertiary markets," Thypin said. "They can do larger loans too, which most local banks can't do."
Deutsche Bank AG and UBS AG in February sold $2.2 billion of bonds backed by commercial mortgages on office, retail, hotel apartment, industrial and mobile-home properties around the U.S., including smaller markets such as Phoenix; Cincinnati; and Jacksonville and Lakeland, Florida.
Unilev took out a $130 million loan to help purchase the Houston properties, which was bundled with other debt and sold to investors in a CMBS, according to Bloomberg data.
"It's good to see the sales spreading out from just, say, D.C. and New York," CoStar's Macke said. "What that indicates is increased confidence among the investors willing to go to markets that aren't the absolute gold-plated guaranteed markets that you would go to first."