- May 14, 2001 - When the economy sinks and vacancy fears rise, the smart money heads for the safety of trophy skyscrapers. How to join in.
In the early 1990s millions were lost on New York's Rockefeller Center, a supposedly unsinkable office complex. The iconic property fell into bankruptcy despite continued strong tenant appeal. Home to such sturdy attractions as Radio City Music Hall and the Today show, the 6.2 million-square-foot property had a 6% vacancy rate at a time when midtown Manhattan suffered triple that overall.
In fact Rock Center's problem stemmed from its very allure: A bedazzled Mitsubishi Estate took on too much debt in 1989 to buy a controlling interest in the place, which even its solid rent rolls couldn't service.
Without the ill-advised leverage, Rockefeller Center would have done fine during the last economic slowdown.
Trophy holdings are the most resilient in tough climates-a point investors might keep in mind as the economy softens and office-space demand with it. The trophy quotient is something shareholders in real estate companies should home in on. We've listed five prominent real estate companies with significant trophy positions, which should be good ballast in a recession and should do very well once the outlook brightens, (see table below).
A Bevy of the Best Addresses
These real estate companies, whose stocks are down a bit or flat this year, own big amounts of trophy office space. That will help in hard times and boost them when things get better.
No matter what, companies want to lease space in Chicago's Sears Tower, San Francisco's Embarcadero Center and Boston's Prudential Center. Magnate Mortimer Zuckerman, whose Boston Properties owns Embarcadero and Pru Center, likens a trophy tower to a consumer-product brand name with marketing magic. Top-notch tenants will pay higher prices for it.
The Deloitte & Touche accounting firm, for instance, rents several floors of lower Manhattan's World Financial Center when it certainly could find cheaper space elsewhere. Space in the riverfront office palace now goes for $59 a foot annually, versus $50 and less in nearby buildings. "There's no better property for recruiting and retaining our employees" than the WFC, says Steven Silverstein, head of real estate for Deloitte.
How can you tell what's a trophy? "Trophy buildings are the ones the out-of-towners have heard of," says James Sullivan, senior analyst at Green Street Advisors, the real estate research outfit. They're the standouts
among an area's so-called Class A buildings-which are the shiniest and best-appointed addresses making up around 20% of the local office inventory. The trophies' distinguishing mark is fame.
In recessions trophies will lower their rents somewhat when leases come up for renewal or for new tenants. "Even Mercedes has to offer rebates when car sales slow down," says Jacque Ducharme, head of the Julien J. Studley office brokerage. In the early 1990s' real estate crash, Rockefeller Center lowered rates from $40 per square foot to the low $30s.
Still, leases (usually for ten years) don't tend to expire all at once. And given trophies' characteristically deep-pocketed tenants, few bounce the rent check in a downturn and get forced out for nonpayment. "These buildings are much less prone to falling during hard times," says Zuckerman, "and much quicker to rise when times are good."
While the current economic slowdown hasn't yet affected office real estate in a big way, the vacancy contrasts between trophies and other properties are vivid. "In this business vacancies are everything," says Douglas
Shorenstein, who with his father, Walter, owns several trophies privately. Office vacancies in the Chicago Loop generally are running at 13%, while the Class A rate is 7.2% and the Sears Tower's just 3%, according to
Insignia/ESG and Cushman & Wakefield. The story is the same in lower Manhattan, with its 5.1% overall rate, 2.7% for Class A and 0.7% for the World Financial Center. In San Francisco the numbers are 6.5% in toto, 5.4%
for Class A and 1.4% for the Embarcadero Center.
A comfort for investors is that the office market shouldn't take as big a hit as it did a decade ago. Most landlords have avoided crippling debt. And developers have been reined in: Since 1997 only 300 million square feet of
new office space has gone up nationwide, helping hold vacancies below 10%, says CIBC World Markets. Contrast that to the late 1980s when 723 million square feet of offices went up in five years, and vacancies languished at
18% to 20%.
