From SoCal Real Estate’s November 2018 issue:
Elements that lead to the handshake
By Carrie Rossenfeld
Newmark Knight Frank (NKF) Capital Markets has closed some of the largest office deals in Southern California during the last half of 2018.
Based in Los Angeles, Kevin Shannon, co-head of U.S. capital markets for NKF Capital Markets, led his team in representing the sellers in a number of these large transactions. To name just a few of the more memorable ones, these include Summit Office Campus, a five-building, 479,451-square-foot mid-rise office project in Aliso Viejo, California, which a global investor sold to Rockpoint Group LLC in early June (industry sources unrelated to the deal reported it to be in excess of $150 million) and which sources say was the largest office investment sale this year in Orange County; The Campus on Villa La Jolla, a five-building, 198,453-square-foot mixed-use campus in La Jolla, California, which La Jolla Village Professional Center Associates sold to GPI Companies for $97.1 million in May; 1500 Quail Street in Newport Beach, California, a seven-story, 90,715-square-foot office building, which New York Life sold to a joint venture between Lincoln Property Company and an institutional advisor for $32.14 million in July; and Empire Towers V, a five-story 124,529-square-foot, class-A office building in Ontario, California, which TA Associates, also represented by NKF, sold to MGR Realty for $29.87 million in July.
What’s the firm’s secret to success in capital markets? “It is critically important as an advisor to develop trust with your clients,” Shannon tells us. “That is achieved by providing consistently honest advice. That simple philosophy in conjunction with our track record and tremendous capital-markets pulse has allowed our team to be very successful.”
Longevity also helps. Shannon says he has been focused on capital markets in Southern California for more than 20 years, during which time he has gotten to know all the submarkets and nearly all the significant ownership groups very well. “I make it a point to touch base with these owners consistently and advise them on important capital-market trends. I have been fortunate during my career in that I have had a tremendously deep and talented team, which has greatly contributed to our tremendous Southern California sales track record. My team at NKF is by far the deepest and the strongest that I have ever had.”
His knowledge of the industry and market has also been a factor in his success, Shannon says. “I credit my previous position with CBRE as leader of its Western United States office vertical and my current role for my intimate real-time access to the latest trends for both debt and equity. My understanding and coverage of all Western U.S. office markets is very unique for a broker and allows for a deeper understanding of capital flows and trends, which is of great value to the sellers I work with in Southern California.”
Having the support of a strong brokerage firm behind him is another advantage. Shannon calls NKF the only full-service brokerage company that is capital-markets centric. “Approximately 25 percent of our company’s revenue is from capital markets, and our other service lines are frequently built out around premier capital-markets teams nationally.”
He adds that NKF has a collaborative culture that strengthens his team’s access to the most aggressive capital and to important national trends. “NKF’s office capital-markets teams are also strongest in the gateway markets such as Los Angeles, Seattle, the Bay Area, Boston, and Washington, D.C., where institutional and foreign capital is looking to buy, which increases our leverage.”
The firm also has service divisions such as appraisal and property management, which assist in providing the client with the valuation work. Shannon says NKF’s appraisal division’s recent rapid growth rate puts it on track to be the largest in the country by next year.
Another plus is its global footprint of more than 350 offices, which allows the team “to develop deep and credible relationships with the most aggressive global capital sources,” Shannon says. And he adds that the firm’s debt-and-structured-capital solutions personnel is strong as well.
To be fair, the large number of high-priced deals NKF has helped close in the last six months also has a lot to do with the growing number of foreign and domestic investors’ solid appetite for SoCal assets. “I think the velocity of larger deals in Southern California had been fueled by a wall of debt-and-equity capital,” Shannon says. “There is too much capital chasing too few coastal class-A-market deals, which is a very favorable seller dynamic in these sought-after markets.”
For example, for The Summit Office Campus transaction, the company had 50 buyer tours, which demonstrates the amount of capital in the market chasing deals. Shannon says this same dynamic occurred on the $97.1 million Campus at Villa La Jolla sale in San Diego this year, with nearly 30 buyer tours, and also on the recent $117 million Campus 2100 sale in El Segundo.
But what goes up may soon come down, particularly in the West Los Angeles market, which Shannon says has accounted for the majority of Southern California’s larger transactions recently. “I do believe the big-deal velocity in Southern California will be declining primarily due to a slowing pipeline of office product in [this submarket].”
There is a still an abundance of available capital for that submarket, and it is the most under-allocated market for institutional capital nationally, with the highest barriers to entry for new office buildings and the highest current projected rent growth of any of the major gateway markets nationally, Shannon says. “West L.A. is also characterized by more permanent capital with long hold periods. This means inventory will be scarcer now that the EOP portfolio has been sold off.”
The majority of other office markets in Southern California will see their inventory trade more frequently in typically smaller-sized deals, he adds. “This is a characteristic of markets that are not considered core. The South Bay, San Fernando Valley, and San Gabriel Valley office submarkets in Los Angeles, for example, are not considered core office markets. The capital for these more ‘commodity markets’ tends to have a three- to seven-year hold period, so the sales velocity is more consistent.”
Investor strategies need to evolve in order to close these large deals. Shannon says there is a tremendous amount of capital for both debt and equity in the system that is having a very difficult time finding a home. “If you are raising capital at the pace of a Blackstone, for example, you need to make larger acquisitions to move the needle. There is simply more capital for bigger deals because of the record amount of dry powder sitting on the sidelines.”
He adds that the trend of increased allocations to real estate by pensions and other institutional investors isn’t going to change either, as the industry is becoming increasingly transparent and therefore safer. “Real estate is going to continue to have increasing allocations as a preferred asset class in most investment portfolios, whether it’s institutional or a high-net-worth family office.”
Many investors are now looking at secondary and suburban markets, chasing improved yield and less competition to allow them to get more capital to work, Shannon says. “The pipeline of available deals in the gateway coastal markets … has decreased, so investment parameters need to be adjusted to get money out.”
Urban/suburban product is another new strategy for many buyer groups, he adds. “If you can’t be competitive in the popular CBDs … the theory is to go to proximate suburban markets with retail and a 24/7 vibe near major transit hubs.”