FEATURE ARTICLE, OCTOBER 2004

OFFICE & INDUSTRIAL ACTIVITY
Office and industrial players weigh all the factors before making their next market move.
Brian A. Lee

Promenade Corporate Center in Scottsdale, Arizona.

Variables such as the job market, interest rates, product location and product condition help produce the matrix from which industrial and office supply and demand are generated. Western Real Estate Business tapped into the office and industrial activity to see how key industry players are approaching these markets.

Office

The recent economic downturn and the current jobless recovery have had their effect on the office market in the West. However, opportunistic investors and developers have employed a ‘the-cup-is-half-full’ philosophy, viewing this sector as having the most upside.

Santa Ana, California-based Triple Net Properties, a tenant-in-common buyer group, certainly saw upside in the San Diego office market this past summer when it purchased a 1.16 million-square-foot portfolio there. The $274.5 million purchase, believed to be the largest office sale in San Diego history, comprised three office buildings, including Emerald Plaza.

“The properties collectively had a high level of credit quality including a significant concentration of government tenants,” says Stephen Corea, senior vice president of acquisitions for Triple Net Properties. “Triple Net had identified San Diego as one of the best recovering markets in the country. We also believed that the window of opportunity was about to close due the volume of sales and leasing activity occurring in the market.”

The record acquisition made Triple Net the largest landlord in San Diego’s central business district office market, controlling approximately 12.5 percent of the office space there.

Tremendous acquisition opportunities exist in the secondary markets, says Zaya Younan, founder, chairman and CEO of Younan Properties Inc., an office and hotel real estate investment and operating company based in Woodland Hills, California.

“Valuation in the primary markets, such as California, has increased significantly and the cap rates have compressed to some of the lowest levels that we’ve seen in over a decade,” he says. “In the primary and high demand markets such as [Southern] California, the price per square foot for the properties is exceeding the replacement costs, which create the excess gap or exuberance in valuation. There is simply too much demand and too much capital chasing the limited supply.”

Younan says that, because of this, his firm is focusing on secondary markets like Phoenix and San Francisco where the office values are “extremely reasonable.” Younan’s firm purchased 10 office properties totaling more than $325 million in 2003.

Marc Spellman, founding principal of Lee & Associates-LA North/Ventura Inc., still lists Younan Properties as one of the most active investors in his suburban Los Angeles market area. As opposed to the office density found in Century City or downtown L.A., Spellman says that office acquisitions in his coverage area run the gamut from high-rise Class A office buildings and mid-rise campuses to concrete tilt-up flex facilities and garden-style office properties. “Transactions range from large corporations seeking corporate headquarters from 50,000 square feet to 300,000 square feet to professionals — accountants, attorneys and entrepreneurs — seeking 1,000 square feet.”

The Pederson Group is developing the $25 million 260,000-square-foot Promenade Corporate Center in the hot market of Scottsdale, Arizona. The complex will feature two four-story, Class A executive office buildings, one of which began occupancy last month. As is the trend across the West, multiple uses makes for more appeal.

“The development combines specialty retail, entertainment, community retailers and Class A office all in a unique setting inspired by a Frank Lloyd Wright design,” says Jeff Manelis, vice president and director of operation for The Pederson Group in Phoenix. “Its focal point is a 125-foot, internally illuminated spire, originally designed by Frank Lloyd Wright.”

Promenade Corporate Center is part of an 80-acre project. The Pederson Group partnered with Taliesin West, DFD Cornoyer Hedrick and Ellermann & Schick on the development.

Bill Lindsay, a founding partner at Pacific Coast Capital Partners, verbalizes the caution still required when investing in office real estate. Reposition opportunities seem to be the best way industry players can exert their influence on an investment.

“We are currently not very bullish on office in any market due to the apparent lack of job growth,” he says. “However, we would target partially occupied or turnaround office [projects] in strong or varied economies, where there is an opportunity to bring an office building back into the market that hadn’t been participating due to ownership issues.”

Industrial

Eugene Page, senior managing director of Charles Dunn Company, says that the main concerns industrial investors new to the California market will have to address are the lower cap rates — and, subsequently, higher costs — for properties, which are directly related to the limited amount of land available there.

“Also, California — Los Angeles County in particular — has a very difficult and lengthy permit and approval process, more so than any other western U.S. city, with Seattle coming in at a close second,” he says. “Simply put, California is not a very business-friendly environment.” Despite this fact and the lower cap rates and higher costs, California properties are more secure investments — “just for the pure fact that land is scarce and the demand is high.”

The lack of developable land has made it difficult to build or purchase a large industrial facility in the Golden State. This factor and the still-low interest rates have helped smaller owner/ user firms looking to buy their own facilities, and developers are working to satiate that demand.

“Overall, in the past 9 months, the industrial sector has seen a dramatic demand for owner/user sale product,” confirms Randy Kobata, senior associate of Lee & Associates-LA North/Ventura Inc. “This is due to the great loan opportunities that users were receiving. As the demand grew, less product became available and consequently prices skyrocketed and are still continuing to increase, although as of today the prices are starting to taper.”

On the other hand, Kobata says that Southern California has experienced a great deal of development of big box industrial buildings built on a spec basis. On the big box theme, The Alter Group is making a big entry into the Southern California industrial market. The Chicago-based real estate development firm will develop two large distribution centers, totaling $65 million, in Fontana and Rancho Cucamonga, California. The facilities, which will total more than 1.35 million square feet, are scheduled to be completed first quarter 2005.

“We made a business decision to actively pursue large bulk distribution buildings in the top U.S. distribution markets,” says Pat Gallagher, senior vice president of The Alter Group, noting his privately held firm’s significant flexibility advantage over its publicly traded or institutionally controlled competitors. “California is Number 1 in the country so we had to be in that market.”

Lindsay says Pacific Coast Capital Partners’ view of the Southern California industrial market differs from that of office because of its size, deep “old economy” and the import/export business. In early August, Pacific Coast Capital Partners, in partnership with Overton Moore Properties, formed a joint venture with New York State Teachers’ Retirement System (NYSTRS) to acquire $400 million in value-added industrial properties in Southern California. NYSTRS has committed $125 million to the venture. The joint venture, called OMP Industrial, plans to assemble the portfolio over a 2-year period and will target Class B and C assets in in-fill markets to reposition/rehabilitate.

“Because industrial is so hard to replace, instead of selling our industrial, we [thought we would] team up with a longer hold venture,” says Lindsay. “The plan is to buy product to hold for 5 to 7 years with a more modest repositioning opportunity.”


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