Is the investment market for core commercial properties cooling a bit? If so, what does this mean for Boston?

According to Pensions and Investments newsletter, the California Public Employees’ Retirement System (CalPERS) is considering dropping its real estate allocation to 8% from 10% by year end.

The buying pressure for core “trophy” properties from pension funds, foreign investors, REITs, and private investment pools are pushing acquisition pricing back to the pre-recession highs.  Locally, 33 Arch Street traded at a sub 5 cap rate ($530/sf.)  Earlier, Boston Properties acquired the Hancock Tower at an initial 4.6 cap ($475/sf.) Most recently, Landmark Center was purchased by Samuels for $530.5 million ($558/sf.)

The Blackstone Group told investors it had raised another $4 billion for its latest real estate fund with a target of $10 billion.  It has already invested/committed $4.4 billion to real estate deals during the first six months of this year.  Blackstone believes that the opportunities lie with the relatively low prices and the sluggish global economy.

At some point, investors will need to ask whether these investments have been worth the high prices paid for them.  Will they achieve the projected rental increases and vacancy decreases that the investments were based on, if the economy continues to remain sluggish with nominal job growth?

According to Colliers’ Boston office , although the vacancy rate in Boston only dropped from 16.6% to 16.3% during the second quarter, the Back Bay submarket showed an overall 8.0% vacancy, with class A space at a very low 5.8%.  Rents have improved with Class A asking rents averaging slightly above where they were before the rental spike that occurred in mid-2007. However, Boston Class B space and the suburban markets are another story. Vacancy rates are still high with the Route 128 submarket at 19.3% and Route 495 at 25.6%. With Boston class B space discounted 30% off class A space and suburban rents having dropped 20%, properties in these markets are clearly going to be challenged for some time.

The good news is that Massachusetts is actually doing better than the rest of the nation, but even here there may be fears of another bubble – especially in light of recent market events.  Could we have a “double-dip” downturn in commercial real estate?  If the world economy does not show some initial stabilization followed by real growth, we may see some of these recent property acquisitions reselling at a loss. Only time will tell.