This chart shows that investor demand for core assets, a sharp improvement in credit conditions, and initial signs of a strengthening economy powered a strong recovery in commercial real estate, particularly in major markets like the nation's capital. Cap rates compressed by 40 to 50 basis points across all property types in the fourth quarter of 2010, but as you can see, the rebound has been the most spectacular in the office sector, and office capitalization rates in certain Washington D.C. submarkets have declined by more than 200 basis points since the 2009 meltdown.
Notably, what it also shows is that average cap rates for core CBD office property in Washington D.C. have NEVER declined below 5%, EVEN during the bubble years.
Unfortunately, Leo Wells can't be bothered with such data, because he has other people's money to spend (and a 2% "acquisition" fee just for collecting it). Wells REIT II's $615 million purchase price ($904 p/sf) actually translated into a cap rate that was well below 5%, and that clearly makes the price tag wildly rich relative to today's market, or any market. Wells said generally that the cap rate was "under 5%" but one official Wells statement pegged it at 4.60%. The CRE Review, which I would consider to be, ahem, a more reliable source on this matter, quoted the acquisition cap rate at 4.22%.
Initially, the property had been expected to fetch no more than $450 million, according to Commercial Real Estate Direct, or about $622 p/sf. Indeed, Less than 25 days after Wells bought Market Square, the Rockefeller Group announced the joint venture purchase of 1101 NW K St., a 293,598-square-foot, Class A office property fewer than ten blocks to the North (2006 construction). The Rockefeller Group joint venture bought the property for $199 million, or about $678 s/ft, which is nearly $226 per square foot less than Wells paid for Market Square, but in line with what Market Square was thought to be worth before Wells showed up.
Significantly, there was virtually no difference in rental income at the two properties. According to Costar, the average asking rent at Market Square is $54 p/sf, while the average asking rent at 1101 NW K St. is $59 p/sf.
Officially, Wells is justifying this craziness with a 2006-era bet that even though the property was purchased "at under a 5 cap rate," there was "great potential to increase cash flow over the next several years as the current below-market leases...approach expiration." Essentially, Wells is rolling the dice on its ability to renew expiring leases at much higher rates than tenants had been paying. Meanwhile, on the very same day that the Wells acquisition machine was trumpeting potential rent growth at Market Plaza, the other side of the house was busy cutting the Wells REIT II dividend. The reason given for that move was as follows:
As our tenants’ leases have come up for renewal....they are seeking more rent concessions, tenant improvements, and lease accommodations than in the past. In addition, we are seeing some of our tenants courted more aggressively by other office building owners more willing to offer tenant-favorable lease terms. We currently find ourselves negotiating lease terms in a tenant-favorable environment
Source: Wells REIT II March 2, 2011 Letter to Stockholders
Given this market data, it seems pretty clear that Wells did overpay for Market Square (significantly so), and whether Wells REIT shareholders will ever get their money back this monster purchase is somewhat doubtful. Furthermore, without some significant rent growth there is no way that a $615 million purchase with an unlevered yield of 4.22% can fully cover its share of the freshly cut dividend (now 5%). It's not likely that Leo is too worried about any of this. After all, he earns a 2% "acquisition" fee just for raising the money, and in 2009 and 2010 that fee alone entitled him to pocket $30 million -- regardless of how his deals performed or what he bought. How's that for data?
Related Story: Wells REIT II Signals 40% Drop in Share Price