Real Estate Forum

NEWS FRONT
New Ownership Likely to Help CityNorth

PHOENIX—The best way to describe the 630,000-square-foot CityCenter of CityNorth might be “rollercoaster ride.” Launched in 2006 by Klutznick Co. as “a true mixed-use project with retail, restaurants and office and residential above retail,” according to John Klutznik in 2006, the project fell into disarray thanks to the Great Recession and its aftermath. Then came years of foreclosures, fights and lawsuits, ending in a judge awarding master-developer rights to Gray Development Group during the summer of 2012.

But CityCenter at CityNorth could be
back on track, thanks to new ownership.
Scanlan Kemper Bard Cos. and equity
partner Wayzata Investment Partners
acquired the asset at 5310-5455 High St.
for $67 million. The owners, operating
under the name City North Associates
LLC, plan to invest about $7 million into
the asset, which includes 99 condominium
units, approximately 175,000 square feet
of retail space and 330,000 square feet of
office space. Also part of the deal, which
was negotiated by HFF and Lee &
Associates, was five acres of undeveloped
land and a six-level parking garage.

Monitoring the “Risk Spread”

An investor must compare the risk of investing in real estate with other investment options such as stocks, bonds, treasuries or other capital investment opportunities. There is and always will be a risk when investing in real estate—even in North Texas. How that risk is measured depends on the investor.

One way this risk can be measured is by the spread between the capitalization rate (OCR— overall capitalization rate) and the cost of funds (COF— typically the loan or mortgage rate), herein referred to as the “risk spread.” A typical risk spread ranges between 2% and 6%, depending on the investment and investor. So, if your COF is 4.5%, then the OAR should range between 6.5% and 10.5%, depending on the type of investment. Certainly there are other factors to be measured, such as the golden rule in real estate—location, location, location.

During the past recession, investors suggested there was no risk in real estate investments, as the OCR and COF grew closer together and the risk premium was less than 2%. Although the risk in the actual performance of the real estate asset never left, the perception of risk was compromised by the lack of alternative investments, the influx of capital into the real estate market and the 1031 investor trying to avoid capital gains. There was also the expectation that the economy would continue to grow—and for a real estate asset, that meant continued rental rate increases and strong or stabilized occupancies.

The spread measuring the risk shrank during 2006 and the first part of 2007. The smallest spread was noted in the net-leased prop-

By Mark O’Briant

erties, which typically reflect triple-net investments or properties that were leased to a single credit-worthy tenant on a long-term basis. The triple-net or net-leased investment was impacted most by the 1031 investor and new capital entering the real estate market. There were record levels of capital in the market looking for investments, and the number of 1031 exchanges increased significantly.

The risk associated with the stock market and its historical performance pushed more capital into the real estate market. This created more competition in the commercial real estate market and buyers were forced to accept lower returns. Thus, as we witnessed between 2008 and 2010, a property purchased with a lower or no “risk spread” coupled with declining revenue due to lower occupancies and no rent increases, resulted in foreclosures, fire sales, real estate auctions, etc.

So for the CRE market, how do we mitigate the potential damage of another recession, monitor the spread, considered the risk and be realistic about future projections, especially revenue? The CRE market will always be cyclical, especially in North Texas, where we have limited barriers to entry for development, pro-growth government, and projected employment and population growth. Though it’s easy to be positive about the North Texas commercial real estate market, as demonstrated in the past, things will get competitive as more capital enters the market and lending rates continue to be favorable. As such, the pressure on the “risk spread” will begin again—but monitoring that spread could minimize the downturn.

Mark O’Briant is president of Henry S. Miller Consulting LLC, based in Dallas. He may be contacted at obriant@henrysmiller.com. The views expressed here are the author’s own.