By Dana Dubbs - Commercial Property News

San Francisco, CA, - March 16, 2002 - If top-quality office buildings are your game, keep an eye on Shorenstein Co. Its 22 million-square-foot portfolio is full of coveted Class A office buildings, including two recent acquisitions-the $250 million, 1 million-square-foot 500 W. Monroe St. office tower in Chicago's West Loop and the $160 million Washington Harbour, a five-acre mixed-use development in the Georgetown section of Washington, D.C. And the firm is planning to spend another $1.5 billion.

"In 2002, the capital is on the sidelines," said Doug Shorenstein, chairman & CEO of the real estate fund investment and management firm. "Historically, that's when we buy, and that's what we will be doing this year."

Shorenstein's growing presence in top-tier markets across the United States might come as a surprise to those who still think of the 330-person firm as a San Francisco developer. The company earned that reputation under the 23-year rule of Walter Shorenstein. Walter's passion for real estate led him to develop millions of square feet in downtown San Francisco and become the dominant Class A landlord in that powerful investment market.

Walter passed the reins of the family-owned business to his son Doug in 1983. The younger Shorenstein focused not on developing buildings but on acquiring and managing them.

"I hate development," said Shorenstein. "Development, historically and generally speaking, is the most efficient way of losing your shirt in the real estate business. We will develop a building, however, when we feel we can take a lot of the development risk out of the deal. The only deals we've developed in the last several years are situations where we bought an existing complex that has come with sites that we attach no value to going into the deal, and then a market emerged or a tenant had grown within that complex that we could build a building for." Thus, Shorenstein is building a 472,000-square-foot office building in the City Center complex in Oakland, Calif., its only major project currently under construction. The new building, scheduled for completion next month, is the first of several to be developed in that complex, which Shorenstein bought six years ago. The company is also working through the approval process to construct office buildings on the last two undeveloped sites in the heart of San Francisco's Financial District.

While those projects are close to home, Doug Shorenstein, unlike his father, chose to look nationally for assets. "The Bay Area is a great market, but it's only so big," he said. "We really go where the interesting opportunities are at any point in time."

Shorenstein's investment timing kept it quiet during the high-priced period from 1986 until the early '90s, focusing instead on taking care of its existing portfolio and providing third-party management services for similar buildings. The company jumped back into the game in 1992 while the industry was still suffering through one of its worst downturns ever. It launched its first investment fund and started buying high-quality assets from coast to coast.

In 1993, Shorenstein acquired a 2 million-square-foot portfolio from Beta West that included properties in San Francisco, Denver, Phoenix and Omaha. During 1995 and 1996, it acquired 3.7 million square feet, including properties in Waltham, Mass.; Charlotte, N.C.; Nashville; Miami; and Garden City, N.Y. Under Doug Shorenstein's leadership, the firm's portfolio has grown from 8 million square feet to its current 22 million square feet in 14 markets with an estimated value of $5 billion.

Shorenstein currently has six funds. The first five are fully invested and range in size from $100 million to $281.5 million. The sixth fund closed last summer with $609 million of equity. The Monroe Street tower was the first deal made through that fund.

It also continues to own assets developed or acquired in Walter Shorenstein's day, owning them individually or in partnership with one of a few institutional investors. Among the trophies are the John Hancock Center and Prudential Plaza in Chicago, Bank of America Center in San Francisco, First Union Financial Center in Miami and Bay Colony Corporate Center in suburban Boston.

Shorenstein has pursued the same investment strategy for more than 40 years and has no intention of changing. "We buy Class A, high-quality office," said Shorenstein. Those assets are significantly pre-leased to ensure cash flow. And it times its transactions carefully. "We buy at points in time when the capital is out of the market, and we sell when the capital overvalues the real estate fundamentals. We look for value-added assets-quality assets that have some real estate component that we can fix with our management, leasing and construction expertise."

At the Hancock building, for example, it updated antenna technology on the roof, enabling it to turn short-term leases with major broadcast companies into long-term leases, resulting in greater cash flow. When it bought Energy Centre in parking-strapped New Orleans, it also acquired a parcel next door to add a garage and make the property even more attractive to tenants.

Because the fund format allows Shorenstein to keep a significant amount of capital on tap, with total discretion, it can move quickly when an opportunity arises. Cases in point: John Hancock Center and Bank of America Center each closed within three weeks.

