12/02/08

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Sales prices quadruple for retail space

Robin Abrams of Lansco has a buyer under contract for the three-story retail building at 431 Seventh Avenue between 33rd and 34th streets.

After the eye-popping $1.8 billion sale of a premier Fifth Avenue building set tongues wagging about overpayment, the Kushner Companies may find its Midtown investment paying off as bidders seek some of the world's priciest storefront space.

At the end of last year, the New Jersey-based developer bought 666 Fifth Avenue, between 52nd and 53rd streets, and blew the lid off the city's commercial real estate market.

Skeptics called the deal crazy, but rocketing demand for retail space is now making it look like a pretty shrewd move. Only 99,000 of the building's 1.5 million square feet is set as ground-floor retail, but that's what's been getting purchase bids as high as $640 million, which comes out to $6,500 a square foot. Set in the heart of a premier shopping district, 666 Fifth's retail tenants include the NBA Store, Brooks Brothers and Hickey Freeman. Kushner paid around $1,200 per square foot for the entire office tower.

While projections suggest regular office space rents will increase 10 to 15 percent over the next five years, meaning the office portion of the Class A tower will appreciate nicely, the ground floor is turning out to be the real moneymaker.

"A third of the value of that building is in the 99,000 square feet of retail," observes Andrew Oliver, managing director and principal of investment banking firm Sonnenblick-Goldman. "It's only 6 percent of the square footage, but 36 percent of the value."

Several major owners have been peeling off and selling the retail portions of their office buildings, capitalizing on a robust market. The average sales price per square foot for retail space more than quadrupled between 2002 and 2006, shooting from $300 to nearly $1,300, according to a study by Real Capital Analytics (see chart).

In one recent transaction, Equity Office Properties sold a small portion of the four-story retail space at 717 Fifth Avenue to SL Green Realty Corp., a REIT that has been moving aggressively into retail ownership, and partner Jeff Sutton, for $46 million. The 28-story Class A office tower houses Hugo Boss and Escada's Manhattan flagship store.

"The lack of good retail space in prime markets makes the space that's sold so much more valuable," says Faith Hope Consolo, chairman of retail leasing and sales at Prudential Douglas Elliman.

Sales prices are rising for several reasons. The primary factor, of course, is the seemingly unstoppable increase in retail rents.

Not long ago, Robin Abrams, executive vice president of commercial brokerage Lansco, showed clients the ground-floor retail condo at 1251 Lexington Avenue. "It was priced so aggressively the buyer we represented passed it up," she recalls. "Then it was sold at asking or above and commanded retail rents from tenants that we thought were totally unobtainable."

The buyer figured the new building Extell was developing on the corner of 86th and Lexington would reposition 1251 Lexington -- "which it did," says Abrams. "The rents there have been traditionally around $150 a foot. They went in and put it on the market at $250 a foot and locked in Starbucks for the corner and Radio Shack, a good-credit tenant."

Abrams currently has a buyer under contract for the three-story retail building at 431 Seventh Avenue between 33rd and 34th streets.

"It's a good example of how crazy the market has been," she notes. While the current net income is just $300,000 a year, Abrams advertised a projected annual income of $1.5 million for the property, a reasonable estimate for a building in the heart of booming Penn Plaza. The property could earn another $500,000 a year on billboard signage and has some air rights that can be traded in the future.

"We ended up with three offers of $16 million," she says.

Buyers have become boldly optimistic. "The old rule of thumb used to be 10 times the rent roll," says Abrams. "Now it's more like 20 times rent roll. And sometimes if they're putting something together in an assemblage, they're buying at really insane numbers."

As an investment, retail is easier and cheaper than office space to maintain. "With office space," says Oliver, "even in the strongest market, you have to give the tenant some money to fit out their space. In retail, the tenants do their own work. You don't go into the tenant's space. It's almost like a net lease."

In New York City, once a location with retail space becomes viable, the space seems bound to appreciate steadily. "It always goes up," says Oliver. "There may be some dips in the market, but long-term retail gets more valuable. Everybody wants to be in a prime area.

"You can build an office a block away [from a major avenue or street] and it's still prime," he added. But every retailer wants to be on the main drag, he said.

While most retail space is sold to investors who in turn lease to retailers, there are advantages for end users -- the stores themselves -- to buy rather than rent. It might the only way to avoid being priced out of their current location. Buying their space requires a cash outlay upfront, but it protects them from devastating rent increases.

"Buyers can project long-term what their expenses are," says Abrams. "They don't want to be in a position where after they've established their business in a certain location, they lose it and have to rebuild somewhere else."

Retail investment is typically a long-term strategy. There has not been a lot of speculative buying and selling of retail space. But brokers are reporting a surge of activity in recent times.

"We're coming off our best year ever," says CB Richard Ellis vice president Andrew Goldberg. "Quality locations are coming available. When you have such a robust investment sales market on the office side, that translates to the retail on those buildings as well."

Some buyer urgency comes from investors who have cashed out of a property and need to buy another one in a 1031 exchange to avoid tax penalties. Retail condominium space is an attractive long-term investment alternative.

Also, banks are finally giving other retailers a chance at prime spots.

"There's a huge slowdown in retail bank branches," according to Goldberg. "There are still banks that are expanding and filling in areas, but there is not nearly the same growth that there was."

Vornado Realty Trust has been particularly voracious over the last year, gobbling up retail parcels big and small. Sonnenblick-Goldman arranged Vornado's purchase of 17,000 square feet on two floors on Madison Avenue between 69th and 70th streets for $113 million. At $6,647 per square foot, it was the highest price ever paid per square foot for real estate anywhere in the world, according to brokers. The high-end retailers in the building -- Gucci, Cartier and Chloe -- all have leases extending to 2018.

With the major tenants locked into long-term leases at below-market rents, "people said, what's the upside?" recalls Oliver. "Vornado went in and negotiated with Gucci, got back some space on the ground floor, and leased it to another high-end retailer," vastly increasing the earning power of the building.

"Every time Vornado buys something I think they're crazy," says Abrams, "but then they always end up getting what they want." Six months ago she sold Vornado a small building at 215 Columbus Avenue that contained Banana Republic on a lease about to expire -- a one-story building with 5,600 square feet for $24.2 million.

"Vornado understood the market," recalls Abrams, "and was confident that they could command $300 a square foot from a new retailer coming in. That's $1.5 million a year in rent."

Most recently, Vornado purchased the Manhattan Mall, a 1-million-square-foot mixed-use center with 164,000 square feet of retail, for $689 million. At about the same time, they also bought the Bruckner Plaza in the Bronx, a 386,000-square-foot shopping center, plus adjacent land, for $165 million.

They must be on to something. "With retail," says Oliver, "your downside is limited. There can be some dips, but you can always lease it. You rarely see a lot of vacancy in retail, even in depressed times. If you do, someone is asking too much rent."


Go to chart: Manhattan retail building sales