Even before Daon Corp. began construction of its huge new office building at 1300 New York Ave. last year, there were rumors that the project would never get underway. After all, interest rates were high and the market was soft.
To many, the 750,000-square-foot project seemed like an enormous gamble. But Daon--the American subsidiary of a Canadian development firm--went ahead with the project because of its confidence in the vitality of the Washington market, not to mention its own ability to attract major tenants despite stiff competition.
Other foreign investors feel just as strongly about the Washington market, and they are betting millions of dollars that they are right. Their approaches and goals vary, but most foreign investors give similar reasons for their unshakeable faith in the city.
Foreign investors have been buying U.S. real estate since the '70s for two very basic reasons. There are more development opportunities here because of the vitality and diversity of American markets, and the returns are often higher. The United States also offers political stability and minimal government interference in private development.
But of all the U.S. markets, Washington is among the most attractive to foreign investors. "Our clients decided Washington was the most attractive to them because of variables it offers that other cities do not," said Julian Josephs, whose Julian Josephs Co. has been representing British investors here since 1980. "It has a defined downtown within a city which is less affected by recession than others due to the strong government base."
The city's height and zoning restrictions make it even more attractive, Josephs said, limiting buildings to a scale and cost that Europeans understand and preventing competitors from erecting skyscrapers that "take the market away."
Washington has less tangible advantages, too, according to Robert Osinoff, vice president of Jones Lang Wootton, a 200-year-old British consulting firm that opened an office here two years ago. "The offshore investors feel Washington is an excellent market for several reasons--its European flavor, its sophistication," he said. "Being the capital of the U.S. has a patina to it. They find it an attractive city, a comfortable city."
It's a bit harder to see why that interest has withstood what brokers readily admit is a tenants' market. There is a supply of 11.5 million square feet of unleased office space in the city, including existing space and projects to be finished through next year, according to local consultant and broker Julien Studley. Only 1.7 million square feet were leased last year, and projections call for 2.6 million to be leased this year, according to the firm.
"Undoubtedly, the amount of space makes it a buyer's market," said Graham Bond, senior vice president of Richard Ellis Inc., a British real estate consulting firm. After watching rents for office space jump from the $10-a-square-foot range in the late '70s to the $30-a-square-foot range in the early '80s, project owners now are cutting deals in the mid- to high-20s, Bond said.
But foreign investors simply don't expect that situation to last. "What you see is the result of development which is underway or already planned, and as that product gets leased up, there will be less to follow it," Bond said. Figures from the Coldwell Banker brokerage bear that out, projecting delivery of only 2 million square feet of office space in 1985 and 1.7 million square feet in 1986.
Bond points out that there also will be less turnover among existing properties, because many of them already are owned by institutions that intend to hold them for long periods.
Looking at the other side of the supply-and-demand equation, foreign investors see continued strong demand for office space in Washington. They expect international banking and trade organizations moving to the city to lease much of the current oversupply, a trend that already is becoming evident.
"It will be a lot tighter in three to four years, like it was three or four years ago," said Coldwell Banker's Vernon Knarr. Prices for existing buildings already reflect that scenario, Knarr added, pointing out that buyers are offering as much as $250 a square foot for prime properties. The current record for a completed deal is $182 a square foot, the price paid for the Board of Trade Building, Knarr said.
The balancing out of supply and demand also will bring stabilization, if not increases in rent, putting an end to the buyer's market, brokers say.
"In terms of a long-term strategy, Washington is one of the best office markets year in and year out," said Michael Prentiss, president of Cadillac Fairview Urban Development, the American subsidiary of a Canadian firm, which is planning an 800,000-square-foot office project at 1001 Pennsylvania Ave.
Like Cadillac Fairview, most foreign investors plan to hold their Washington properties for the long term. The bulk of the foreign investment comes from pension funds interested in a sustained return, even if it means waiting a few years for the market to turn around. Insurance companies and other institutional investors share that approach. When they do sell, these investors are likely to reinvest in other U.S. properties, international brokers say.
Foreign investors diverge most sharply on where they can find the long-term returns they seek. While the Canadians gamble on the future of the east side and the Dutch emphasize northern Virginia, the English and most other Europeans stick to the prime downtown office district known as the Golden Triangle.
"The English are not going to pioneer. They want to see others go first and, if they succeed, they would rather pay a premium price to get in when an area is proven," said Julian Josephs, the English consultant who likened K Street to Paris' Champs Elysee in a recent article on the Washington market. "We are only interested in first class locations and first class properties," he said.
If location is the most important consideration for a successful project in a soft market, quality is the second most essential factor, especially when the location is less than perfect.
"Washington has been renowned for poor quality construction by developers building for the government," said Josephs. "The English objective is to get as high rents as possible, and to do that, you have to build to as high a level of quality as possible."
In order to draw tenants to the east side, the Daon building at 1300 New York Ave. is being built to standards that will make it an "historic landmark before it is finished," according to Knarr. It also may be the most expensive project in the city, he added.
Foreign investors can afford that kind of quality. In real estate parlance, they have "deep pockets." Most of them can and do pay all cash for 100 percent interests in new or existing projects. Freed from the burden of construction or permanent financing at high interest rates, they can rent their space for less than owners who have mortgages to pay.
Ownership and development plans vary, but they often involve a series of companies or partnerships that obscure the ultimate owners of a property or the ultimate beneficiaries of an investment. For ownership purposes, most foreign investors create American-based entities that often do not indicate any foreign interest.
A Dutch pension fund, for example, owns an interest in Trans Potomac Plaza in Alexandria through an American firm called Bryce Mountain Inc. An American firm called Second British American Properties owns the Demonet Building development at Connecticut Avenue and M Street, but a British insurance company is financing the project and will take the profits.
With the notable exception of the Canadian developers, most foreign players in the Washington market prefer to remain anonymous. Brokers say some investors may be hiding their interests from their own countries to avoid taxation or to skirt controls on exporting currency. Some simply want to avoid criticism at home for investing abroad.
But most foreign investors are doing nothing illegal, their representatives say. "It's just the desire not necessarily to be seen as buying this or that property," said Bond. "It's the desire to retain a low profile."