Real Estate Forum

INSTITUTIONAL

Institutions Diving Deeper Into Development Game

When you start seeing enough new development projects breaking ground, you realize that there is suddenly a significant volume of new construction slated to hit the US market over the next few years. And it turns out that institutional investors are driving much of the new development trend.

This increased interest makes perfect sense when you consider the context of today’s market. Though traditional lenders have loosened their underwriting standards a bit, they have not returned to the crazy pre-recession practice of offering 90% to 95% debt, or more. To help bridge the present-day equity gap, many institutional lenders are stepping into the fray in a more aggressive fashion.

Major institutions are still grabbing headlines with their commercial real estate asset purchases, primarily in major coastal markets which offer better pricing transparency. But pricing has risen to the point that it is off the charts and nearing—and sometimes surpassing—pre-recession market peaks.

Still, institutions need to put out the money to generate the type of significant returns required by their beneficiaries. That’s where the development game comes into play, particularly in those favored coastal markets, and there are plenty of examples to prove the point.

In New York, the long-awaited $15-billion Hudson Yards project on Manhattan’s West Side has officially kicked off and is being funded by Oxford Properties Group, the Ontario Municipal Employees Retirement System’s real estate investment unit and Related Cos., a New York City-based real estate developer.

In Washington, DC, Oxford is also in a joint venture with local firm Gould Property Co. to develop a 620,000-square-foot office building. Meanwhile, local developer Akridge is teaming with Mitsui Fudosan America to build an 11-story office building in Dupont Circle, with law firm Pillsbury Winthrop Shaw Pittman anchoring the project.

In San Francisco, Boston Properties and Houston-based developer Hines broke ground in late March on a 61-story office tower that is part of a redevelopment of the city’s Transbay transit center. The much anticipated development will be the tallest office tower west of the Mississippi River.

Other primary markets are also seeing growing development pipelines. In Chicago, Ivanhoe Cambridge, the real estate arm of Canada’s largest pension system, the Caisse de Depot et Placement du Quebec, and Hines broke ground in January on a new 45-story office tower and 1.5-acre public park in the West Loop. The deal represents the first speculative office tower to be announced in Chicago since the start of the recession.

In all, Ivanhoe Cambridge has allocated $3 billion to future US commercial property development, and the firm’s stated target markets include New York and other gateways such as Boston,

By Ben Johnson

Seattle, San Francisco, Los Angeles and Washington, DC.

Speaking of L.A., in February, Korean Air Lines Co. unveiled plans to build a $1-billion, 73-story office and hotel tower in Downtown Los Angeles, making it the tallest building in the western US when completed in 2017.

One recent development bet by a local pension fund has not been the epitome of a shining success story, however. Dallas’ Museum Tower, a 42-story luxury condominium funded by the Dallas Police and Fire Pension System, recently opened with only a small fraction of its 100 units sold.

As a general trend, jumping on the development train is indicative of an overall renewed interest in commercial real estate as an asset class by institutional investors. A study by DLA Piper in late April noted that 85% of executives it canvassed have a “bullish” outlook on the commercial real estate markets. That is a marked turnaround from what can only be described as a “pes-

The big question, which no one
seems capable of answering except
in hindsight, is what level of new
construction starts will yield an
imbalanced market.

simistic” view as recently as 2011, when only 30% of those same executives described themselves as bullish.

Another recent study, conducted by Ernst & Young of private equity fund managers, found that development was considered one of the most lucrative strategies for deploying capital in 2013.

As market pundits such as Sam Zell have extolled over the past few years, the lack of meaningful development, particularly in the US office sector, has been the industry’s saving grace. The big question, which no one seems capable of answering except in hindsight, is what level of new construction starts will potentially yield an imbalanced market.