Last week the media reported that a NYC skyscraper sold for about $600 million, and according to Real Capital Analytics the prior purchase price was $1.74 billion. The property has 1.8 million gross square feet, 1.6 million rentable square feet, and is 50% vacant.
From the information provided by the media, one would conclude the new buyer stole the property. After all, the property was purchased at a 65% discount from its previous purchase price only 2.5 years ago. For the naive, the story would end there and open the door to believing they found the deal of the century. Before running out to buy the next property at a discount to its previous purchase price, or giving money to a proclaimed bottom-feeder buyer, let’s look at all the facts.
Just as the rest of the country is experiencing economic hardships, New York City is seeing drops in monthly rental rates and less demand for rental units. With a building that is only half full, as was this building, the investor is most certainly losing money. In the best possible scenario, the buyer would have paid cash for the property, and still the operating costs would be higher than the rental income. The bottom line is that the buyer who thought he was getting a great deal, paid $600 million on a property that will cost more to maintain than the income it will generate.
Because declines in real estate prices are so tempting, many investors find themselves in a scenario such as this. Once the property has been purchased, there are two options: fix it or sell it. Of course, selling it will result in a loss, but fixing it will require a large investment. But despite the overwhelming realization that the property is in trouble, it is often possible to rectify the situation. This will not be a simple task, but it may be worth the effort. If the goal is to rent 10% of the available space per year, the occupancy rate will increase from 50% to 95% in five years. Some of the items that must be addressed are updating the rental space and commission for leasing agents, not to mention the negative cash flow already in place.
New lessees never say the space is perfect. In weaker markets, lessees are more demanding and the lessor pays. To get to 95% physical occupancy, 360,000 square feet need to be leased. The going rate for TIs is in the area of $125 per square foot. That comes to approximately $45 million.
Leasing agents charge 6% of the rent to be collected for the length of the lease. In a weaker market it might be 5%. If the buyer could get $50 per square foot per annum with a three-year lease, that would amount to approximately $3 million in commissions paid up front.
Interestingly enough, this investment may have a positive outcome for individuals involved in the transaction, such as the recipient of the fees for insurance, management, and oversight. As for the investor, if concessions do not have a negative impact and the market takes a turn for the better, in five years time the property has the potential of growing to $750 million at a 6% capitalization rate. All that is left for the buyer to do is weigh the options and determine the best course of action.