Fall 2000
	Cover Story Doing the REIT Thing Western Properties’ Brad Blake and Bradley’s Tom D’Arcy put their shareholders first. Now they’re looking for work. Company Spotlight Failure to Communicate The "REIT Story" is a good one. Unfortunately, many companies haven’t done as good a job as they should have in telling it. Sector Spotlight Critical Conditions Opportunities among the healthcare REITs, but be careful out there. The New Economy Plugged In Making Money in the Internet Age Tracking The Market Bye, Bye Bear Market Blues After two of the worst years in their 40-year history, REITs have staged a strong comeback. By The Numbers Much Better, Thank You Real estate fund managers may never live down the 1998-99 bear market, but at least these days they can go out in public. Washington Wire Legislative Relief No legislation in the roughly 40-year history of REITs had the potential to alter the landscape more dramatically than the recently enacted REIT Modernization Act. Investment Basics Just How Safe Are REIT Dividends, REALLY? Yield-conscious investors drawn to REITs by their "rich" yields need to look beyond what’s printed in the stock tables of their daily newspapers. Investment Insight Opposites Attract It didn’t come as a surprise to portfolio managers at LaSalle Investment Management that REITs soared when tech stocks hit the wall this past spring. Investment Fundamentals NAV Growth: A Meaningful Performance Yardstick Growing FFO and enhancing shareholder value are not always one and the same. Focusing on NAV growth is a better, though not perfect, alternative suggests Green Street’s Mike Kirby and Jon Fosheim. Editor's Note The Journey Continues ... Parting Shot Wrestling With Net Asset Value The Penobscot Group’s Frederick S. Carr Jr. questions whether the market is telling investors that NAV is irrelevant. Newsline Urban To Be Acquired By Rodamco For $3.4 Billion Investor's Guide Questions Back Issues Feedback

by Lee Schalop, Alexis Hughes, Dimitri Gavriel, and Josh Paradise
Illustration by Marc Mongeau

We see the increasing convergence of technology and real estate as providing money-making opportunities for real estate stocks. We envision two ways that technology could positively affect real estate stocks: first, by increasing revenue, primarily through selling new services like telecommunications, and second, by lowering costs, either through operating efficiencies or by altering the ways real estate companies operate. Both areas are interesting, but new services offer more than just increased cash flow; they also offer real estate companies the opportunity to take advantage of the higher multiples awarded to tech-related companies.

The multiple differentiation is key because near-term revenues from ancillary services are small and profits are smaller or nonexistent. In fact, until recently we were not very excited about opportunities to generate ancillary revenues because small changes in same store net operating income (NOI) had a much more dramatic impact on cash flow than large changes in ancillary revenues. This assumed, however, that real estate cash flow and technology-related cash flow would be valued similarly. This hasn’t been the case.

One example of multiple differentiation is Frontline Capital, formerly Reckson Services-an Internet-related operating company that identifies, acquires, invests in, and develops business-to-business e-commerce and e-services companies-that was spun off from Reckson Associates in June 1998. At the time of the spinoff, Frontline’s equity market cap of $82 million was a fraction of the then $950 million equity market cap of its former parent. As of mid-January of this year, the equity market cap of Frontline had climbed to $1.4 billion, exceeding the then-current $1 billion equity market cap of Reckson Associates even though Frontline generates annual losses of about $45 million and Reckson Associates generates an annual cash flow of about $160 million. (Like other Internet-related companies, Frontline’s stock price plunged following the Nasdaq’s April meltdown.)

We see similar opportunities from a number of companies that have begun to create technologically related adjunct businesses using their existing portfolio as leverage. We are most excited about Equity Office Access, the subsidiary of Equity Office Properties.

Selling Ancillary Services
We are excited about opportunities to generate ancillary revenues for two reasons. First, as a result of recent regulatory changes, primarily the REIT Modernization Act [see "Legislative Relief" on page 51] that was signed into law in December 1999, real estate companies now have significantly more opportunity to earn ancillary revenue without forfeiting REIT status. Second, because a number of the ancillary services are likely to be technology-related, there is the opportunity for the technology-related cash flow generated by real estate companies to be valued at the higher multiples awarded to other tech-related companies.

There are a number of opportunities for real estate companies to generate revenues through additional services. For apartment owners, there are services like cable and telephone, which can be purchased wholesale and then resold at a markup to tenants. For office and industrial building owners, there are services like telecommunications, advertising, office suites, cleaning, and temporary help, among others. These services also can be purchased wholesale and then resold at a markup to tenants; however, most office and industrial building owners prefer to allow a third-party provider direct access to their tenants in return for a share of the revenues.

For retail owners, there are also a large variety of services that can be sold to tenants; however, there is the additional opportunity to integrate the power of dominant retailers, retail portfolios, and the Internet to garner an increased portion of consumers’ shopping dollars.

Shining Example
During 1999 Equity Office Properties created a subsidiary called Equity Office Access to generate additional revenues for the company by providing its tenants with business products, services, and conveniences. In our view, the revenue-generating opportunities for Equity Office Access are significant because of the size of Equity Office Properties.

However, we believe the real upside for Equity Office Properties is in the potential value creation if the business is spun off. Among the services currently offered by Equity Office Access are telecommunications, instant office suites, advertising venues, and business motivational services.

