CORRECTED: Fund managers bank on office rent hikes

Corrects quote in last paragraph to read "I can't think of any market in the world that isn't priced to perfection, as it were," instead of "No real estate market in the world is priced to perfection."

By William Kemble-Diaz

NEW YORK (Reuters) - Rising office rents in many European and U.S. cities will compensate for a likely rise in commercial property yields due to higher interest rates, leading U.S. real-estate fund managers said on Monday.

"We aren't anticipating any further cap rate compression, but vastly improved fundamentals in the majority of markets that we're in will offset increased borrowing costs," Robert Speyer, senior managing director at Tishman Speyer, said at the Reuters Real Estate Summit in New York.

Cap rates are a measure of the operating income on a building -- or its rent after expenses -- in proportion to its capital value. They are also known as property yields and move in the opposite direction to property prices, much like yields on a bond.

Average cap rates on U.S. central business districts fell to 6.5 percent in May 2006 from 8.5 percent in 2003, according to Real Capital Analytics. The CB Richard Ellis European Weighted Average Prime Yield has fallen by just over 100 basis points to 5.15 percent in the three years to March.

Speyer said office rents were set to increase at a faster pace than the cost of borrowing in New York, London, Paris and Milan.

Tishman Speyer owns New York landmarks such as the Chrysler Building and Rockefeller Center. Office holdings in Europe include The Atrium in Amsterdam, the Paris Bourse and the Millbank Center in London.

Also staying positive despite a more challenging environment was Apollo Real Estate Advisors L.P., which is positioned at the riskier opportunity fund-end of the market, historically targeting an annual investment return of more than 20 percent.

The company has offices in New York, Los Angeles and London. Landmark buildings on its books include St Katherine Dock in London and the Time Warner Center in New York.

John Jacobsson, a managing partner at Apollo who was also speaking at the summit, said there was a fair amount of downside risk for pure cap rate plays because yields were so low and funding costs were rising.

"But the good news for buyers is that the fundamentals are improving," he said, citing surging office demand in midtown Manhattan.

"There might be a higher cap rate down the road, but we will have increased cash flow that will more than make up for that," Jacobsson said. "We still need rents to be higher to justify a lot of office construction, but we're not that far away from that."

REFINANCING PRESSURES

Jacobsson also said that he saw new investment opportunities arising as a tougher funding environment exposed real-estate acquisitions made in previous years which had not gone according to plan and as default rates on commercial mortgages began to rise.

"Refinancing pressures will create opportunities to buy assets or to recapitalize those assets," he said.  Continued...