09/29/2010

USAA Strikes Deal for Suburban DC Complex

In one of the biggest deals this year in the Washington area, USAA Real Estate has agreed to pay $240 million for a Northern Virginia office complex.

The price tag is slightly below expectations for the 622,000-square-foot property, One and Two Potomac Yard in Arlington. But market pros described it as solid nonetheless, especially for a suburban property, and further evidence of the strong demand for core buildings in and around Washington.

USAA Real Estate, a unit of San Antonio insurer USAA, is acquiring the fully occupied complex from J.P. Morgan Strategic Property Fund. At the $386/sf valuation, its initial annual yield will be about 6.5%. CB Richard Ellis is brokering the transaction.

Earlier this year, investors waged bidding wars for the few office properties listed in the area, driving up prices. The strengthening market, bolstered by an expanding federal government, encouraged other owners, including the $9.7 billion J.P. Morgan fund, to put core and core-plus properties on the block.

Capitalization rates for core buildings inside Washington's city limits have ranged from about 5% to 6.5%. For example, Generali Group of Italy acquired the 147,000-sf Farragut Building from ING Clarion of New York this month for $93.5 million, or $636/sf, resulting in a cap rate of about 6%. In June, TIAA-CREF bought the 227,000-sf Evening Star Building from a KanAm partnership for about $180 million, or $793/sf. That price translates into an initial annual yield of just 5.3%.

The cap rates for larger properties have trended toward the upper end of the range, but that is still impressive compared to other parts of the country. The city's largest office trade of the year carried a 6.2% cap rate. In that transaction, Northwestern Mutual Life acquired the 589,000-sf Two Constitution Square in June from a Walton Street Capital partnership for $305 million, or $518/sf.

The cap rates on properties in nearby suburbs have generally exceeded 6.5%. Before USAA's deal, the largest office trade this year involved Three Ballston Plaza, an Arlington building that commanded a 7.3% cap rate. Boston-based AEW Capital acquired the 304,000-sf property from Cornerstone Real Estate Advisers of Hartford for $121.3 million, or $399/sf. The 6.5% initial yield on One and Two Potomac Yard suggests that valuations are rising.

The two-building Arlington complex, at 2777 and 2733 South Crystal Drive in the Crystal City submarket, was completed in 2006 by Charlotte developer Crescent Resources. Crescent acquired the 300-acre site in 2001 from a company controlled by a Lazard Freres fund and later sold the complex to the open-end J.P. Morgan fund for $193 million. Crescent also sold parcels that were developed into retail, hotel and residential space.

Federal agencies lease 90% of the office complex. The U.S. Environmental Protection Agency, the largest tenant, leases about 460,000 sf through 2016. Rents are 10-15% below the market average. Leases on less than 5% of the complex are scheduled to expire before 2016.

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