By Peter Grant - RealEstateJournal.com

- November 28, 2001 - San Francisco developer Douglas Shorenstein is a man of his word. Last year, he predicted he would step up his pace of acquisitions using funds he raised from institutional investors. Since then he has acquired Chicago's Prudential Plaza and Washington Harbour, a five-acre mixed-used development in the Georgetown section of Washington, D.C. Last week he reached a tentative deal to purchase 500 West Monroe St. in Chicago and was one of the finalists in the competition for 450 Lexington Ave. in Manhattan. His success at landing trophy properties is even more remarkable, given the sharp decline in sales activity in the rest of the market since Sept. 11.

Why has Mr. Shorenstein moved to the front of the pack? It's not because there aren't other willing buyers out there. Opportunity funds, real-estate investment trusts, pension funds and foreign investors have all targeted commercial real estate as a relatively attractive investment, especially the kind of trophy downtown office property that Mr. Shorenstein has been buying. "Real estate is a pretty good alternative considering what equity markets have been doing," says Paul Lundstedt, executive director of Cushman & Wakefield Inc.'s Chicago office.

But many of the investors that have been lured to real estate are expecting significant discounts reflecting the uncertain economic times and declining rent rolls. Sales volume is down largely because sellers have been unwilling to cut their prices to meet these expectations. While prices of trophy office buildings clearly are below their peaks, they are still not low enough to ease the fear that many investors have that values and rent rolls will drop further.

Mr. Shorenstein has emerged as one of the biggest buyers of trophy property these days partly because his long-term investment strategy has been less altered by the economic hard times than those of his competitors. He has continued to focus on what has worked well for him and his investors for the past decade: buying top-tier office buildings in major cities that he can add value to by increasing their cash flows. This strategy meant that in the late 1990s, when prices reached record levels, Mr. Shorenstein bought very little. When prices began to fall about 18 months ago, he began to see more opportunities. He's buying now because he can pick up trophy properties that he can improve at what he considers good prices. The possibility that the overall market might fall further in the next 12 months seems to mean less to him than it does to his competitors, experts say.



"When I buy, my decision is simple: Are rents going to be higher or lower one year from now? If rents are going to be lower, I'm not going to buy. I want to be able to get out quickly and easily," says a senior executive with one of the leading opportunity funds. "But Shorenstein is more of a value buyer. If a building is well-located and has good rents and he can get it for a certain number, he'll buy it even if he and his investors have to go through a period of prolonged softness."

Over the years, this strategy has worked well for Mr. Shorenstein as he expanded the San Francisco development business that his father built into a giant investment company with national scope. He did this starting in the early 1990s when the real-estate industry was in its worst downturn since World War II. He raised his first fund and began buying well-located, top-tier property at prices that were well below what it would cost to replace them. The foundations, college endowments, pension funds and other institutional investors have been pleased with their returns and most of them have reinvested money in subsequent funds. In August, Mr. Shorenstein announced the closing of his sixth fund, which has $600 million in equity, $75 million contributed by Shorenstein Co.

"This is a very good example of the younger generation of a real-estate family taking a very significant portfolio and expanding upon it and diversifying," says Hal Ellis, a well-known developer in the San Francisco Bay area for the past 40 years.

This strategy has worked partly because prices steadily appreciated throughout the 1990s. Mr. Shorenstein also was successful at improving the cash flow of his properties. For example, in 1998 one of his funds acquired Chicago's John Hancock Building, one of the city's most famous properties. He was able to increase the cash flow partly by updating the telecommunications technology on the roof. The result: Radio and television stations were willing to pay much more to use its antennas.

"One of the key reasons he's been successful is that he's surrounded himself with some very smart people who know how to enhance cash flow and run things more efficiently," says Paul Muratore, who worked for Shorenstein for seven years and is now a broker with Insignia/ESG's New York office.

The big question of course is whether his strategy will continue to work in the midst of a recession. A number of real-estate experts expressed surprise that Mr. Shorenstein agreed to pay $250 million for 500 West Monroe in Chicago. While that's $20 million below the asking price, it's still considered to be a bet that net rents in Chicago will rise to over $30 a square foot by the time the major leases in the building start expiring about five years from now. Net rents today are in the low $20-a-square-foot range.

Mr. Shorenstein declined to comment on the 500 West Monroe deal. But experts who have watched his career note that if he closes on the property, his Chicago portfolio will become more geographically balanced. They also point out that he tends to use low leverage in his deals, which would help insulate his investments from any short-term market downturn. "He has a relatively conservative strategy," Mr. Ellis says. "They invest in sectors they know and understand and they have reason to believe in good, long-term markets."