A group of wealthy investors represented by a unit of HSBC Holdings PLC has purchased a 90% stake in a Washington office building, in a further sign of the relative strength of the U.S. capital's office market and the dominant role foreign investors are playing as buyers of commercial property.
HSBC Alternative Investments Ltd. paid $203.4 million in debt and equity for 1625 I St., a fully leased 85,000-square-foot building about two blocks from the White House. The deal values the property at about $587 a square foot, one of the highest prices paid per square foot in Washington during the past 12 months, according to Real Capital Analytics, a New York real-estate research firm. The seller was Brookfield Properties Corp., which will retain a 10% interest and management responsibility for the building.
While the values of commercial real estate have fallen as much as 50% in some areas, the Washington office market has held up relatively well thanks to demand for space from government agencies and the Obama administration.
Office vacancies in the metro area rose to 14.7% in the third quarter from about 11.9% a year ago, but the levels were still well below the national vacancy average of 19.4%, based on the major U.S. markets tracked by Property & Portfolio Research, a unit of CoStar Group Inc. In addition, the rents landlords are asking for in Washington's central business district aren't expected to experience as drastic a decline as in some markets in the U.S., according to PPR.
"Washington has been the most consistently performing market in the nation for a long time," Rick Clark, president of Brookfield's U.S. operation, said in an interview Monday. He said Brookfield is selling to switch capital from core assets into more opportunistic ventures like buying distressed property. "Any prudent asset manager doesn't buy, hold and die. They recycle capital," he says.
The HSBC deal also is the latest in a number of high-profile acquisitions of commercial properties in the U.S. by non-U.S. investors. While there were few big deals of any kind in 2009, many of the notable transactions were driven by foreign buyers. In September, DekaBank Deutsche Girozentrale paid $208 million for 1999 K St., a 12-story office building designed by Helmut Jahn and located in the central business district. And earlier this year HSBC was on the opposite side of the table when it sold its office tower in New York to Israeli investor IDB Group for $330 million. Swedish construction group Skanska AB also acquired a stalled office development near the White House for $85 million.
Mr. Clark said that Brookfield received five "strong offers" for the property as well as numerous other feelers. Of the five offers, three were from foreign investors. "There's a lot of capital around the world particularly in countries whose currencies have floated up versus the dollar," he says.
Brookfield purchased 1625 I St., known locally as Eye Street, in late 2003 for $157 million just as it was being completed by the Union Labor Life Insurance Co. At that time, it was about 50% leased, Mr. Clark says. HSBC's purchase of the 90% stake values the property at about $226 million.
Harry Heathcoat Amory, associate director of HSBC Alternative Investments Ltd., said the deal was the group's first direct property acquisition in the U.S. since it added its real-estate fund-management business about three years ago. HSBC Alternative invests in property on behalf of its private-banking clients, a majority of which are high net-worth individuals based in the Middle East, Asia and the U.K., though some also are in the U.S.
Mr. Amory said HSBC is looking at making more property acquisitions in Washington as well as other mature U.S. markets such as New York and Boston where new supply is constrained. "Those other markets are also places to look but Washington is the strongest office market in the U.S.," Mr. Amory said. "It's weathered the storm."
Mr. Amory said the deal, which included the assumption of about half the price in debt and the rest in equity, computed to a 7.5% capitalization rate, a measure of the property's income relative to acquisition price. Near the peak of the market, average cap rates were in the mid-5% range in the Washington area, according to Real Capital.
Michael Knott, a senior analyst with Green Street Advisors, said Brookfield agreed to the deal earlier in 2009 before the national economy and Washington office market had begun to strengthen. "Things have moved in sellers' favor since the deal was struck," Mr. Knott said. "My guess is if they had to do it over again, they would require higher pricing."
While foreign investors are interested in U.S. property, the volume of deals remains down sharply because of financing issues and the reluctance of most owners to sell when most markets are slumping. Last year, the total value of commercial properties sold to foreign investors and valued at $5 million or more fell to about $2 billion, down from $33.4 billion near the peak in 2007, according to Real Capital Analytics. The level was still a relatively small part of the $48.7 billion transactions completed overall in 2009.
Germany is among the leading foreign buyers of U.S. real estate while many Irish and Australian investors have become sellers, according to a report by Real Capital Analytics.
Foreign investors like to reduce risk by focusing on trophy buildings or occupying properties with strong architecture and long-term leases, said Andrew Weir, a managing director in Washington with Holliday Fenoglio Fowler. "There aren't a lot of deals that fit their parameters," Mr. Weir said.
HSBC, which has been in discussions with Brookfield about the property for about 12 months, was advised in the transaction by Edge Fund, a Washington real-estate-investment adviser. As the talks continued and the market improved, Mr. Amory said it became increasingly aware of the opportunity it had to buy a property as market sentiment was improving but while competitors that would have pushed up pricing remained on the sidelines. "The timing was spot-on," Mr. Amory said.
The building's largest tenant is the Washington office of the Los Angeles-based law firm O'Melveny & Myers.