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Online Exclusives
GE/Arden Deal
Caps Big M&A Year
By Parke M. Chapman
When General Electric agreed to buy office real estate
investment trust (REIT) Arden Realty for $3.2 billion last Thursday, the
deal capped a heady year for REIT mergers. Not only is southern
California-based Arden the eighth publicly-traded REIT to be sold this
year in roughly $20 billion worth of deals, but it's also further
evidence that institutional capital still has a huge appetite for real
estate. December proved to be an especially active month for REIT
mergers: Centerpoint Properties Trust was sold to a joint venture
earlier this month for $2.4 billion.
"The Arden transaction provides GE with an established portfolio in a
strong office market," wrote analyst James Sullivan of Prudential Equity
Group in a research note following the announcement. "Market sources
suggest that historically high levels of capital continue to search for
real estate assets and find public REIT portfolios attractive options
for investment."
GE plans to sell 13 Arden properties to another office REIT, Trizec
Properties. That disposition will yield $1.6 billion, which is equal to
the amount of debt that GE will assume to buy Arden. The Arden portfolio
consists of 19.2 million sq. ft. of suburban office buildings located
across Los Angeles, San Diego and Orange County.
More than two-thirds of Arden's 2004 net operating income (NOI) was
derived from its Los Angeles properties. The Southern California office
market has been buoyed by strong job growth in recent years, and that
activity has helped cut office vacancy in markets such as Los Angeles to
below 10% , as of November, according to Grubb & Ellis.
Assuming that the Arden transaction closes, there will be just two major
office REITs with portfolios located entirely in Southern California.
They are Kilroy Realty Corp. and Maguire Properties, which own more than
20 million sq. ft. of office properties in and around the Los Angeles
market. Sullivan of Prudential believes that investor interest in both
Maguire and Kilroy is likely to heat up in 2006 given both REITs' focus
on the Southern California market and the absence of Arden.
And, aside from the enticing Southern California office market, he sees
other advantages to snapping up REITs, too: "The REITs offer sizable,
regionally-focused portfolios with seasoned regional leasing and
management teams," says Sullivan, who predicts that M&A activity will
continue to be strong in the first half of 2006. REITs with market
capitalizations under $3 billion and portfolios in strong markets will
be targets.
What does this portent for small public REITs? "As evidenced by the
pricing on the Arden transaction -- a 3% discount to the December 22
close -- we believe that current level of REIT multiples reflects the
acquisition potential and that REIT multiples should return closer to
historical multiples once demand from private investors for real estate
subsides." In other words, it's a good time to sell.
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Public
REITs Going Private
By Stan Luxenberg
During the early 1990s, private real estate companies with large
portfolios rushed to become public real estate investment trusts. Now
the pendulum has swung. In the past two years alone, eight public REITs
have sold to private investors.
Recent transactions include Gables Residential Trust, which was sold to
ING Clarion for $2.8 billion, and Prime Group Realty Trust, which went
to Lightstone Group for $900 million.
"The market moves through cycles. Sometimes it makes sense to go public,
but right now there are incentives to go private," says Mike Acton,
director of research for Boston-based AEW Capital Management, which
manages assets for major pension funds and other institutions.
Both buyers and sellers have compelling reasons to complete the deals.
Because of market conditions, some public REITs are having trouble
growing through acquisitions.
At a time when prices for quality properties routinely smash records,
REITs have limited ability to match the bids of aggressive private
buyers, which can use leverage of up to 100%. Public REITs have less
flexibility because shareholders often resist efforts to take on heavy
debt loads.
The challenge for REITs has become especially pronounced in the
apartment sector. In hot markets, developers are bidding aggressively to
buy apartments and convert them to condominiums. That has left public
apartment companies with little room to grow.
A REIT that acquires rental apartments may only be willing to accept a
capitalization rate -- or initial return on its investment -- of 7%,
says Timothy Welch, executive managing director of broker Cushman &
Wakefield. "There are plenty of condo converters who will pay much
higher prices and take cap rates of 5%," says Welch.
If property prices remain steep, as many analysts expect, then the
public REITs could face limited growth prospects for the next two or
three years. That could erode share prices. "If you expect your stock
price to go down, then it could be a good time to sell," says Richard
Imperiale, portfolio manager of Forward Uniplan Real Estate Fund.
Private buyers have been willing to pay a 20% premium for REIT stocks
with plans to aggressively cut costs. A middle-sized public REIT must
spend about $1 million a year meeting government rules and complying
with terms mandated by Sarbanes-Oxley legislation, says Welch of Cushman
& Wakefield. Those costs virtually disappear when the REIT goes private.
In addition, the owner of the merged company can save millions in
salaries through layoffs of non-essential employees.
Are the buyers paying too much? That's a relative question. In the
1990s, some acquirers of public REITs paid premiums of 30% or more.
Today, such high prices are considered excessive and likely to dilute
earnings of the acquirer.
