A drop at the top in office sales

Housing isn't the only aspect of the property market to have cooled off.

After three years of frenetic activity, sales of premier Twin Cities office properties are running at about half the levels of 2006.

In downtown Minneapolis, the total value of properties sold so far this year is about $344.8 million, compared with $780.9 million in 2006 and also considerably lower than 2004 or 2005, according to figures compiled by Bloomington-based United Properties.

In downtown St. Paul, the total value of this year's sales is about $84.9 million compared with $194.2 million in 2006 and $91.3 million in 2005, United Properties said.

It's a trend that's showing up nationwide, largely because of tighter lending conditions for all forms of real estate investment. The value of large office property sales in major markets fell 70 percent in October, the most recent month for which figures are available from Real Capital Analytics, a New York-based real estate research firm.

In the Twin Cities, the most significant change from last year has been a dropoff in sales of top-tier buildings. Last year's deals in Minneapolis included 225 S. 6th St., which went for about $245 million, and the IDS Center, where the $277 million price tag set a record for the city's office buildings. Likewise, the $106 million sale of Wells Fargo Place in 2006 set a record in St. Paul.

In Minneapolis, the biggest deal so far this year is the sale of Fifth Street Towers for about $186 million. Brokers familiar with the Minneapolis market say the pending sale of ING Group's three-building campus at the north end of downtown could be the only other deal of more than $100 million that closes this year.

While the marquee sales got the most attention in recent years, the sales totals for 2004 and 2005 were also the result of an explosion of smaller transactions. While most of those sales were to buyers interested in maintaining the properties as office buildings, some transactions involved smaller, older office buildings slated for redevelopment as hotels or condominiums.

The depressed condo market has put an end to many of those types of transactions.

The recent brisk trading of office properties was fueled by historically low interest rates and large pools of investment capital looking for a place to land. Both factors drove prices up, encouraging some investors to buy and re-sell at healthy premiums within a year or two.

The Chicago-based John Buck Co. paid about $225 million for the IDS Center in 2004 and sold it about 18 months later for more than $50 million over that price.

Those bullish conditions -- which brokers say were unusually favorable by historical standards -- changed a few months ago when the spreading defaults in the subprime mortgage market began to affect other forms of lending, including the commercial real estate market. Now borrowing costs are higher, and buyers have to come up with more cash to meet stricter lending requirements.

Buss and others said buyers used to be able to borrow up to 90 percent of a property's purchase price but now might be offered only 65 percent.

The tightening of credit markets has led to the cancellation of at least one prominent sale among Twin Cities office buildings.

A deal to sell Landmark Towers, one of only six Class A buildings in downtown St. Paul, was called off earlier this year because the prospective buyer could not arrange financing, according to people with knowledge of the situation. The property went back on the market and area brokers say a new deal could be announced soon.

The tighter loan market could force some sellers to accept lower bids for their buildings, prompting some to postpone plans to put them on the market, said Scott Pollock, vice president of investment services at United Properties.

Investors' interest in office properties also could be waning because vacancy rates, which started to drop significantly a couple of years ago, now are declining at a slower pace. Lower vacancy rates enable building owners to boost rents. Job growth has slowed down in the Twin Cities and nationwide, reducing the prospects of increased demand for office space.

Brokers believe increased interest from foreign buyers could help revive sales of commercial properties, including office buildings.

They say interest from offshore investors has begun to grow and should continue because of the strength of foreign currencies against the dollar. An example is London-based Strategic Real Estate Advisers, the new owner of Fifth Street Towers.

"Everything in America is on sale, and that includes real estate," said Mark Kolsrud, senior vice president of investment services for the Twin Cities office of Colliers Turley Martin Tucker. Besides having increased purchasing power because of their stronger currencies, foreign buyers are more willing to accept the lower returns now offered by commercial real estate, Kolsrud said.

"Their expectations are less than [those of] investors in this country," he said.

Acquisitions of U.S. office properties by foreign buyers reached $12.5 billion through the end of October, topping the $11 billion total for all of 2006, according to Real Capital Analytics. Foreign buyers have been attracted to all types of commercial real estate, with office buildings accounting for about 36 percent of the deals, the research firm said. Most of the office buyers were from Germany and the Middle East, Real Capital said.

"There's a historical connection here with people in Canada," Pollock said. "Minneapolis is a pretty easy step for them to make."