In addition, a number of companies are using an intranet-based system for all aspects of their operations, including asset management, marketing, training, human resources, and financial services. One example is Jvelon (formerly Project Javalon), a "resident management system" software that is being developed jointly by AvalonBay Communities, United Dominion Realty Trust, and Post Properties.

AvalonBay, United Dominion, and Post expect the Internet-based system to result in $3 to $4 million of annual savings for each company following its rollout later this year. In addition, Jvelon has the opportunity to generate revenues through sales of the software. Total development costs are estimated at $7.5 million, and the companies have already received inquiries from a number of other real estate companies to purchase the software. In a scenario management called "reasonable and conservative," the companies could sell the software to 10 percent of the apartment communities with 50+ units in the United States (roughly 6,000 communities) by 2003, which would generate annual revenues of $20 million.

Growth in Demand for Telecommunication Services

According to J.P. Morgan’s Broadband and IP Data Services analyst Mark Langner, the consumption of data-based on IP standards and broadband in nature-will be the centerpiece in the creation of the next wave of growth in technology. He believes bandwidth consumption will become the prime mover of an increasingly technology-driven economy. The Commerce Department has estimated that by 1997 information technology already accounted for 25 percent of real economic growth in the United States, and that efficiencies associated with that technology trimmed 1 percent off the annual inflation rate (roughly a 30 percent reduction)-even though the majority of U.S. businesses had (and still have) yet to implement the broadband and IP data services that will drive much of that efficiency. Langner sees demand for connectivity to the Internet growing as businesses are realizing the Internet can significantly enhance communications among offices and employees as well as with customers and suppliers. In addition, more and more businesses use the Internet to conduct business and more effectively manage their human resources, allocate capital, reduce operating costs, access valuable information, and reach new markets. According to International Data Corporation, business-to-business commerce over the Internet amounted to $24.8 billion in 1998 and it’s expected to be $632.9 billion in 2003. Speed Matters While most large enterprises build or lease expensive, dedicated high-speed networks, most small- and medium-sized businesses are using comparatively slow dial-up connections. Forrester Research estimates that in 1998 approximately 93 percent of enterprises accessed the Internet through dial-up connections. Over time, faster, always-on connections enhance the productivity of employees of small- and medium-sized businesses. International Data Corporation forecasts that dedicated connections to the Internet for small- and medium-sized businesses will grow from approximately 240,000 in 1998 to approximately 771,000 in 2000, representing an 83 percent compounded annual growth rate. Forrester Research projects the worldwide market for dedicated Internet access spending among businesses will grow from $1.4 billion in 1998 to approximately $33.5 billion by 2003. In addition to Internet connectivity, small- and medium-sized businesses already demand enhanced services such as Web hosting, network security, e-commerce, video conferencing, data storage and retrieval, conference calling, branch office connectivity, and business television. However, most small- and medium-sized businesses do not have full access to these services because the existing in-building infrastructure is unable to provide broadband services to small tenants. According to International Data Corporation, value-added services is one of the fastest growing segments of the Internet services market and it’s expected to grow from $3 million in 1998 to over $12.9 billion in 2003. In addition, International Data Corporation estimates that Web-hosting revenue from small- and medium-sized businesses will grow from $658 million in 1998 to over $3.4 billion in 2000, representing 96 percent of the total Web-hosting market. Businesses of moderate size also do not usually have the resources to fully analyze the evolving service options on their own. In our view, companies that can provide these services will be winners over time. Telecom Spending Will Increase, As Well The real estate industry rule of thumb is that office tenants currently spend $5 to $7 per square foot on telecommunications. In addition, the expectation is that this amount will increase over time even though communications costs will likely fall because higher volume will more than offset lower prices. For office building owners, the opportunity is to get a piece of the increased amount spent on communications services by providing one-stop shopping to tenants. We use the term "communications technology" very broadly, but we are including voice, data, and video and communications services, such as local and long distance telephone; Internet access; remote access; advanced Internet services such as hosting; video services; and dedicated networks. Langner sees the broadband and IP data services industry as three groups of companies: broadband and IP infrastructure builders, solutions providers, and customer coordinators. These groups roughly correspond to the three primary functions of traditional telecom service providers: network creation, product development, and sales and marketing. In the past, telecom service providers had to provide each of these functions to be successful. Today, broadband service providers must focus on a select portion of the market in order to be successful. Thanks to the ready availability of infrastructure building blocks and the emergence of horizontally focused service providers, the business model for communications services companies is disaggregating. There are three core functions in the broadband and IP data market: (1) create the infrastructure: support the proliferation of broadband and IP data solutions; (2) create the solution: create the content and applications solutions that businesses can use to improve their operations; and (3) coordinate for the customer: effectively create a distribution channel for a segment of the market and then choose best-of-breed partners to coordinate a solution for that customer base. The broadband and IP data service companies that are most relevant to the real estate communities are the customer coordinators, companies that create effective distribution channels to reach customers on a retail basis. This distinguishes them from broadband and IP infrastructure companies that support the proliferation of broadband and IP data solutions and solutions providers, companies that create the content and applications solutions that businesses can use to improve their operations.

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