In some cases, the public REITs are worth extra because they have
unusual portfolios, says Imperiale of Forward Uniplan Real Estate Fund.
For example, when DRA Advisors paid $3.4 billion for Capital Automotive
REIT, the buyer acquired 347 properties that included real estate used
mainly by the 100 largest auto dealers in the 50 biggest metro markets.
"These are trophy properties that are worth a premium," emphasizes
Imperiale. "You could work 10 years to build a comparable portfolio and
not be able to match the REIT's quality."
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Atlanta
Bets On Massive Development
By Walter Woods
While it's still too early to call Atlantic Station a smashing success,
the 138-acre mixed-use project located on the site of a former steel
mill in Midtown Atlanta is proving to be a strong performer on multiple
fronts: A 22-story office tower is 94% occupied, two condo projects are
sold out and another is 80% sold, and retail sales at Dillard's and
AnnTaylor Loft meet or exceed expectations. So far, Atlantic Station is
"coasting," says Jim Jacoby, the project's founder.
Still, some concerns persist about ambitious plans for as much as 6
million sq. ft. of office space to be built at Atlantic Station. Can
Atlanta's recovering Midtown office market, which is currently burdened
by an unhealthy vacancy rate of 15.5%, absorb a wave of new
construction? And will the residential component of the project run into
head-winds if a real estate bubble emerges, particularly in the condo
sector?
Wachovia anchors the newly built 22-story office tower, which is almost
fully occupied. Insurance giant and owner, AIG, put the tower up for
sale in September. A second, similarly sized office tower is already in
the works and waiting for tenants.
AIG plans a relatively aggressive development schedule for its new
offices, says Kevin Fitzpatrick, president of AIG Global Real Estate.
The company will keep "delivering supply as long as the market holds
up," he says.
The success of the first office building, however, was a surprise to
many in the Atlanta development community, says Bob Voyles, former
senior vice president of Hines in Atlanta, who is currently putting
together a competing mixed-use project in the same submarket. Atlantic
Station is located on the opposite side of Interstate 75 from the
traditional Atlanta CBD and its famed Peachtree Street. A new bridge
connects the project to the rest of the city.
"It's a big psychological change to move across the Interstate to a
project that's fairly avant guarde," says Voyles. But Atlantic Station's
managers are still bullish on their prospects for meeting market demand.
The city's office vacancy rate is improving from historic lows in recent
years -- the overall Atlanta vacancy rate is 18.2%, down from 19.4%
last year. What's more, the 15.5% vacancy rate in Atlantic Station's
submarket has dropped 10 percentage points in a year and a half, says
John Whitaker, CEO of Atlantic Station and AIG Atlanta point man.
But the complex is not without other, smaller challenges as well.
Atlantic Station was built above one of the country's largest parking
decks. Consumers can lose their way, and many big office tenants aren't
used to mixing employee parking with retail customers, Voyles says.
Voyles also questions whether the brisk retail business is due to the
novelty of the project, or if it has true staying power.
Developments like Atlantic Station are new to Atlanta, a community that
has historically thrived on big-box shopping centers, acre-lot
subdivisions and single-use office parks.
The mixed-use project has the region's only IKEA store, an 800,000 sq.
ft. retail village, more than 1,700 condos -- both mid-rise and
high-rise -- and an office tower.
The success of the residential condos is not exclusive to Atlantic
Station, however. Atlanta is enjoying a "condo phenomenon" of young
buyers seeking living spaces in lively, urban markets, says Marc
Pollack, president of Lane Co., which is building six multifamily
projects at Atlantic Station.
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Storms
Rattle South Florida Condo Boom
By Hortense Leon
The condo market in Miami-Dade County, which is bursting at the seams
with new construction and intense investor demand, took an unexpected
hit in October when Hurricane Wilma ripped through South Florida.
Already burdened by rising construction costs, developers now confront
the likelihood of further price hikes and shortages of both building
materials and labor.
Hurricane Wilma resulted in total insured losses of $7.2 billion,
reports the Insurance Information Institute. Those losses, coupled with
higher building costs, have made lenders increasingly reluctant to loan
money on condo projects. This latest blow could well be "the nail in the
coffin," says Jack Winston, senior consultant with Goodkin Consulting in
Miami.
With diminished building supplies, South Florida condos are beginning to
experience project delays. Before Wilma struck, Dan Whiteman, president
of Miami-based Coastal Construction Co., says that he waited three to
six months for deliveries of roof tiles. Now, he expects to receive roof
tiles in nine to 12 months.
PVC (polyvinylchloride) pipes are in particularly short supply, explains
Ken Simonson, chief economist at Associated General Contractors of
America. The raw material used to make PVC pipes is natural gas, but
Hurricane Rita knocked out about 10% of natural gas producing platforms
in the U.S. Those platforms were still offline as of early November, he
says.
