 |
  Play it Again, Alan and Lionel! No one expected Alan Leventhal and Lionel Fortin, who ran Beacon Properties day-to-day prior to its merger with Equity Office Properties late last year, to sit on the sidelines for very long. Then again, not many people thought they would be back this fast, either. by Barry Vinocur |
As Alan Leventhal, who was Beacon Properties' president and CEO, told us recently, though emotionally tough, agreeing to the deal with Equity Office was very straightforward. "When we decided to become a public company we knew our primary duty would be to our investors. When we looked at the deal Sam Zell was offering, it was clear that taking it was in the best interest of our shareholders."
Nine months later, it looks as if Leventhal's timing couldn't have been better. After peaking in early-October last year, the Morgan Stanley REIT Index has headed south. None of that, however, dampens Leventhal's enthusiasm for Equity Office, in which he and his family remain large stockholders. "We believed then and we believe today in Sam Zell's vision. Consolidation is inevitable, and the merger of our two companies only strengthened Equity Office's position as one of the country's pre-eminent office owners."
As bullish as Leventhal is on Equity Office's future, he sees other opportunities in an office market that he says is "stratifying." So early this year, Leventhal and Lionel Fortin, who was Beacon Properties' chief operating officer, formed Beacon Capital Partners.
A private REIT, Beacon Capital Partners raised just over $400 million this past spring in a Rule 144A offering underwritten by NationsBanc Montgomery Securities. Not surprisingly—given Beacon Properties' impressive track record as a public company—investors lined up to get into the deal. (They raised more than twice the amount they originally intended.) For the next 12 to 18 months, Leventhal says the new company will target office deals not on the radar screens of most public companies.
Leventhal is mum, however, when the discussion shifts to when Beacon Capital Partners might go public. Nevertheless, industry veterans say the question isn't if Beacon Capital Partners will go public, only when it will happen. Most are betting it will be before the end of this year.
A lot of people, myself included, were surprised when you announced the merger with Equity Office. What led up to that decision?
In early-1997 I felt that though things were going very well for us at Beacon Properties that we had entered a new phase in the cycle. I remember talking with Lionel about how much more capital was available and how much more competitive it was becoming in the office sector. So when Sam approached me I was receptive because I thought, given where the market was, his case for consolidation was a very compelling one. Ultimately, the decision I made, which the directors supported me on, was that it would be very hard to realize those types of values in the near term, and that the combined entity would be much stronger than either company would be on its own.
Beacon Properties was a family-owned company. It must have been tough to tell your father that you thought selling was the right thing to do.
It was very difficult. It was a very emotional time for all of us. But we understood when we went public in May 1994 that the company would have a different constituency. So, when Sam Zell first approached me with the idea of merging into Equity Office, I knew whatever we decided, it would have to be based upon what was best for our shareholders.
You announced the deal on September 15, 1997 and the Morgan Stanley REIT Index peaked on October 6 at 367.35. Since then it has been pretty rough sailing. You couldn't have timed it much better than you did. Are you that smart, or just that lucky?
When you have been through cycles—and despite the market's strength since the early 1990s, we are still in a cyclical business—you understand that the economy won't continue growing forever as it has in recent years. There will be some adjustments. So, to answer your question, I think our "good" timing was the result of experience and a little bit of luck, too.
You and your family continue to be large shareholders in Equity Office Properties. Is that because you want to own Equity Office, or because you would take a huge tax hit if you sold?
If the capital gains are there, you can always choose to get out and pay your taxes. Our view is that it's hard to think of another company that we would have been interested in merging into. So, when Sam approached me, I responded because of the quality of Equity Office's assets and because I thought his vision of the markets he wanted to be in was correct.
One has to wonder whether you had the new company in mind at the time you announced the merger.
I can understand why some people might think that was the case. But when Sam first approached me I had nothing else in mind. In fact, when Lionel and I had dinner with Sam and Tim Callahan [Equity Office's president and CEO] to hammer out the final details five days before the merger was announced, I remember telling Lionel that when it was all over we would do something together. Neither of us knew at the time what that would be, however.
When did you come up with the idea for Beacon Capital Partners?
It's an interesting experience being in the middle of a merger. Once we had talked to our shareholders, we really didn't have anything to do. You show up at work every day, and you're fully employed, but you really can't make any decisions. It was during that time, between mid-September and December 19 when we had the closing dinner, that we came up with the idea.
Now we know when. Fill us in on the why behind the idea.
Lionel and I felt that there was a great opportunity in the phase of the cycle that we are in now for a smaller company—one that focuses on value-added transactions.
A lot of the people who were with you and Lionel at Beacon Properties have joined the new company.
When the merger closed on December 19, Lionel and I looked around and we saw some very talented people who were going to end up elsewhere, people who wouldn't be part of Equity Office. In January, we started making offers to people. We have been very fortunate; we made 25 offers and we got 25 acceptances.