Shorenstein's modus operandi is to establish a new fund when the current one is 60 to 70 percent invested. It targets an amount of capital it should be able to invest within two to three years. Leverage is typically 60 percent, so it can fund as much as $1.5 billion worth of investments through the sixth fund. Funds are set up for 10-year holds, plus five one-year extensions, though assets may be sold within that time frame.

It has relationships with U.S. and foreign lenders such as FleetBoston and Germany's Deutsche Bank, borrowing on a non-recourse basis, asset by asset, with each investment structured as a stand-alone entity through a limited partnership or limited liability company. It does not commingle assets between funds, and it maintains separate accounts for each investor.

The company is currently looking for opportunities in Washington, Chicago, Boston, New York City, San Francisco and Southern California. It sticks to the United States because management feels that is where it has the expertise needed to operate at a competitive advantage.

The Right Investor

To play in Shorenstein's world requires a minimum investment of $10 million. The company always puts a large amount of its own cash into each fund-usually 10 to 15 percent of the total. For its sixth fund, it committed $75 million.

Said CFO Rich Chicotel: "Doug and I watch (revenues and costs) every single month so that we know when the seventh fund comes, he will have the cash to make that statement to investors: 'I have a huge chunk of my net worth in this thing.' "

The firm has cultivated a small group of investors, including college endowments, private foundations, pension funds and wealthy individuals. Investors have been happy with the fund format, strategy and returns, and they return to invest in each new fund, precluding Shorenstein's need to use placement agents to raise capital for them.

Although Shorenstein is not currently in fund-raising mode, Chicotel plans to spend more time this year courting foreign capital and pension funds, something the company has not done before. He wants to use this time to introduce the firm to select investors and get them thinking Shorenstein.

Chicotel, who has been with the company since 1988 and started its asset management function, described Doug Shorenstein as a hands-on CEO with his dad's gift for staying on top of important issues. He also called Shorenstein a prudent investor-someone careful enough to take appropriate risk, who is focused on liquidity and willing to sell buildings in order to raise cash.

"Our strategy is wealth preservation, not necessarily wealth creation," said Shorenstein. "We underwrite assets to provide a very durable income stream through the leases and cash flow that come off the properties on a monthly basis. Historically, that's been in the 10 percent distributed cash-flow range. Then there's the real estate residual, which you see when you sell the asset. Historically, that's added another five to 10 percent."

Shorenstein's pre-fund properties are the foundation on which the empire is built. "There's more Shorenstein capital in the pre-fund properties than in the fund properties," said Tom Hart, executive vice president and caretaker of those family jewels. "And because the pre-fund properties are located primarily in San Francisco, they are more valuable. We have larger amounts of equity in each of those properties than in the fund properties. It's the cash flow from those properties that allows Shorenstein to be able to continue its participation in larger and larger funds."

Shorenstein harvested some of that capital when it sold 50 percent of the prestigious One California St. to Ohio State Teachers Retirement System in 1996 and then another 40 percent in 1999. "We sold 50 Fremont St. just two years ago and made some significant returns," noted Hart, who recently celebrated 20 years with the company. "That was a fully mature building. It was fully leased up for some period to come, and there was very little more we could do to spiff that building to higher returns."

Repositioning for Success

Shorenstein Co. traces its roots to real estate brokerage firm Milton Meyer & Co., founded in 1924. Walter Shorenstein joined Milton Meyer as a leasing agent in 1946, was named partner in 1951, and became owner and president in 1960. Walter ruled. He oversaw every detail of the business and could do everyone's job for them. He could also walk every single one of his assets within a relatively short time, largely because the assets were concentrated in downtown San Francisco.

"If you listen to our employees, Walter walked two or three buildings at a time," said Glenn Shannon, president. "We have sightings that, in a metaphysical sense, weren't possible."

Renamed Shorenstein Co. by Doug in 1990, the business grew rapidly during the eight years after its first fund was launched. People were running fast, taking advantage of positive market conditions and trying to make decisions in cities where Shorenstein lacked an infrastructure or presence. By 2000, it was time to put the house in order.

"It works very well for a while to draft the best athletes and have them run all over the field while you explore your opportunities and build a platform," said Shannon. "But at some point, those things need to be well attended to." Shannon was heading the firm's New York City office when he was tapped for the new position of president and challenged to take the firm to its next level of maturation.

"When my father ran the company, it was an absolute, flat organization and everybody reported to him," said Shorenstein. "That is more of a historical, real estate family-based structure. As we have grown, we have had to organize the company such that we're efficient and act like any other well-managed business."

