Andrew Neilly
Gallen.Neilly & Associates
PH: 925/930-9848

By Lizette Wilson - San Francisco Business Times

October 22, 2004 - Shorenstein Company may have left its heart in San Francisco, but it's putting much of its money someplace else.

Following the sale of four San Francisco properties over the past five months for $1.2 billion, the privately held real estate firm has carved its city assets from 5.5 million square feet to 2.5 million square feet.

The San Francisco-based company is no longer the biggest owner of commercial buildings here -- nor is it necessarily eager to reclaim the title.

"We've evolved as an organization from a local company in San Francisco to an investment company focused nationwide," said Chairman and CEO Douglas Shorenstein. "We have more square footage in Chicago and New York than we do in San Francisco."

Looking around the Shorenstein lobby on the 49th floor of the Bank of America building, signs point to that transition. Glossy coffee table books detail architecture and history in Chicago and Miami. Framed photographs lining the walls include buildings Shorenstein owns in New York, Boston, Philadelphia and Sacramento -- landmarks in the firm's total portfolio of 28 assets and 14 million square feet of commercial space across the country.

If San Francisco is less of a force in Shorenstein's portfolio, so too is Shorenstein in San Francisco. With Shorenstein's recent sales, property owners Hines, Equity Office Properties and Boston Properties easily eclipse the home town company's San Francisco holdings with 6.1 million square feet, 5.9 million square feet and 3.9 million square feet, respectively.

The deal to relinquish its interest in the Bank of America building has barely concluded and already the Shorenstein name on the trophy tower is fading, with the "S" and "R" missing from the gold colored stencil on the main door.

The legacy
When Walter Shorenstein took ownership of the company in 1960, he focused on developing new properties and investing in existing ones, like the historic Russ Building, which Shorenstein still owns today. The company grew through such acquisitions, working with the same handful of investors, holding properties and managing and maintaining them for the long term. Almost all of these so-called "legacy" assets were in San Francisco. In 1992, nine years after joining his father's business, Douglas Shorenstein formalized a different course for the company's future. The firm raised its first fund -- a $160 million in equity -- from college endowments like Yale, large foundations and high net worth individuals. It has repeated the strategy every few years since then, raising $775 million in its seventh fund in February. All told, the funds have acquired and developed more than $2.8 billion in assets.

Acting much like a venture capitalist would, Shorenstein puts roughly 10 percent of its own cash into each fund, which buys buildings or provides capital to other real estate investors. Shorenstein then sells its properties, or its interests in them, when the numbers pencil, earning not only its share of the returns but also incentive compensation based on the fund's performance.

The funds mean a couple of things. First, they give Shorenstein total control over decisions, enabling the company to buy or sell quickly. Shorenstein is the sole general partner and doesn't need to get approval from other investors. Once Shorenstein has raised the fund, it calls the shots.

"In my father's era, he had the same four or five joint venture partners for 30 to 40 years. He had great relationships and we still have good relationships with them. But everybody was a co-general partner," he said. "You're dealing with different agendas. I'm not saying they're the wrong agendas -- they're just different strategies, different horizons. With the fund format, there's just one strategy."

Besides autonomy and the quick execution that it enables, the fund structure has allowed Shorenstein to diversify risk.

Shorenstein's sweet spot? Class A commercial buildings in six metro areas: New York, Washington, D.C., Boston, Chicago, Los Angeles and San Francisco. "What I'm doing is investing the same amount of money in real estate that we have always done. I'm just moving it from the legacy platform to the fund platform," he said. "I weigh San Francisco the same way I weigh those other markets. Since most of our legacy assets have been in San Francisco, most of our sales have been here."

Sweat equity
Indeed, having rapidly unloaded its holdings in Hills Plaza, 425 Market St., 333 Market St. and most recently the Bank of America building at 555 California St., Shorenstein has fueled much of the white hot commercial sales market this year. Not including 555 California, downtown building sales this year tally 35 and are tracking now to beat the all-time historic dollar high set in 2000 of $2.4 billion.

So why hasn't Shorenstein been among the buyers and re-invested in San Francisco? It tried.

Shorenstein was among the 20 bidders going after the Cousins/Myers buildings at 55 and 101 Second St., but Hines snagged the pair with a $290 million highball. Shorenstein is known for its property leasing and maintenance expertise, so the company prefers to bid on the low side, going after buildings that can benefit from the company's sweat equity. Now, with $750 million from the seventh fund plus its share from the recent sale proceeds, Shorenstein says: "We're sitting in cash."

A smile plays at the corner of his mouth when he says it, but that disappears when he begins talking about the tough work ahead.

Finding and sealing the right deal -- one that's in a stable market, but can be sold later for a decent return -- is challenging these days. Money is cheap, inflation is low and a 90:10 debt-to-investment ratio on commercial buildings is not uncommon. Those factors, along with a gush of money from investors still sour on the stock market, has made real estate the "gotta have it" investment of 2004.

"Clearly, right now there is more capital chasing fewer opportunities than we've seen in recent history. That's evidenced with the pricing level for prime real estate," said Jim Buie, executive vice president at Hines. "Shorenstein has done an excellent job of timing the market. They've come in when it was low and taken the money off the table when the values were high. I have great respect for Doug -- he's a very savvy investor."

Along with finding good product, Shorenstein says his biggest challenge is running what has evolved into a 250-person organization managing properties and investing across the nation.

"My father used to run all these buildings just by walking in them every day and we can no longer do that," he said. "In the past, we just had a bunch of entrepreneurs running all over the place who did not want to be managed. We have a very strong management team today, and I underline team. We have spent a huge amount of sweat building an investment platform. We are there now, and our funds are large enough and we can attract the capital we need. The fund format is our present and our future. The legacy format is our past."

Lizette Wilson covers real estate for the San Francisco Business Times.