Plenty of suitors, but at what price?

After years of feasting on cheap debt and driving up prices, lenders are demanding tougher terms. And an entire market is wondering what prices Atlanta’s choicest properties will command.

Bailey Webb

October 22, 2007

The Atlanta housing market's current malaise doesn't transfer to Atlanta office investment properties, the monoliths and suburban glass rectangles where hundreds of thousands toil each day.

Institutional and foreign investors still have plenty of money allocated for American – and Atlanta – commercial real estate, and value- added buyers readily pluck up older or troubled properties that, they hope, offer an upside after a fresh coat of a paint and more aggressive leasing strategy attract new tenants.

Campanile B2B

"The perception is a lot worse than reality, but if you have to do something, you might have a problem," says Steve Martin, managing director, Atlanta, for Dallas-based Granite Properties. "I don't think liquidity is going away. There is a real hit to value of about 5 percent, and that's certainly the case for highly leveraged buyers."

Those highly leveraged buyers feasted on an abundance of cheap debt over the past five years and drove up asset prices, says Steve McCarthy, managing director in the Atlanta office of Buchanan Street Partners, a Newport Beach, Calif.- based real estate investment bank.

At the same time, institutional investors increased their commercial real estate allocations by 50 to 100 percent, further increasing prices and driving down cap rates. Lenders are "pulling in their horns" McCarthy says, leading to more onerous terms, especially on Class B and Class C properties with more risk. Over the next year, McCarthy expects cap rates to increase about 1 percent.

"The result is investors will have to use more equity and less debt going forward, which means there will be fewer buyers in absolute terms," McCarthy says. "Lending terms are getting tighter and staying tighter."

Despite credit uncertainties, demand for Atlanta office properties remains strong, even after 18 torrid months marked by record sales and volumes. Trophy properties such as Downtown's Georgia-Pacific Center, AT&T's Campanile building in Midtown and Cobb County's Wildwood 2300 and 3200 have plenty of suitors, though each offers its share of leasing risk.

After the St. Joe Co. recently completed disposition of more than 1million square feet here, approximately 15 million square feet of office properties remain on the market, though AT&T reportedly is close to a deal with Chicago-based Transwestern Investment Co. for the Campanile, BellSouth's former headquarters. One highly sought asset, Newell Rubbermaid's future headquarters at Three Glenlake, found a buyer in Wells Real Estate Investment Trust II before its 2008 completion.

Still, prices are expected to slip a bit, perhaps 3 to 5 percent. Also, Buckhead and Midtown have millions of square feet of speculative office space either announced or under construction in a market with overall vacancy around 20 percent. The prospect of new spec space and 20 percent vacancy work to some companies' advantage if they're looking for office space, but leave some investors wary.

A speed bump
"From the macro perspective, the general consensus is that, yes, there's been a shift (in pricing) out there, but it's business as usual," says Will Yowell, executive VP of CB Richard Ellis in Atlanta and one of the leading investment brokers of office properties in the Southeast, if not the United States.

"We were going way too fast and maybe needed a speed bump," he says. "There's been a slight, though not drastic, re-pricing of assets. Because of all that's happened with subprime lenders, underwriting agencies began to more closely scrutinize lending criteria. Overall, 2007 is probably going to be a high water mark."

Yowell's CB Richard Ellis team routinely confers with peers across the country. With the exception of Southern California, where many subprime lenders are based and occupy a large segment of the region's Class-A office space, Ellis says investment brokers across the country are optimistic.

Of course, brokers tasked with selling investment properties are paid to be optimistic and achieve. Like many other top Atlanta properties, the Campanile has numerous interested buyers. the highest possible price for those buildings. On the other hand, they're paid to be realistic, too, and accurately gauge a property's position in the market and the underwriting. They can't afford to assess a property incorrectly and return to their clients, generally multi-billion-dollar pension and investment funds and developers, empty handed.

"For the most part, people still are underwriting with the same metrics in terms of projected rent growth and occupancies," says Randy Evans, managing director in the Atlanta office of Eastdil Secured, which arranged the Glenlake Three transaction and is marketing Georgia-Pacific Center. " While the dislocation in the credit markets certainly affects the real estate industry, it doesn't damper enthusiasm for all asset classes."

Smashing records
Enthusiasm abounded over the past 18 months as per-square-foot records were set and then smashed again. Last summer, Cousins Properties set a new record when it announced the $436 million, or $348 per square foot, sale of Bank of America Plaza to Los Angeles-based Bentley Forbes. A few weeks later, Houston-based Hines eclipsed that mark with the $273 million, or $408 per square foot, sale of 1180 Peachtree Street, King & Spalding's headquarters, to General Electric Pension Trust.

Other eye poppers included Barry Real Estate Co.'s sale of 30 Ivan Allen Plaza, Southern Co.'s new headquarters, to a private buyer for $90 million, or $339 per square foot, and investment advisor RREEF's acquisition of Doctor's Center Four at St. Joseph's Hospital for $61.3 million, or $293 per square foot.

There also were bargains, although most of them were Downtown. Cousins snatched up 191 Peachtree Street, a Downtown landmark that was practically empty at the time after departures by King & Spalding, Wachovia and Powell, Goldstein Frazer & Murphy,from Equity Office Properties Trust (EOP) for $153 million, or $126 per square foot. Cousins is treating 191 as it would a new development, projecting lease-up of the 1.2 million-square-foot, 50-story tower over five years.

A block north of 191 Peachtree, Miami-based America's Capital Partners (ACP) acquired Peachtree Center's 2.5 million square feet of office and retail from New York-based Colonnade Properties. ACP bought the venerable complex for about $215 million, which was approximately $30 million less than Colonnade paid for it in 1998. As part of a flight to private equity, EOP and Trizec Properties bailed out of Atlanta, too. EOP sold its 3.5-million-square-foot portfolio, primarily centered in the Central Perimeter submarket, to a joint venture of Barry and Philadelphia-based Rubenstein Partners for $544 million, and Trizec sold its 3.5-million-square-foot Atlanta portfolio for approximately $675 million to international real estate giant Tishman Speyer.

Trophies on the market
Three trophies currently on the market – Georgia-Pacific Center, Campanile and Three Glenlake – may fall somewhere in the middle, though Glenlake Three could set a per-square-foot record for the Central Perimeter submarket. With its 70 percent vacancy and need for upgraded building systems, Campanile falls into the value-added category, but still reportedly could draw around $230 per square foot, or about $95 million, as investors and potential tenants seek out Midtown and its burnished image as Atlanta's yuppie hot spot.

While Georgia-Pacific Center, owned by Georgia-Pacific and MetLife, still has significant vacancy after Arthur Andersen's implosion in 2002, the 1.1-million-square-foot landmark is fairly well leased, according to management company Taylor &Mathis. If Georgia-Pacific signs a long-term lease with the impending sale, the property is a top-shelf, core asset that could set a Downtown per-square-foot record. If Georgia-Pacific's new private equity masters, Wichita, Kans.-based Koch Industries, reduce the company's presence Downtown, the skyscraper is much less attractive to potential buyers. More importantly, if Georgia-Pacific reduces its presence, it's another black eye to the Downtown business community and Atlanta overall.

Glenlake Three represents the core-property caveat. With its investment, Wells REIT II joins the development team of Granite Properties and locally based Greenstone Properties and Pope & Land Enterprises. Wells' investment closes when the 355,000-square-foot office tower delivers in 2008, fully leased to Newell Rubbermaid. While other office investment classes may see slight decrease in pricing, core assets – Class-A properties with long-term leases to the most desirable tenants –most likely will not. For those buildings, a flight to quality will continue to boost values.