Watergate Price Weighed Down by High Vacancy, Poor Property Condition
Submitted August 24, 2010, 7:01 PM
US Bank may achieve close to its target price for Emeryville’s Watergate office complex, but the property’s sale is being complicated by millions of dollars in deferred maintenance, the size of the asset itself, high vacancy and constrained debt markets.
According to sources close to the bidding process, more than 10 parties and possibly more than 15 submitted offers Aug. 18 in the first round of bidding. A second bidding round among a smaller group should be completed in the next week or two, according to one San Francisco Bay Area-based bidder who declined to be named.
But a second San Francisco Bay Area bidder questioned how serious all of the proposed purchasers are and their ability to actually consummate the deal. Between the purchase price and “tens of millions of dollars for needed repair,” only a rarified few would seem positioned to buy, he said.
Debt financing will be critical to the ultimate purchase price, he said. Lenders today are not favorably disposed toward assets like Watergate. Once occupancy drops below about 85 percent, loan terms become very different, he said. At the same time, he believes the Watergate’s status may have changed, perhaps permanently. It may have been considered a core property at one time but is no longer because of its vacancy and condition, the bidder said. In the past, rents in the buildings exceeded those for comparable properties in Oakland, he said. That is not so any more, raising questions as to whether they ever will be again.
Eastdil Secured, which is handling the sale on behalf of US Bank, did not respond to several requests for comment. Michael Covarrubias, whose San Francisco company TMG Partners is managing the towers on the bank’s behalf, referred queries about the sale to Eastdil.
Watergate sold to global landlord and property developer Hines in 2006. Hines bought one tower for its Hines Real Estate Investment Trust Inc. and the three towers now selling for a joint venture with the California Public Employees’ Retirement System. Last year, Hines and CalPERS defaulted on the $152 million loan against the three office towers. The buildings were ultimately turned over to Pacific National Bank. When Pacific National failed, US Bank, which bought Pacific National’s assets from the Federal Deposit Insurance Corp., gained ownership of the loan.
Helen Bean, who heads economic development for the city of Emeryville, said Aug. 24 that the city is aware of Watergate’s travails and is eager for a new owner who will be enthusiastic about upkeep and occupancy. Emeryville’s largest employers are Swiss healthcare company Novartis International AG and Pixar Animation Studios, creator of the “Toy Story” movies.
The five-building complex is adjacent to the San Francisco Bay and is seen as an overflow location for San Francisco. The complex, which includes a free-standing restaurant building and four office towers, has 1.2 million square feet. Its office space accounts for about a quarter of Emeryville’s total Class A and Class B office stock, according to brokerage Cornish & Carey Commercial.
The second quarter was not a particularly happy one for Emeryville or the Watergate, Cornish & Carey said in a second-quarter office and report released Aug. 24. Emeryville vacancy rose from the previous quarter in both Class A and Class B offices, the broker said. Class A buildings are now 23 percent vacant, including properties available for sublease; Class B offices are 16 percent vacant. “A good deal of this additional vacant space (rendered in the second quarter) was vacancy that was added to the market at Watergate Towers I, II & III,” the broker said. Several Watergate tenants vacated or downsized.
Total East Bay office and flex-building vacancy in the second quarter was 20 percent, about the same level it has been for the last six quarters, according to Cornish.
Ed Del Beccaro, a managing director in the East Bay for brokerage Grubb & Ellis, said the outcome of the bidding process has resonance beyond Emeryville. He described Watergate as “core, Class A product” based on its location adjacent to San Francisco in a “fantastic city.” His office has had contact with at least five of the bidders, he said. He described them as a mix of public and private real estate investment trusts, sovereign funds and private equity.
Ownership issues have contributed to at least a third of Watergate’s current vacancy, said Del Beccaro, who is working with a tenant now who is considering Watergate but is worried about the current transition.
The tension for any buyer will be between keeping rental rates low enough to steal tenants from rival buildings while keeping income high enough to pay debt service, do property maintenance, finance tenant improvements and pay broker commissions, he said.
“I think the private equity guys will have the upper hand [in the bidding],” he said. “This market is not going to recover in the next year. It is going to have anemic recovery for the next two or three years.”
Whoever buys is going to have to be able to wait for a time for their returns to blossom.
