Commercial real-estate prices expected to drop

U.S. commercial real-estate prices may fall as much as 15 percent over the next year in the broadest decline since the 2001 recession as rising borrowing costs force property owners to accept less or postpone sales.

"People aren't willing to do deals right now," said Howard Michaels, chairman of Carlton Advisory Services, which has arranged financing for real-estate purchases. "The expectation is that prices will come down."

Investors in July bought the fewest commercial properties since August 2006, and apartment-building acquisitions were down 50 percent from June, data compiled by industry consultants at Real Capital Analytics show. Archstone-Smith Trust in August postponed its $13.5 billion sale to a group led by Tishman Speyer Properties until October.

"There are so many deals falling apart," said David Lichtenstein, chief executive officer of Lightstone Group, an owner of more than 20,000 apartments and 30 million square feet of office and retail space. "People who can get out are getting out."

About 930 commercial real-estate transactions valued at $5 million or more closed in July, preliminary data from Real Capital show. That count could climb as much as 15 percent when all the month's deals are tallied, which would still be the lowest this year, said Dan Fasulo, director of market analysis for Real Capital.

Average prices for commercial properties might drop 5 percent to 15 percent in the next two years depending on the type of property and its quality and location, said Matthew Ostrower, an industry analyst at Morgan Stanley.

Michael Knott, a senior analyst at real-estate research firm Green Street Advisors estimates commercial prices may fall about 10 percent in the next 12 to 18 months and up to 15 percent in the office market during that period.

Commercial mortgage rates have climbed as defaults rose in the subprime part of the residential real-estate market. The increase has halted a rally that lifted prices for office buildings, apartments and hotels to records this year. The average price paid for high-quality office properties in city centers reached $291 a square foot, up from $188 in 2005 and almost double the average $152 in 2001, Real Capital reported.

Real-estate investors typically purchase properties with the expectation that the yield will outstrip conventional investments and make their financing affordable.

When prices for prime urban office buildings fell in 2002, capitalization rates, or a property's net operating income divided by the purchase price, rose to an average 9.25 percent, according to data provider Real Estate Research. Such yields attracted investors and, by this year's first quarter, the average cap rate had fallen to 6.5 percent.

New York-based Blackstone Group, manager of the world's largest buyout fund, purchased Sam Zell's Equity Office Properties Trust for $23 billion in February to gain about 540 office buildings in the U.S. That worked out to a capitalization rate of about 5.3 percent, a record low for an acquisition of a real-estate investment trust (REIT), according to Green Street Advisors. Including debt, the price was $39 billion.

Tighter credit standards at banks have given an advantage to investors with ample cash, said Joaquin de Monet, CEO of General Electric's Arden Realty. All-cash buyers might include insurance companies, pension funds and REITs.

Arden bought 5.9 million square feet of offices from Blackstone in July. The properties, part of CarrAmerica Realty when Blackstone acquired it last year, were in Seattle, Portland, San Diego, San Francisco, Salt Lake City and Orange County, Calif.

"The private-equity firms used to be the winners, but now lower-leveraged and all-cash buyers are more competitive," de Monet said.

Even so, sellers are pulling properties from the market, said James Corl, chief investment officer for real-estate securities at New York-based Cohen & Steers.

"No one's going to want to sell in this environment, because you're not going to get your price," Corl said.