Has Houston reached the status of international gateway city? One recent commercial real estate transaction points to this possibility and demonstrates the success of Houston’s effort to redevelop its downtown district through the Discovery Green project.

In December 2011, H&R Real Estate Investment Trust (H&R) from Toronto, Canada, announced the acquisition of Hess Tower for a record price of $523 per leasable square foot ($442.5 million). Completed in June 2011, the tower is fully leased to Hess Petroleum in a long-term deal. The REIT cited several attractive physical characteristics of the property.

•  It’s one of Houston’s most energy efficient buildings with a “prestigious” LEED platinum certification of Core and Shell.
• The tower is connected to Houston’s pedestrian tunnel system.
• The building is in a unique location overlooking the Discovery Green Park.

The combination of quality credit tenant and attractive physical features motivated the REIT to pay a premium as reflected in the price and financial terms of the deal:

• The purchase price represents a 6.6 percent capitalization rate.
• Financing was a $250 million first mortgage (56 percent LTV) at 4.5 percent per annum for eight years.

The cap rate paid is less than the December 2011 average of 7.3 percent for Houston office properties, according to Real Capital Analytics.

Figure 1. Average Cap Rate for Houston, Texas, Office Properties (Source: Real Capital Analytics, Bloomberg)

According to Management’s Discussion in the REIT’s January 2012 8K filing, the REIT focuses on acquiring creditworthy tenants with long-term leases rather than targeting specific property types. In a world where the supply of safe assets is declining and the demand for stable income is increasing, a strategy like H&R’s would motivate the firm to pay a premium for a deal like Hess Tower.

The REIT has also completed recent trophy property acquisitions like Gotham Center in New York and the Bow in Calgary to provide steady income to shareholders for the long term.

Has Houston become a gateway city? The Hess Tower acquisition could be a step in that direction. The combination of prudent redevelopment and strong economy certainly placed Houston on the radar of one international investor.

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