Even before Wilma, prices for asphalt -- a pretroleum-based product
-- had jumped 15.1% over the previous 12 months ending in September.
Diesel fuel, which is used to operate construction equipment and trucks
delivering materials to building sites, jumped 50.9% during the same
period.
The biggest problem for condominium developers today is the availability
and cost of labor, says Winston of Goodkin Consulting. "Electricians,
carpenters, all kinds of skilled laborers are in short supply," he says.
Today, South Florida skilled tradesmen earn $17 to $24 an hour, says
Randy McDade of Mello Concrete Service Inc. -- 4% to 5% more than a
year ago.
It is only a matter of time before some proposed condo projects get
shelved, and some projects have already experienced delays, says Jack
McCabe, CEO of McCabe Research & Consulting. How big is the development
pipeline? In Miami-Dade County, as of early November there were slightly
less than 100,000 condominium units in the works, according to Integra
Realty Resources of South Florida. Of those, about 50% were proposed,
25% were in the approval process and 25% were under construction.
If there is a pullback in development, vulture funds -- buyers of
distressed assets -- will play a waiting game, says Winston. These
funds will only become active as buildings are completed and receive
certificates of occupancy, he says, and for a lot of condominiums that
day is still 18 to 24 months away.
Some banks have already cut back on their loans to condominium
developers in Miami-Dade. At Great Florida Bank in Miami Lakes,
executive vice president Vince Post says that the bank is very cautious
about lending to high-rise condominium developers in the county. "We are
mostly doing townhouse and mid-rise condominiums with a maximum of four
stories and about 40 units."
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One
Lethargic Office Recovery
By Parke M. Chapman
Despite falling vacancies and limited new construction,
the national office market is experiencing only a modest uptick in
rents. Landlords in tight markets like Washington, D.C. and New York
City are two notable exceptions to the rule.
Data from New York-based Reis shows that average effective rents
nationally increased by just 0.9% between mid-year and the end of
September when they hit $20.45 per sq. ft. And rents are still well
below the $27.35 per sq. ft. peak achieved in late 2001.
"The office recovery is moving slow and steady, but it doesn't look like
2006 will be the year that most office owners can significantly boost
rents," says Bob Bach, national director of market research at real
estate services firm Grubb & Ellis.
How can that be? One explanation behind the slow office recovery is the
rise in worker productivity since the recession. Also, corporate real
estate executives have become more adept at controlling occupancy costs.
The prospect of slower job growth, higher energy costs and rising
interest rates in 2006 could only compound the problem for landlords.
For the impasse between lower vacancy and flat rents to be broken,
leasing demand must increase -- and the only means to that end is
jobs. After expanding by 2.2 million jobs -- or 1.7% -- in 2005,
Economy.com expects employment to grow by 2%, or 2.6 million jobs in
2006. And roughly 700,000 new office-using jobs should be created this
year alone -- a gain of 2.5%. That percentage is expected to hit 3%
next year, too.
This low single-digit employment growth has helped buoy the office
market. Reis reports that 51 of 69 markets posted positive absorption in
the third quarter, down from 54 markets in the second quarter. This
activity helped cut the national vacancy rate to 15.1%, down from a peak
of 16.9% in early 2004.
Vacancy may still be high from a historical basis, but the chances of a
glut materializing next year are remote. Just 35.3 million sq. ft. of
fresh supply was completed in 2004, according to Torto Wheaton Research,
and that total represented a meager 3% of total inventory (refer to
chart at left).
One reason is soaring replacement costs. In October, for example,
Armstrong Suspension Systems increased its prices for ceilings by 4%
based on rising steel, fuel and transportation costs. And the cost of a
standard office suite build-out from shell space in Fort Lauderdale has
risen from $28 to $35 per sq. ft. between the end of October 2004 and
2005.
Bach of Grubb & Ellis also believes that higher construction costs will
continue to make it more difficult for developers to pencil out new
projects. The veteran researcher expects construction prices to rise
well above the underlying rate of inflation next year as the massive
reconstruction along the Gulf Coast accelerates through 2006.
If development is too expensive, of course, investors may continue to
bid up prices on existing properties. Through the end of September,
Manhattan-based real estate research firm Real Capital Analytics reports
that more than $70 billion of office properties changed hands. That was
roughly equal to the total sales volume in 2004.
"The disturbing news is that investors have built aggressive fundamental
gains into their thinking, and as a result are outrunning the recovery,"
says Lloyd Lynford, CEO of Reis.
Lynford believes that rising interest rates could dampen demand to buy
office assets in 2006. But improving fundamentals could generate
interest on their own as he believes that many investors will buy on the
basis of thinning vacancy and decent absorption. The only catch is that
not everyone will win by doing this.
"The reality is that most of the rents that landlords are signing today
are a dilution of previous rents from the late 1990s," says Lynford.
"And that suggests that all buildings simply will not benefit from this
recovery at the same pace."
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