High-Yield Plays Start to Revive in DC Area

The strong demand for core office properties in the Washington area is starting to spill over to higher-yield plays.

A handful of buildings suitable for core-plus or opportunistic investors have attracted spirited bidding in recent weeks, including the 126,000-square-foot property at 1227 25th Street NW in Washington and the largely vacant 183,000-sf building at 3120 Fairview Park Drive in Falls Church, Va.

Local pros say that's a notable development. Since sales began to resume following the market crash, activity nationwide has centered around two categories: core buildings on the one hand, and distressed offerings at sharply discounted prices. Properties that fall in between - such as ones that have significant vacancies or need to be renovated - have mostly been unsellable. The reason: Buyers have been unable to hit their yield goals, because of the weak economy and the lack of available debt financing.

But now the Washington area is among the first markets nationwide to see signs of life in the sale of higher-yield office properties by nondistressed owners.

To some degree, that's a reflection of strong demand for the region's core properties, which have benefited from the expanding federal government's need for additional space. Multiple transactions have been completed, clarifying valuations and giving buyers more confidence when underwriting higher-yield purchases. What's more, the strong demand has driven down capitalization rates for core office properties in the region to the range of 5.0-6.5%, encouraging some players to chase higher-risk properties in search of more yield.

To be sure, high-yield investors are still being highly selective. In Washington, they are pursuing Class-B properties in less than prime locations that need some renovations. In the suburbs, the main target is Class-A buildings in prime locations with significant vacancies or maturing leases. Investors are still bypassing redevelopment plays, older properties in need of major renovations and those in less desirable markets.

Offerings that fit the profile are finding a swarm of interest. For example, almost 20 investors have bid on the Class-B building at 1227 25th Street NW, even though the occupancy rate is only 70%, well below the 93.4% average in the local submarket. "People are willing to underwrite through that," said one market player.

The offers for the core-plus property have generally been $350-370/sf, or up to $47 million. At that price, the capitalization rate would be around 6% - higher than the sub-5% rate that some core properties in the city recently commanded. Some bidders have lined up preliminary financing commitments for 60% of the purchase price, a sign of growing lender confidence in the Washington market. New York-based Vornado Realty, which is shopping the building via Holliday Fenoglio Fowler, is expected to pick a winner soon.

Meanwhile, the buzz is that a buyer has stepped up for a vacant 100,000-sf office condominium at 2055 L Street NW. Verizon, which also owns the rest of the property, shopped the condominium last year and twice had it under contract, only to see the deals unravel. The current valuation is estimated at about $130/sf, or $13 million.

In the suburbs, properties with significant vacant space are attracting strong interest. Bids came in at roughly $40 million, or $220/sf, for the building on Fairview Park Drive in Falls Church. A decision is expected shortly. Jones Lang LaSalle is advising the seller, investor Rick Adams, who completed the property in 2008. The occupancy rate is just 4%.

Another property with vacancy problems drawing interest is the 288,000-sf Summit 1&2 complex in Reston, Va. CB Richard Ellis is marketing that property for James Campbell Co. of Kapolei, Hawaii.

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