Commercial Grade

by Tyler King, Resident Hipster

As I write this, the bulls and the bears are locking horns in an epic battle of post-recession predictions. However one thing has become clear, investors have started underwriting much more aggressively for quality assets. SL Green is currently in the midst of a buying spree and is increasing asking rents for prime office spaces. Here at Miller Cicero HQ, just a year ago I was underwriting office and retail rent growth at zero in the near-term, however in the last few months rent spikes are creeping into our discounted cash flow models for prime properties. But one has to keep in mind these optimistic near-term estimates come after an unprecedented drop in rents in the city since 2008. Essentially the market is clawing back to zero.

Even after my countless broker interviews and market research (which is part of my due dilly responsibilities to our clients) the level of positive investor sentiment didn’t really hit home until, well, it hit home. The lease renewal notice for my apartment came in the mail. My landlord is asking for a nearly 20%, yes you read that right, t-w-e-n-t-y percent, increase for a new one-year lease. Bullish much?

So I did what any self-respecting real estate professional would do and hit the streets and made some calls. I live in a Class A apartment building in the Financial District. Lucky for me, the competition is relatively homogenous and within walking distance. The wife came along and we dropped in on some leasing offices to see what the other buildings were asking for similar units to mine. Sure enough, I am currently getting a relatively good deal, however I can get a much nicer apartment in a similar building for the rent the landlord is offering to renew at.

So who is right? Well I am of course. Actually, we are both a little right. The market has improved, and concessions are starting to fade, however it is nothing I would call a bounce-back. I am going to counter with a 5% increase in my net effective rent. I think based on what is currently being offered at comparable buildings that is reasonable. But my experience shows that investors throughout the city truly are gearing up for positive directions in all sectors of commercial real estate in the near future. However keep in mind, there are still many real estate professionals that claim the bottom has yet to be hit and the market is currently inflated. They would call it a bubble, but that is so 2008.

I’ve been commuting to Midtown Manhattan for the past 30 years or so, but every so often I need to trade in my comfortable air-conditioned seat on Metro North to drive in to NYC. Driving into Manhattan is always an adventure, a real balance of offensive and defensive driving. And every time I do drive in I am reminded of just how valuable 200 square feet of prime real estate can be: the parking spot!

In Midtown Manhattan a parking space can cost over $50 for the day (more for SUV’s and vans!) however, just like car sticker prices, you seldom pay full rack rate. But the rates can vary quite dramatically and it used to be very stressful for me to drive around from garage to garage deciphering the signs, trying not to get ripped off: “In by 6, out by 7″ or “Special: $9.87 plus tax for 30 minutes”, etc. And, like a hotel or an airline, a parking garage can change its rates daily, so the great deal you get one day may not be available the next.

Recently, however, I came across a web site that completely eliminated the stress: BestParking.com. It is right up there with the GPS (and Nintendo Wii) as one of the miracles of technology. Plug in the neighborhood and time of arrival and it tells you how much garages are charging for spaces that day. You may have to print out a coupon in advance, but the other day armed with my coupon I paid $14 to park when others were being charged $32 (without a coupon!) It was the next best thing to getting a free spot on the street…

I am a terrible business man. Over the past five years I must have turned down dozens of potential appraisal assignments of air rights. Air rights, sometimes called transferable development right (TDR’s) refer to the unused development potential above an existing building. In New York City a developer can expand the size of a project by acquiring air rights through a zoning lot merger with an adjoining parcel. Therein lies the problem…

In order for there to be a “market value” of a property there must be a market. With respect to air rights, the “market” essentially consists of the three property owners that abut the site: the one to the right, to the left and to the rear (admittedly, sometimes there are irregularly shaped lots that can abut as many as five or six sites). If one of those three property owners has no interest in buying your excess air rights, then they can’t be sold. If that’s the case, there is no “market!” If there is interest in acquiring the air rights the pricing all comes down to negotiations: how badly does buyer need them for the project? how badly does seller want to sell them? Just because the air rights across the street sold for 50 cents on the dollar (based on the full underlying land value) it doesn’t mean that yours will. Further, just because you my have 20,000 SF of air rights, it doesn’t mean that your neighbor will need all of them. So I explain to my (potential) client that i can’t really report a “market” value of the air rights, since the “market” it too limited, though I can help them understand their options as a consultant.

At that point they thank me for my time and call another appraiser.

Over the past few weeks I’ve heard from a couple of different institutional clients that they are underwriting commercial rental growth so that rents are “cost feasible” in a couple of years. That phrase, “cost feasible”, has a nice ring to it. I like saying it cause it makes me feel smarter, but I’m not really sure what it means. On the one hand, it’s clearly a justification for building rent spikes into a model, but who is making the determination of what rent level justifies new construction, and when it is warranted? and what methodology are they using? and why should rental rates all of a sudden grow to the point where new construction is feasible? the sudden blip in the market is a function of torrents of investment capital being unleashed, but doesn’t unemployment remain high and the fundamentals of the office market remain sluggish?

I mean, I get it. Prices for office product are up and, whether justified or not, investors see this as a good time to pick up some good assets and are underwriting more aggressively than they have for the past three years. But just when I got used to saying “price discovery”, it looks like I have to switch to “cost feasible.”!