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One of the anomalies of the current commercial market is that while occupancy rates and rents have been declining, the value of office buildings is on the rise. Of course, the surge in prices does not apply to all office buildings, just those that are fully leased to strong, credit-worthy tenants. One of the best examples of this trend is the sale last November of the two-building complex known as Independence Square, located in Southwest D.C., a few blocks from the National Air and Space Museum. This 918,000-square-foot complex, built in the early 1990s, houses the headquarters of both NASA and the Comptroller of the Currency. It was sold by Boston Properties, the nation’s third-largest office real estate investment trust, for $345 million, which makes it the largest D.C.-area commercial property sale of 2002 and one of the highest prices ever paid for any office building in Washington. According to Trendlines 2003, a report published by Transwestern and Delta Associates, investment sales in 2002 for the Washington metro area totaled $3.9 billion, 22 percent above the total volume in 2001. This boom in sales has been fueled by a shift of capital away from a weak and volatile stock market, historically low interest rates, and an abundance of capital — both debt and equity — from many nontraditional sources, both foreign and domestic. It also confirms that Washington is one of the prime real estate markets in the country. The buyer of Independence Square was Atlanta-based Wells Capital, one of a new breed of REITs that have been buying up trophy office buildings in many of the country’s largest cities. Wells Capital is reported to have spent more than $1 billion last year in its acquisition of several office properties around the country. Both individuals and institutional investors are pouring money into these private REITs in the hopes of receiving a long-term, secure return that is several percentage points above the return available on U.S. Treasury bonds. The fact that private REITs have been able to attract significantly greater amounts of equity than public REITs have been able to raise in the stock market during the past three years is an indication of the wariness of investors toward the stock market. CITICORP TOWER For Boston Properties, the sale of Independence Square was part of a larger strategy. Earlier in the year, Boston Properties, which is based in Boston but also has large holdings in New York, Washington, and San Francisco, had purchased the Citicorp Tower at 399 Park Avenue, in midtown Manhattan, for slightly more than $1 billion, one of the largest real estate acquisitions in history. To pay for this landmark building, Boston Properties decided to sell several of its premier properties in New York and Washington that are filled with strong tenants with many years to run on their leases. The sale of Independence Square was one of the linchpins of this strategy. There is more than a little irony that an office complex housing government agencies outside of the Central Business District should garner the highest total sales price in the District last year. It was not very long ago that government buildings were relegated to Class B or Class C status by many investors, and sales prices were often discounted because of the unusual and sometimes onerous lease provisions required by the General Services Administration in its leases. Today, the credit of the U.S. government is considered sterling, and the continuing growth of the federal agencies in the Washington area is viewed as a strong stabilizing factor. It is also noteworthy that the threat of terrorism has not dimmed the appeal or value of buildings like Independence Square, even though they are within walking distance of the Capitol and the White House. The sale of Independence Square is interesting not only because it reflects trends in the local real estate market but also because the seller imposed a selling process that is unusual for large real estate transactions and may foreshadow how real estate will be sold in the future. The first unusual element of the process was that Boston Properties hired Morgan Stanley, one of the leading investment banking houses on Wall Street, to serve as its broker. In the past, Wall Street firms have generally shunned the real estate industry, and the industry thought that Wall Street firms did not have the local knowledge or relationships that were seen as crucial for generating the highest price. What has changed in recent years is the size and complexity of many transactions, with property sales often exceeding the prices paid for going businesses. In addition, the real estate industry has increasingly turned to Wall Street due to the global nature of the investment capital markets and Wall Street’s access to overseas capital. Will Morgan Stanley and the other investment banking houses retain their interest in real estate once the stock market turns around and IPOs and merger activity return to their pre-recession levels? That remains to be seen, but it is likely that real estate investment will continue to be seen by Wall Street as a lucrative profit center, even when it is competing with their more traditional lines of business. DUE DILIGENCE BEFORE CONTRACT With Morgan Stanley’s assistance, Independence Square was put up for sale as part of a formal auction process. This process required all interested bidders to do their due diligence on the property before a contract was submitted. The due diligence consists of checking title to the property, inspecting the buildings, conducting an environmental inspection, reviewing the leases, studying the zoning ordinances, and numerous other details. Traditionally, a commercial real estate sale starts with the buyer submitting a contract, which is negotiated, and if the negotiations are successful the contract is signed. The contract usually calls for a study period of anywhere from 30 to 60 days, during which the buyer will conduct its due diligence. At the end of the study period, if the buyer is dissatisfied with its findings or has a change of heart, it can terminate the contract and walk away. Boston Properties was unwilling to adhere to this traditional format because it was essential that the sale take place quickly and with no contingencies. Timing and certainty were the drivers in this selling process. To make sure that the selling process would meet these objectives, Boston Properties insisted on the following steps: • Bidding process. The large number of initial bidders was winnowed down over a period of days to a select group who were invited to submit “best” and “final” offers. • No study period. As noted above, each prospective purchaser was expected to complete its due diligence review before submitting a bid. • Parallel negotiations. Negotiations over the final terms of the contract were conducted with several of the final bidders at the same time. • No conditions to closing. Boston Properties would accept only a contract that had virtually no conditions to closing. Even a breach of a covenant by the seller could not be grounds for the buyer to walk away before closing. • Quick closing. Not only did the contract have to be signed within a week of submitting best and final offers, the closing had to take place within two weeks after the contract was signed. This timetable is almost unheard of in office building transactions. THE RUSH TO CLOSING You may ask why speed and certainty were of such paramount importance to Boston Properties. There were probably two key factors that mandated this approach. First, given the recent volatility of the capital markets and the uncertainties stemming from terrorism and the possibility of war, there was concern that untoward events might occur that would suddenly squelch the interest in this building or the favorable investment climate. The second factor stemmed from the fact that Boston Properties was trying to qualify this sale as part of a tax-free exchange with its purchase of the Citicorp Tower. In fact, since the Citicorp Tower was purchased before Independence Square was sold, this type of exchange is known as a reverse tax-free exchange. The Internal Revenue Service issued guidance for reverse tax-free exchanges a few years ago, and since then a whole cottage industry has sprung up to help real estate investors satisfy the complex requirements for these types of exchanges. One of the IRS’s requirements is that the matching purchase and sale take place within 180 days. Thus, when Boston Properties was conducting its auction of Independence Square, the clock was ticking; it wanted to be sure that the sale would be completed well before the deadline. This sales process represents a radical departure from the traditional approach in real estate transactions. Now that it has been shown to be workable, future commercial real estate sales, especially the larger ones, may include many of these novel features. Sheldon J. Weisel and Diane Shapiro Richer are partners in the real estate group at Shaw Pittman. In the sale of Independence Square, they represented Boston Properties.

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