Finally big publicly traded companies, many of them real estate investment trusts, have come to own more and more trophy properties. Unlike the foreign buyers and tax-dodge-happy syndicates of the 1980s, today's landlords are watched hawkishly by analysts, portfolio managers and directors.
Historically, marquee office properties are owned by private investors or institutions, as with Rockefeller Center. Still there are now a wealth of opportunities for the public to own them. Most on our list are trading at
prices below the companies' net asset values. This year the National Association of REITs office index is down by 6%, as Wall Street anticipates a slump that will hurt rent rolls; that is almost identical to the S&P 500's 2001 losses. Last year the office index enjoyed a 35% rise while the S&P fell 9%. Some high-class landlords-like Toronto's TrizecHahn-are not REITs but trade publicly.
Trizec owns the Sears Tower. Like Rockefeller Center, the 3.5-million-square-foot, 110-story Chicago landmark had its headaches a decade ago-although not just from overleverage.Sears, Roebuck abandoned it
for less expensive quarters in the suburbs after 1990, meaning the building had to fill lots of empty space during a recession. Its market value fell from $850 million to $450 million. Today the Sears Tower is worth more than
$850 million again; it accounts for roughly 10% of TrizecHahn's assets. The company also boasts trophies like Houston's Allen Center.
An unusual opportunity is embedded in TrizecHahn's stock, says Green Street Advisors. The shares are trading at $15, giving the company a stock market value of $2.3 billion, a 33% discount to the company's $3.3 billion in net assets (arrived at by subtracting TrizecHahn's $5.4 billion in debt and liabilities from the $8.7 billion estimated liquidation value of its properties). The discount on TrizecHahn's stock is only partly warranted.
The company had been investing in offbeat properties like eastern European shopping malls and Hollywood entertainment complexes. But this year Chairman Peter Munk has hired a new chief executive, General Electric veteran Christopher Mackenzie, to return the company to its office roots. "We've been distracted," says Mackenzie.
The stock, with a 2.3% dividend yield, is priced at an affordable 12 times its $1.27 a share in funds from operations (earnings before depreciation but after needed capital expenditure). Mackenzie says by 2003 his FFO will rise above $2.50 a share.
Boston Properties, a REIT run by publisher and pundit Zuckerman and longtime partner Edward Linde, scooped up its two best-known holdings-Boston's Pru Center with 2.1 million square feet and a 52-story main tower, and San Francisco's 3.9-million-square-foot Embarcadero Center-in the 1990s. Boston Properties' FFO will climb from an estimated $3.04 a share this year to $3.46 in 2002, according to Green Street. The reit's $38 stock, with a 5.6% yield, is at an 8% discount to its $41-a-share net asset value.
Toronto-based Brookfield Properties, in addition to New York's WFC, has Denver's Republic Plaza and Toronto's BCE Place; together they account for a third of the 35 million square feet of office space it controls. If you're looking for a pure possible play on name properties, this $17 stock, traded in New York and Toronto, comes closest. Yield: a modest 1.6%, because it isn't a REIT.
Brookfield's strategy is simple enough. "Buy nothing but the most advanced, well-located properties with the best access to transportation," says Chief Executive Bruce Flatt. Brookfield is not a growth stock; it has turned down
legions of chances to buy lesser skyscrapers that could pad rent income. Yet its FFO has risen quicker than those of more acquisitive reits wanting commodity-type office space.
Brookfield is the happy recipient of first-rate properties cast off from the early 1990s' biggest casualty, the Reichmann family's Olympia & York empire. Richard Clark, Brookfield's U.S. chief, is a former Reichmann lieutenant. The sweet part is Brookfield inherited O&Y's tax-loss credits, which should
last it through 2006. It trades at eight times the likely 2001 FFO.
Chicagoan Samuel Zell's Equity Office Properties Trust has the lowest trophy exposure (5%) on our list. That should improve. While Zell specializes in nonritzy buildings, he has tried to move more into trophies, bidding
(unsuccessfully) for Pru Center and San Francisco's Bank of America Tower. Pricey, but they're worth the money.
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