Shannon, who has been with Shorenstein since 1994, aimed to maintain the company's entrepreneurial spirit but within a more focused, more team-oriented environment. He moved people into positions where they could add the most value to the organization, and implemented greater coordination and communication across functions. He created two investment manager positions, reallocated the financial portions of property management to the CFO and filled the vacant capital transaction manager slot with two people. (The second one, Bob Underhill, joined on March 5.) Strategy, best practices, national standards and efficiency became the new keywords. Success became less about highest occupancy and greatest velocity in leasing and more about producing quality investment results.

"The efficiencies come from our people sorting through all the things they could spend their time on every day and then spending time on the ones that are really related to our business thesis," said Shannon. "People come in and spend their time on the things that plug into our strategy, whether it's operating, financial, asset management or investment management."

As national director of leasing, Charlie Malet spends far less of his time transacting and a lot more time looking at ways to deliver a consistent, high-quality, strategic leasing program throughout the United States. "We're doing much more than filling vacant space. We're looking at the rollover profile of the building and trying to stagger large tenants and lease terms so that we never have 60 percent of the building rolling at once, which would make it difficult to sell or finance," he explained. To ensure leasing agents are focused on that strategy, they are Shorenstein employees with at least 10 years in the business, compensated with salary, not commission. Outside brokers are used only in smaller locations where retaining in-house agents does not make financial sense.

Likewise, Stan Roualdes, who has been with Shorenstein since 1988 and is head of property management and construction, pays less attention these days to which buildings have what systems going in and more to what programs and standards are needed to run properties efficiently and cost-effectively.

In order to maintain coordination, control and oversight of its activities on a national basis while still being able to execute effectively on a local basis, Shorenstein's organizational structure has coalesced around a strong leader of each functional group at San Francisco headquarters, backed by strong regional support. The New York City regional office was established in 1990 when Shorenstein started providing third-party management services to MetLife. The Chicago office was established in 1998 when Shorenstein bought John Hancock Center, its first building in that market. Because Shorenstein is interested in very large and prominent assets rather than unique, off-market deals, it is comfortable with its ability to track markets from the three offices and has no plans to open additional regional offices at this time.

Investments are divided into fund and pre-fund, each with its own manager. Tom Hart, a 20-year veteran of the company, serves as investment manager for the pre-fund basket, with strong support from Jim Christian, who has been with the company since 1996. Susie Baker, who joined Shorenstein in 1993 and is based in New York City, rides herd over the fund investments. Each asset is managed by a team.

Late last year, Shorenstein decided to quit the third-party management business in order to concentrate its resources and achieve greater efficiencies, although it continues to take care of its own assets through Shorenstein Realty Services, a wholly owned, property services affiliate.

The Walter era of property management, characterized by tremendous attention to detail, still holds fast today, and it has helped keep the vacancy rate averaging 4 percent even in the current soured economy. "We're always walking our buildings," said Roualdes. "People want to come into a clean, attractive building. It doesn't matter if you're the leasing person or a construction person. If you're walking around and see something on the ground, you bend over and pick it up.

"Our mantra has always been that once you move into a Shorenstein building, you stay in a Shorenstein building," added Roualdes. "And if you relocate to another city, you look for a Shorenstein building. We try to provide that same, consistent quality and level of service in our buildings 24 hours a day, seven days a week, every year, so when people come to the marketplace, they know what they can expect from us."

"They are excellent landlords," said Tim Mason, senior director at San Francisco-based real estate advisory and brokerage firm Whitney Cressman Ltd. "They lease space, improve it in a way that tenants want it done, and have very, very efficient, well-run, well-managed buildings. They do the whole soup-to-nuts thing. They are very, very jealous of the relationships they've established with their tenants. They hate it when tenants leave their buildings. They want to make tenants comfortable and happy, so the tenants will want to stay and re-up in their space."

Shorenstein is not interested in growth for growth's sake but for sustainability. "We've been around for a long time," said Doug. "Knock on wood, we've never in the history of the company defaulted on debt or given properties back. We've tried to set ourselves up to survive for a long period of time."

And Walter? He's nearly 87 and very involved in philanthropic causes and Democratic politics. He still goes into the office regularly and still makes unannounced visits to his buildings.

"Walter's not retired," said Shannon. "He's around, doing the counseling, the guidance and rabble-rousing as appropriate. And it's great."