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Commercial real estate investments at historic high

Prices reflecting record low cap rates

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Over the last two years, cap rates -- the projections of the return or yield the buyer should expect for the first full year if a commercial real estate property was purchased entirely for cash -- have fallen significantly for both office and industrial/R&D properties in the San Diego region.

However, according to Grubb & Ellis/BRE Commercial real estate expert Steve Rowland, one shouldn't assume that lower cap rates are dampening the ardor of savvy private, corporate and institutional investors. All three of these investor categories continue to invest in the San Diego region with great enthusiasm.

Investors in regional office and industrial/R&D properties may not be realizing first-year returns on investment of the magnitude enjoyed prior to 2002, but they do anticipate higher yields in the future and are willing to hold on to their investments to realize bigger payoffs down the road, Rowland said.

While the characteristics of the regional office and industrial/R&D real estate markets differ, they are affected by the same factors -- including relatively stable vacancy rates, relatively firm rental rates, low inflation, interest rates at near historic lows, and the moderation of speculative new development -- according to Rowland, a specialist in sales of leased investment, office and industrial/R&D properties throughout San Diego County with an emphasis on privately owned product.

According to Real Capital Analytics, prices recently paid per square foot for prime office properties are almost equivalent to those being paid for equally prime properties in Hawaii and second only to the prices per square foot being paid for comparable product in the San Francisco Bay area. To put this statistic into perspective, for the first time the market for prime office properties in the San Diego region mirrors that of the housing market -- commanding top dollar in the rarified environment previously dominated by San Francisco and Hawaii.

In early December, the year-to-date increase in the value of office property sales in the region had risen approximately 34 percent from about $600 million to nearly $1 billion. While transactions for Class A facilities accounted for the majority of cumulative value, purchases of Class B and Class C properties have remained steady, Rowland said. Indeed, since today's investors in Class A office properties give every indication that they have purchased for long-term gains, experts such as Rowland expect interest to increase in well-located Class B and C properties that are candidates for upgrading.

Cursory analysis of the year-to-date figures for the regional industrial/R&D sector can be easily misinterpreted, Rowland observed.

"As we approach the end of December, sales volume of industrial/R&D properties are down in comparison to 2003, but that doesn't mean the market should fret," he said. "Given the strength of the region's economic turn-around and the relative scarcity of land for development of new industrial/R&D facilities, investment demand remains strong. The value of industrial/R&D properties has risen to the extent that owners are holding on to their assets rather than selling them. While we'll close 2004 with fewer sales of industrial/R&D properties, the prices per foot are significantly higher due to a stockpile of capital chasing limited product."

Assuming that economic conditions will prevail without dramatic upheaval, Rowland offered the following advice to the owners of office and industrial/R&D properties:

If you have contemplated selling such assets, there's little downside to selling in the midst of what has become the best market in the region's history.

His concurrent advice to potential investors is equally succinct:

Be cautious when buying in a market at an all-time high; more than ever it is a time when you should avail yourself to advice from experts who understand the most minute details of the market, the properties and the players.

"On the office and industrial/R&D side, it is the hottest market I've experienced in 20 years," Rowland said. "While there are no guarantees, realistically there isn't much downside risk for sellers. For shrewd buyers with the mindset and the means to leverage their investments for greater yields in the future, there too should be potential upside."


Submitted by Grubb & Ellis/BRE Commercial

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