You planned to raise $200 million, and you closed the deal with more than twice that amount. Sounds as if your business plan and timing were pretty good, again.
What we found as we went around and talked with people, many of whom had invested with us in Beacon Properties, was that we hit a responsive chord. It was probably the best road show we have ever had.
How much money did you raise? How many investors were there, and how would you characterize the investors?
We raised $420 million. Roughly 85% of what we raised came from 40 institutions; the rest came from individuals. Approximately 60% of the investors in Beacon Capital Partners had been investors in Beacon Properties.
Obviously the response was great. But weren't people bothered by the fact that Beacon Capital Partners was a blind pool?
It was interesting. As we talked with potential investors, we ran across some who didn't want to even read the prospectus because it was a blind pool. But once they met with us and they heard the story, many of them told us that they felt "forced" to read the prospectus. Not everyone of those people invested, but a number of them did.
Potential investors said they liked the idea that they were buying into your new company at net asset value. What exactly does that mean?
Because it was a blind pool, investors weren't buying properties that were worth "x" and paying a premium over what the real estate was worth for management. Instead, net of underwriting fees, every dollar of the $420 million that we raised, including the $15 million that Lionel and I personally invested in the company, was available to execute our business strategy.
Is it fair to characterize Beacon Capital Partners as an opportunity fund?
It certainly was a blind pool, and I recognize that has a negative connotation in some quarters. But an important difference here was that our investors were making an investment in people. Starting at the top with Lionel and myself.
We set up the new company to look like a public company in terms of structure, compensation, and the way in which options are granted. There are no fees based on "assets under management," and there's no "promote." So, though we clearly are opportunistic investors, there are important differences between this company and what comes to mind when most people think of an opportunity fund.
Most investors, today, say they expect 12% to 15% annual total returns from REITs. Opportunity fund investors expect something well north of those numbers. What are your expectations?
We expect to achieve 20%-plus returns, with the emphasis on plus. And, if you look at our track record—noting the standard disclaimer that past results don't guarantee future results—you will see that Beacon Properties returned 42% over 31¼2 years annually compounded [see table above].
That's about as good a segue as I can imagine to start discussing your strategy.
We wanted a very flexible structure in terms of the types of transactions that we could do. So, while we expect our primary emphasis to be on office properties because we think there's still some very good opportunities in that sector, we will look at other sectors. We also have a paper clip that will look at operating businesses that cannot be put into the REIT.
It seems everyone is talking about creating a "clip." Is it something you set up with a specific purpose in mind, or is it there just to keep your options open?
If we're going to be involved in the long-term ownership of real estate as it relates to an operating business, we'd like to be able to have a position in the operating business as well.
|
||||||||||||||||||||||||||||||||
It really comes down to the fact that the market has stratified. There are the large public companies, and some of them are going to do very well. As we already discussed, I think Equity Office will be among those companies. But companies like Equity Office are looking at different types of transactions.
To generate even 12% to 15% total returns, the large companies will have to do a large volume of transactions. So, they will focus, for the most part, on the larger deals. That's where there's the most competition. Our strategy is to focus on the smaller deals, ones that aren't on the radar screens of most of the larger companies. Deals that are, say, in the $50 to $150 million range. Now we will bump into the occasional REIT; more often it will probably be the opportunity funds. But the difference between us and the opportunity funds is that we not only are able to recognize the value in the transaction, but we also can add value through our skill and management.
Have you done any deals yet?
Yes. Our first was for One Kendall Square and 215 First St., which together comprise roughly one million square feet. And, we recently announced that we were buying Technology Square and the Draper Building in East Cambridge.
Who else bid on the properties?
In one case, a public company was involved. And there were certainly some opportunity funds involved. But we were very aggressive in going after the deals because of the value that we saw. For example, we will own two million square feet of space in the East Cambridge market. That's roughly 20% of that market, and East Cambridge is the strongest sub-market in greater Boston.
Fill us in on the details of the Technology Square deal.
The purchase price was $123 million. Just under half of the one million square feet of space that we're acquiring is under long-term lease to Draper Laboratories, which is in the defense industry. The balance of the space, roughly 550,000 square feet, is occupied by Polaroid and MIT. The leases on that space roll over in the next 12 to 18 months.
We're paying in the range of $120 per foot, and we should get net rents, including parking, of about $28 per foot. So, we expect an unleveraged yield in the range of 15%, which we think is quite extraordinary. Again, we believe if you're very focused and very selective in what you buy, you can earn the sort of returns that we and our investors expect.
You said your near-term focus will be on office properties. What about geography? Will you buy nationwide?
You'll see us operating across the country. As you know, we've been putting the band back together. Val Wheeler and Jeremy Fletcher, who were with us at Beacon Properties, are back with us. Jeremy will be covering the entire West Coast, and Val will cover the Midwest and down into Texas. So, we're very confident that the team we have in place gives us the platform we'll need to operate nationally.
