Being Gutsy Is Bringing Some Glory

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October 19, 2012
The Wall Street Journal
Being Gutsy Is Bringing Some Glory

Smaller Firms That Bought Commercial Property During Downturn See Profits

The expected sale of a hulking, brick office tower in Midtown Manhattan is on track to net its seller the largest dollar profit to date on any single property that was purchased during the financial downturn.

But it isn't one of the big names in real estate, like Sam Zell or Goldman Sachs, that is poised to rake in hundreds of millions of dollars in profit from a quick sale of the copper-crowned One Worldwide Plaza. Instead, it is a group of investors led by a relatively obscure New York landlord, George Comfort & Sons Inc., which purchased the building in 2009 for about $600 million.

George Comfort & Sons is expected to realize a large profit from the sale of One Worldwide Plaza.

George Comfort, which declined to comment on the sale, has received multiple preliminary bids of well over $1 billion, according to real-estate executives informed of the status. The seller's target price for the 1.8 million-square-foot tower on Eighth Avenue is $1.5 billion, and final bids are due Friday.

As commercial-property values continue to rise in major cities around the U.S., gutsy investors who bought office buildings, hotels, stores and apartments when the commercial real-estate market hit bottom following the recession are making huge profits by selling them.

Values of top-quality properties, which fell 38% in the early years of the downturn, are now within 4% of the record highs hit in 2007, according to an index by real-estate research firm Green Street Advisors Inc.

The increase in values is being fueled largely by ever-lower interest rates, which has made debt financing cheaper and helped push up demand for real estate by investors searching for investments with good yields.

At the same time, more credit is becoming available. At the beginning of the year analysts projected that $30 billion to $40 billion of new commercial mortgage-backed securities would be issued in 2012. Now some analysts are saying the figure could rise as high as $45 billion.

The current cast of bottom feeders that are taking advantage of the sharp rise in prices looks different from those that swooped in during the prior real-estate mess in the early 1990s. Back then, it was largely big institutions like Goldman Sachs Group Inc., General Electric Capital Corp. and a venture of Mr. Zell and Merrill Lynch that purchased big portfolios of distressed debt and properties from lenders and the U.S.-controlled Resolution Trust Corp.

This time, while some big names like Starwood Capital Group and Blackstone Group LP did buy at the bottom, much of the quick selling is being done by lesser-known midsize players like George Comfort, which relied on their knowledge of local markets to snap up what are turning out to be huge bargains. Others include San Francisco-based TMG Partners, which made a set of well-time investments in that city's South of Market neighborhood; Savanna, a New York company that bought numerous older Manhattan office buildings; and Pacific Urban Residential, which turned around a big profit on a complex of apartment buildings in the Seattle area.

"We were not quite sure when [the economy] would get better, but we knew at those prices, we couldn't lose money," said Michael Covarrubias, TMG's chairman.

One reason for the success of these investors is that many of the pension funds and insurance companies that were active in the boom pulled back from real estate when prices were cheap. Also, some of the larger private-equity firms stayed on the sideline when the market hit bottom.

The opportunities to buy were "risks that institutional capital was not willing to take in 2009 and 2010," said Dan Fasulo, managing director at the research firm Real Capital Analytics Inc.

Mr. Zell and others have acknowledged that they were expecting lenders to dump assets in the same way they did in the early 1990s. But that never happened in large part because banks and other financial institutions this time were much more prone to extend troubled loans rather than foreclose.

Since hitting their trough in May 2009, commercial-property values have risen 57%, according to Green Street. To date, the largest single-building turnaround since the recession was the 42-story Seattle office building that was headquarters of Washington Mutual Inc. until the bank failed and vacated the tower, according to Real Capital Analytics. Northwestern Mutual Life Insurance Co. bought the building in 2009 for $115 million, filled it with new tenants and sold it in April for $480 million.

Prices haven't rebounded broadly, as properties in suburbs and smaller cities generally are trailing those in prime locations like New York, Chicago and San Francisco.

In those cities, high demand has pushed initial yields on some properties, particularly apartment buildings, down to 3% and even lower. High demand has led owners to put buildings up for sale. For example, Sony Corp. recently tapped Eastdil Secured LLC to market its Midtown Manhattan office tower.

George Comfort increased the occupancy of Worldwide Plaza, which was half vacant when the firm bought it, by leasing most of the empty space by luring Nomura Holdings Inc. from downtown Manhattan.

That empty space was a big reason the price was so low. "There were very, very few that would even look at that deal who would accept that kind of risk," said Douglas Harmon, of Eastdil, which is marketing Worldwide Plaza.

But values of properties in major cities also have been increasing faster than the buildings' income streams. And in some cases, investors didn't do much to the properties and still reaped big profits from selling them quickly.

For example, a venture of TMG and DivcoWest recently sold an empty office building in San Francisco's gritty mid-Market neighborhood to Dolby Laboratories Inc. for $110 million, more than double the amount they paid just last year.

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