Acquisition outlook getting sunnier, but clouds remain

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About Real Estate Rundown SNL's Real Estate team examines and comments on goings-on in the real estate space.

It's old news at this point that there is not a lot of news on the transaction front in commercial real estate.

Those amazing, once-in-a-lifetime asset acquisition opportunities just have not arisen, at least not yet. Banks are favoring extend and pretend, kick the can down the road policies over foreclosures, creating little incentive for all but the most truly distressed owners to sell their properties. In fact, bank regulators said in a recent policy statement that "prudent CRE loan workouts are often in the best interest of the financial institution and the borrower."

But as NAREIT points out in a recent release, the conditions could be improving to the point where acquisitions start occurring once again. According to the MIT Transaction-Based Index, transaction prices of commercial properties sold by large institutional investors rose 4.4% in the third quarter. Prices now stand 36.5% below their mid-2007 peak, up from their nearly 40% down position in the second quarter.

TBI's supply and demand indexes also indicate that the bid-ask gap is narrowing. "This provides evidence that liquidity may be starting to return to the commercial property market," NAREIT said.

Some REITs are starting to turn their sights toward acquisitions. While a few companies have already made purchases this year, many are actively looking for opportunities.

First Potomac Realty Trust in October acquired a class A business park in Germantown, Md., for $25.5 million. Chairman and CEO Douglas Donatelli noted during the company's third-quarter earnings conference call that First Potomac expects the property, known as Cloverleaf Center, to generate a first-year unleveraged return of about 10.7% on a cash basis and 11.5% on an accrual basis.

"We attribute our ability to source an acquisition with such good returns to both good timing and the depth of our local market relationships," the executive explained. "We don't expect to necessarily find other acquisitions at similar yields, but we do believe that there will be other attractive acquisition opportunities for us."

Equity Residential, which has been an active seller of assets, recently purchased the Metropolitan at Pentagon Row in Arlington, Va., for roughly $100 million, Holliday Fenoglio Fowler LP said Oct. 30. Discussing potential acquisitions the day before during the company's third-quarter conference call, President and CEO David Neithercut acknowledged the "chatter out there" surrounding such opportunities and said the company did have some assets under contract in various stages of due diligence.

"What I can say, however, is that these are all excellent assets in our core markets," Neithercut explained. "They are exactly the kind of assets we want to own going forward. They are under contract at prices that are discounts to replacement cost averaging 15 to 20% or so. They are well occupied assets. They are currently or will soon be stabilized with rent rolls that have been marking expiring leases to market over the next 12 months and are expected to continue to do so over the next 12 months."

Regarding the Pentagon Row acquisition, the executive said the company was acquiring that asset for about 30% or so less than it might have done several years ago. He noted, however, that he did not want to suggest "for a moment" that this was a distressed deal. "This is a great opportunity to add a terrific asset to our portfolio and a fabulous trade with the assets that we've been selling," he said.

But while REITs are looking for and at times making acquisitions, many still caution that it could be some time before deals get done. Boston Properties Inc. President Douglas Linde during his company's recent third-quarter earnings call discussed reasons why it is going to take longer than some might expect for the company to be able to capitalize on attractive opportunities.

"There continues to be tremendous trepidation about the balance sheet of the commercial real estate sector," Linde said. "There is universal acknowledgment that the availability of financing in recent years has led to a situation where individual properties carry debt at levels that couldn't be refinanced today and in many cases greatly exceed the property value. We see the wave of CMBS loans that are going to mature over the next few years and we know that many financial institutions have loans that are greater than the current value of the underlying property, yet examples of ownership transfer are few and far between."

Linde noted that a "critical component" of any investment is going to be Boston Properties' judgment on the underlying real estate fundamentals. "It's hard to predict when we will be able to deploy our capital for productive growth, but staying in touch with the market and actively seeking out opportunities has become a priority equal in importance to keeping our portfolio well-leased and managing our financial requirements," he said.