IDS deal could work out, despite the timing

Just about any real estate buy in the overheated market of 2006, from lake cabins to office buildings, turned out to be a mistake.

That won't be the case for the firm that bought the IDS Center, 40 years old and still the pinnacle of the local office market. It is putting the building on the market again just when intense investor interest driving up values for premium office buildings in places like New York and Washington is reaching Minneapolis.

The IDS Center is a pretty good argument for paying a premium for the highest-quality downtown assets in the first place. The mistakes are easier to fix.

If you define the office market very narrowly -- the central business district's office buildings -- it has roared just about all the way back from the worst days of the Great Recession. According to an index produced by Tad Philipp, the director of commercial real estate research at Moody's, the market for those properties nationally dropped 47.9 percent from its peak in late 2007 to bottom out in November 2009. Philipp said "capital has quickly returned to the top markets and is returning more gradually to others."

Investors have swung their attention to top buildings in selected big towns outside of the half-dozen biggest cities, and "Minneapolis is the first market to see that kind of institutional interest," said Mark Kolsrud, a senior managing director and investment real estate broker with Cassidy Turley's office in Minneapolis.

That means prices in downtown Minneapolis are catching up, at least for trophy office towers. And that certainly includes IDS, a 1.4 million-square-foot, 57-floor property at 8th Street and Nicollet Mall.

Real estate investors mostly talk about prices based upon a measure of returns called a capitalization rate. It's rental income less cash expenses divided by the purchase price. Think of it as a bond yield. As with bonds, when yields -- or the "cap rate" -- decline, that means asset prices rise.

No one knew in 2006 and 2007 that the market was overheated. Fink said investors driving the market higher then were "momentum buyers," who were thinking that increasing rental rates would push a given property's income higher. So while it may have been a 6.25 percent yield at closing, the forecast was for better returns in a few years.

The broader economy promptly slid into the ditch, and that investment thesis did not work out. The dominant buyers now, Fink said, are safety-conscious, yield-oriented investors who just can't bring themselves to buy any more 10-year Treasury notes that yield only 1.5 percent.

A blue glass, architecturally renowned office building with a diversified rent roll is today pitched to investors as a very tall, very attractively priced 6 to 6.5 percent bond.

You know that wasn't the buyer's plan in 2006, when the IDS Center last changed hands, based upon who bought it -- Inland American Real Estate Trust.

Inland American bought the IDS property from a real estate fund controlled by the John Buck Co., an institutional investor even further up the risk/reward curve.

Inland American would take a home run, but that isn't its mission. The company is a very large real estate investment trust, or REIT, formed by the Inland Real Estate Group of Cos. Inc. of Oak Brook, Ill. Inland Group owned and managed more than 129.3 million square feet as of March 31, with more than 363,000 investors in its various REITs and investment vehicles.

A REIT like Inland American is public but without a public trading market for its shares, so its shareholders really count on receiving their distributions, or dividends. Management's mission is to generate enough cash to cover the 7 percent dividend, after the REIT pays its affiliated sponsor some nice fees for managing the REIT and its buildings.

Even by leveraging its own capital with some debt, a REIT structured like Inland American shouldn't be buying properties at 6 percent when the dividend target rate is 7 percent after fees. But if you happen to own a building now priced to yield around 6 percent, selling it may be a good idea.

In response to the question of why list the IDS Center for sale now, Jeff Manno, Inland Group's vice president of transactions, said the portfolio of Inland American was rolling over into growth opportunities such as hotels and student housing. But yes, "the timing was right given the stability of the Minneapolis market, the office tower's 95 percent occupancy and the strong capital markets environment."

IDS Center was listed without an asking price, but if the property has performed financially as Inland has said, the REIT is looking good on this deal.