An Interview With: Brian McVay

McVay joined Cushman in 1982, and headed its regional operations from 1998 to 2004, personally involved in over $2 billion of transactions for clients such as Ernst & Young, Computer Associates, Sallie Mae, Mills Corp., IBM, PRC, Hughes, MCI, AMS, and many others. He was named top broker in the region in 1996 by the Washington Board of Realtors. He has a BA from Notre Dame and did graduate business study at MIT. Cushman & Wakefield has 11,000 employees in 175 offices in 50 countries.

Bisnow: Everyone says the commercial real estate market here is still red-hot, but how does it compare with other hot markets like New York and L.A.?  It’s even better. In our business, it’s generally gauged by a couple of things: the velocity, which means the amount of leasing activity; and the amount of new construction. Just to focus on new construction, there’s more going on in the Washington metropolitan Area than in any other area in the country, including New York, Chicago, and LA.

Do you mean on a per capita basis or absolute volume, even though we’re a smaller city? Absolute volume. Office, retail, industrial, multi-family: it’s all incredibly active right now.

So is there a danger that we’re over-building? Well, there’s always that danger, but I wouldn’t be particularly concerned. There’s a lot of doomsayers in our business who think we’ve peaked, and the with the sales prices and the way they’ve escalated over the last three to four years it seems hard to imagine the market could go much higher. But I’ve said that for the last two to three years, and I would’ve been wrong. Downtown is phenomenally strong. Penn Quarter and the area around the MCI Center has been a hotbed of activity for the last six or seven years, and the newer and more emerging areas are “NOMA” around Union Station and the Anacostia waterfront area. Both of those are seeing just a tremendous amount of activity, and if you think about it, it’s only common sense since that’s one of the few areas where there’s still some available ground for re-development.

Are you predicting that we’re going to be talking about the Union Station area and the Anacostia waterfront just as much as everyone’s been gravitating to the area around MCI Center?No question. There’s no other choice in this market, there’s no other ground available, unless they decide to re-visit the age-old height limitation here of 130 feet, or other buildings are torn down.

You could tear down buildings anywhere.Well you could, but if you have an asset at 18th and K, you’d have to find an economic rationale for knocking that building down and rebuilding it, as opposed to a series of low-rise industrial or underutilized residential assets elsewhere that could be re-tooled and re-positioned for a much higher yield. So it’s a highest and best-use sort of issue.

Just so we know where these places are, where is the Anacostia waterfront? Where is the stadium going to be?The most interesting thing is that it’s immediately adjacent to the old Navy Annex and there’s a tremendous amount of re-development down there that’s going on today. Originally it was the home of the Navy, and since then we’ve had 2 or 3 speculative office buildings, and now all of a sudden with the anticipation of the ballpark and all the hype around the design and the ability to get views of the Capitol, we’ve had a number of the most active developers in the area acquiring ground in and around that. And then there’s the whole Anacostia re-development plan. It’s not simply commercial office buildings, but also retail, residential, and multi-family. It’s trying to make that whole area pedestrian-friendly, and both the Federal and local government have a role in this in terms of trying to encourage municipalities to occupy space in that area, because that brings people, and people bring retail, and retail brings residential. Like every city, they’re trying to make it a 24/7 environment.

Just to put some numbers on it, how much does new Class A office space sell for now, per square foot, downtown? Well, it’s interesting how quickly that has escalated. It’s expected that by the end of the year the first building will sell for over $700 per square foot. We’ve had several in the high $600s already.

And what is so great about these buildings that they keep skyrocketing in value? Well, it’s a combination of things. More than anything else, they’re in great locations, and the simple laws of supply and demand come into play. You have a ton more money chasing opportunities than there is product to be sold, and so what that translates into is premium sale prices. Most of the investors look at it as an option between equity markets and real estate, and real estate has been such a great play for the last 4-5 years that there’s just a ton of money flocking into the area.

From whom? Is it from overseas investors, or pension funds in America? Who are these investors with all this money?Well, the answer is, all of the above. We’re seeing foreign money, but we’re also seeing some of the entrepreneurs who have gotten out of the business over the last 6 or 7 years jump back in. A lot of it has some sort of public or institutional sponsorship behind it, so I would say two-thirds of it has some kind of public backing, but we’re seeing interest from all different sectors of the marketplace. The pension funds that you mentioned are also a very active part of the buying pool.

And is the reason they’re motivated to pay these high prices simply that they’re expecting, like residential home-buyers, more and more appreciation every year? Or is it that they think the stream of rents they’re going to get will make them lots of money?
It’s a combination of both. Obviously they wouldn’t be placing this money if they didn’t assume that they were going to get some kind of reasonable return. It’s one of these ironies of life: we’ll never know until we look back whether in fact we’re able to achieve those rates, because most buildings are bought on speculation. Rents will increase by X and expenses will stabilize over Y period of time, and maybe they feel that in 3-5 years they’ll have a window to sell the asset.

And looking at it from the perspective of the tenants of these buildings, how much rent are they paying today for the best space in downtown Washington?
Well that’s interesting. Let me first draw a correlation between sales prices and rental prices, because if you’re a tenant, it’s really not your concern what an owner pays for an asset, yet at the end of the day the owner has an expectation based on what he paid for that building. That’s a long way of saying that today, for Class A space in downtown, in prime locations, we’re talking about on a full-service basis, high 50s per square foot per year, and typically tenants rent space for a period not less than 5 years and often 10 or longer.

So you would look at this income stream over time and compare it to the return on other possible investments?
Yes, if I were to ask you to invest $1 million with me, you would say well that’s all great, Brian, but what are my choices, what kind of return should I expect, and let’s also give me some kind of risk adjustment. So, traditionally in our business they call that Cap Rates, they have been depressed recently, which means investors are paying premiums for these office buildings. As an example, it used to be that 9% was a very competitive rate of return, but now people are willing to buy these buildings for yields between 5 and 6%, because of expected appreciation and the lower cost of borrowing money.

To change subjects, what’s happening with Metro getting to Tysons Corner?
They’re still doing the final engineering studies which I think will be completed by May of next year, and they’re anticipating breaking ground by the end of ’06 and talking about at least Phase One being completed by 2011. I know it sounds like a long way off, but for those of us who have been in the business or lived around here for the last 15-20 years, I don’t think it can come too soon.

What kind of impact do you expect?
A tremendous impact. The project would be 23 miles, from West Falls Church all the way out to the airport. The first phase is 11 stops, from West Falls Church to Wiehle Avenue. I think at Tysons it will probably have the most dramatic impact because it’s the largest office market outside DC in the Metropolitan area. We have over 100,000 people there, and I think that will have a big impact not only on commercial development but as you’ve already seen with the recent completion of the 350,000 foot expansion in Tysons I. And then there’s two or three very large condominium projects that are being planned and one has just recently broken ground in anticipation of the kind of density that I think many people had really envisioned for Tysons.

And are they really going to be able to re-invent Tysons as a pedestrian-friendly little town?
Well, I think that would probably be an over-statement, it’s just a practical challenge with a pedestrian environment. They’ll do everything they can, but the reality is there’s just physical barriers and constraints that I don’t think will be overcome even by Metro. The buildings just don’t have the same kind of grid that you enjoy downtown. So I don’t think you’re going to be able to walk out of your office building and have 8-10 choices where to eat, as you do downtown.