Bargain buys?: Cash-strapped governments hawking commercial properties, courting investors

States turn to commercial properties for cash

LOS ANGELES — Political cynics often joke about statehouses being for sale to the highest bidder. These days, that’s not far from the truth.

State and local governments are grappling with budget shortfalls and some are eyeing their office high-rises, prisons and even capitol buildings as assets to be sold or mortgaged for some fiscal relief.

In recent weeks, Arizona invited investors to buy bonds secured by several landmark state government buildings. Connecticut, also facing budget woes, has made plans to bring in $60 million over the next two years from real estate sales. But California, with a gaping $20 billion budget gap projected through June next year, has the most ambitious sell-off plan yet.

This month, the state will begin marketing nearly 9 million square feet of office space it values at around $2 billion.

The sales come at a time when the commercial property market is coming off its worst year in decades. Prices are down 40 percent from their peak in 2007 and are expected to fall further this year.

That bodes well for investors looking for a good deal, but not for state coffers.

Government has a history of selling real estate at an inopportune time, said Dan Fasulo, managing director of Real Capital Analytics.

“Usually there’s a crisis and part of that crisis is caused by an economic downturn, which means they wind up getting lower prices when they do actually sell,” he said.

Federal, state and local governments sold 24 commercial buildings worth $4.2 million last year, Fasulo said. That doesn’t include government auctions of seized properties. Governments sold about twice as many properties, fetching $1.5 billion, in 2008, when the commercial real estate downturn was just beginning to gain momentum.

Governments usually sell unused properties, but that won’t cut it with big-money investment funds.

Among the 17 buildings California is selling are two in San Francisco that house the state supreme court and a federal appeals court, among other tenants. Arizona, meanwhile, put up both chambers of its state legislature as collateral.

An attraction for potential buyers is that both states are looking to continue to occupy the buildings for at least 20 years. This offers stability for landlords at a time when U.S. office vacancies are projected to climb as high as 19 percent by the end of the year.

Pension funds, insurance companies and other institutional investors are eager to scoop up properties that offer the prospect of a steady return on their investment, said Jeff Friedman, principal at Mesa West Capital LLC., a private commercial real estate lender based in Los Angeles. He noted it’s something that hasn’t been in much abundance the past 18 months.

“The investor community is going to be quite excited to see millions of square feet of real estate hit the market,” Friedman said.

Some funds have already gotten a taste.

Arizona, hoping to make a dent in its $1.4 billion budget deficit, issued municipal bonds at $5,000 a piece against the value of several properties.

The offering last month raised $735 million in two days. Some of the bonds were purchased by individual investors, but the majority were snapped up by mutual funds, including Fidelity Investments, The Vanguard Group and Northern Trust, said Alan Ecker, spokesman for the Arizona Department of Administration.

Lawmakers aren’t actually selling the buildings, however. They’re using an approach, called a sale-leaseback transaction, when an asset is sold to a bank trustee and leased back to the state for about 20 years. This enables the state to raise money upfront and pay it back over a period of time, like a loan. Once investors are paid off — at an interest of about 4.5 percent — the state recovers the deeds to its properties.

Now Arizona wants to try again and put up more buildings to raise $300 million.

California is going in a different direction.

Last month, it auctioned a 150-acre property best known as the site of the Orange County Fairground. The highest bid came in at $56.5 million — about half as much as what the state initially thought the property would be worth. Officials are still weighing whether to approve the deal.

Still, that property was a sideshow to the mammoth portfolio of office buildings the state will begin marketing on Feb. 22.

The state wants to part with 17 buildings and negotiate 20-year leases at today’s rental rates with the new owners, said Eric Lamoureux, spokesman for California’s Department of General Services.

“We really feel that we’re going to get more than these buildings are worth right now and we also believe that, at the end of the day, over the long term of the leases, we’re going to realize some significant savings,” he added.

Kevin Shannon, a broker with CB Richard Ellis, the firm handling the sale, anticipates the state will draw competitive bids despite the fact that it is selling in a depressed real estate market.

“What we’re seeing right now is there’s far more capital to buy commercial real estate than there are sellers,” Shannon said. “Half the buyers weren’t in the market last year.”

Still, investors are likely to get the better end of the deal.

Friedman of Mesa West Capital anticipates buyers could reap discounts of 40 percent or more than if the state had sold the properties three years ago.

But the state could still manage to fetch an above-market price, depending on the lease terms, he added.

“We’ll only know in hindsight whether or not this is a good transaction,” Friedman said.