By Alejandro Lazo
Washington Post Staff Writer
Monday, October 8, 2007

Sales of office buildings in the District tumbled in the third quarter to the lowest level in five years, as credit-market turmoil has started to affect the commercial property sector, according to a new report by one of the region's largest real estate services firms.

A total of $398.7 million in office properties were sold in the third quarter, down from $740.8 million in the comparable period a year ago, according to data provided by Cushman & Wakefield, which published the report. The last time sales were this slow was in 2002, during the trough of the latest commercial real estate downturn, according to the report.

Several commercial real estate brokers attributed the slowdown to suddenly higher debt costs and increased uncertainty about the future direction of interest rates. Buyers remain interested in D.C. office properties but are showing greater caution and finding it harder to get financing, the brokers said. Cushman projects the sales slowdown to continue at least a few more months.

"[The] fourth quarter will taper off -- it will be across the board," said Sigrid Zialcita, director of research for Cushman & Wakefield and author of the report. "There is just so much uncertainty and volatility, and I think people are still waiting out on how this is going to play out."

Office buildings have been bought and sold at a feverish pace over the past two years, fueled by cheap debt. Large private-equity firms, famed for ever-bigger corporate buyouts, have used their access to low-cost financing to become players in the commercial real estate market.

The buying spree culminated in February with private-equity firm Blackstone Group's purchase of Equity Office Property Trust for about $39 billion, at the time the largest leveraged buyout in history. That transaction included 23 properties in the Washington region, according to Zialcita. Those properties were sold soon after to Beacon Capital Partners, a Boston commercial real estate investment company.

But as problems with loans to high-risk residential borrowers spread to the broader credit market in midsummer, both the corporate dealmaking juggernaut and the commercial real estate market began to slow.

"When things are uncertain, people tend not to make decisions as quickly, so volume slows down," John Kevill, a managing director in the Washington office of the real estate firm Jones Lang LaSalle, said. "People are taking a much harder look at the fundamentals of real estate."

The Cushman & Wakefield report provides a snapshot of the period immediately after the credit markets seized up. With less than two weeks left in the quarter, the Federal Reserve lowered interest rates, but that change will take months to work its way through the financial system.

Compared with the District, Washington's suburban office markets presented a mixed picture during the latest quarter, according to Cushman & Wakefield. In Maryland, sales rose to $429.7 million from $324.1 million a year ago. Sales in Northern Virginia declined 28 percent to $717.4 million, but several large transactions in the first half of 2007 helped make it a record year for that market, with $9.4 billion sales to date, Cushman said.

Nationally, sales of office properties surpassed $13.1 billion in August, almost double the same month last year, according to New York-based Real Capital Analytics. But most of those deals were in the pipeline before the credit crunch, and September is expected to rank as one of the slowest months nationally in years, Real Capital said.

In the District, one deal appeared to be all but wrapped up when it was suddenly called off. JBG Cos., a longtime Washington area developer, pulled a 310,748-square-foot downtown office building off the market last month after the buyer, Blackrock Realty Advisors, backed out of a purchase contract, according to JBG executives.

Blackrock Realty, an affiliate of the New York investment firm Blackrock, declined to purchase the building because it was uncertain how much of the purchase it could finance and at what interest rates, said Ken Finkelstein, a managing partner with JBG Cos., said. A spokeswoman for Blackrock declined to comment.

Instead of selling, JBG is now looking to lease about two-thirds of the space in the building, at 1101 K Street NW.

"We wanted to wait and see how the markets were going to shake out," Finkelstein said.

In Virginia, the market showed some signs of resiliency. The Verizon Tower in Falls Church was sold to the ING Office Fund and Tennessee Consolidated Retirement System for $105 million. The sale was notable because the price was struck during the credit market turmoil, said Warren Dahlstrom, senior director of investment sales at Cushman & Wakefield. In Maryland, Prudential Real Estate Investors completed its purchase of Democracy Center for $280 million.

Despite the effects of the credit crunch, the basic fundamentals underlying Washington's commercial real estate remain strong, several brokers said. Throughout the region, office space continues to command high rents despite slowing demand for such buildings and rising supply.

Jayne Shister, a senior vice president in the Washington office of Cassidy & Pinkard, said, "Prices are still not flattening. The national real estate press is saying it and, I don't think we're seeing it yet here in Washington."

Unlike the residential market, commercial real estate is better positioned to weather a credit downturn because of the rent-producing nature of the properties, said Dionisio E. Meneses Jr., managing director and portfolio manager of Charles Schwab Investment Management, who oversees Schwab Global Real Estate Fund.

"Cash flow is king, and that's what saves commercial real estate in general," Meneses said. "It is driven by cash flow and that's what makes it less risky than other ventures out there."