What about the concern that to buy office properties today you have to "overpay."
It's funny. Whenever I talk to my mother after we announce that we are buying a property, she always asks why we're buying if someone else is selling. It does make you think. After all, by definition, if you buy a property in a competitive bidding process you probably had to pay more than the other bidders.
Clearly, though, it's tougher today to buy properties at the sort of discounts to replacement cost that we bought properties at two years ago. That's why our focus today is much more on value-added transactions.
Now that construction cranes are starting to dot the landscape, there's a lot of talk about buying in supply-constrained markets. Is there such a thing?
The biggest mistake you can make is to believe that there are such strong impediments to new supply that you're not going to see any material new supply. I don't care what market it is. Whether it's Manhattan, Boston, San Francisco, or East Cambridge, if the rents can justify it, you'll get new supply. The only protection you may have in some urban areas is that there will be longer lead times, but that's it.
Historically, Beacon Properties was a developer. Do you and Lionel plan to be active in that arena, again?
We're looking at development. The big question is what additional return can you get for developing. In other words, does the excess return over what you can earn buying properties compensate for the added risk of development.
Interestingly, one of the things we're finding today is that the marketplace wants you to take risk for additional yield. Sometimes, I think we have forgotten the late 80s and early 90s because we've had so many good years. Of course, the real test of whether it was worth taking that added risk won't be known until there's a downturn.
Beacon Properties was an office company, but the Leventhal family had and has interests in other property sectors. Initially you said that Beacon Capital Partners will be focusing on office properties. But beyond 12 to 18 months, what will you be looking at?
It's hard to say. In the short term, at least, the opportunities are so attractive in the niche of the office market that we're focusing on that we haven't really thought about what might be next. It really would depend on what the environment looks like six to 12 months down the road.
Is there anything you would rule out?
No. I wouldn't exclude anything.
I assume that in addition to being structured as a REIT, you're also an UPREIT? Is there an opportunity in the niche you're focusing on to do deals in exchange for operating partnership units?
Yes, we're an UPREIT. And, in fact, we're looking at a number of transactions in which the sellers are interested in taking OP units.
What about the potential for deals with companies that might be looking at spinning off their real estate, either as part of a merger, an LBO, or just in the normal course of business?
We have spoken, for instance, with a number of firms that are active in the LBO arena. By teaming up with us, an LBO firm might be able to put forth a more competitive bid. Of course, we are looking at other opportunities in this general area.
One advantage you have over an Equity Office or a Boston Properties is your size. Percentage-wise, at least, it's a lot easier to grow a company of your size. But I assume you don't intend to be small forever.
You're correct that the size factor is an enormous advantage starting out. And, it was no doubt, a very attractive aspect of our deal. But to answer your question, we believe you can be a $1 billion to $2 billion company and still have the ability to sustain very high growth rates. Of course, as you get larger, it becomes more difficult. So, as we grow that's something we will have to deal with.
What factors will you consider when that time comes?
We will have to ask ourselves whether we can continue to deploy capital in the amounts that we want and still be able to achieve the returns that we and our investors expect. Frankly, if we think we'd be better off selling some assets and redeploying the proceeds, that is what we'll do. But, again, what's going to drive that decision is returns. As we discussed, our focus is on generating 20%-plus annual returns going forward.
Going forward forever?
Forever is a long time, but certainly for the foreseeable future. We're going to be very mindful of our size and very mindful of having the patience and discipline to do smart deals. We won't do transactions because we need to do them to generate earnings, even though those acquisitions may be a little bit thin. That's our discipline, and we expect to maintain it.
Historically, REITs haven't sold many assets. Today, a lot of CEOs are talking about actively managing their portfolios. What do you make of this trend?
There aren't many companies that have sold assets. And there aren't a lot of managements that are willing to sell their companies. We have demonstrated that we're not only willing to sell assets, but we're also willing to sell our company if it's in the best interests of our shareholders.
You have the ability to use up to 60% leverage. That's not high relative to the opportunity funds, but it's higher than what we see at most REITs, today. Does that suggest you think REITs aren't using enough leverage?
Before raising additional capital and before looking at becoming a public company, we wanted the ability to maximize the capital we had raised. So, it's not an indication of what we're going to do in the future. Rather, it, like our UPREIT structure, reflects our desire to maintain as much flexibility as possible.
REITs have had a tough time lately, especially the office REITs. A lot of people are talking about the future. The prevailing wisdom seems to be that the public market will insulate real estate from the sort of swings that were seen in the past. What's your view?
Right now, the economy is very strong. But we're in a cyclical business. So, eventually, there will be a trough. But I expect that we'll bounce back much faster the next time because we won't have to deal with the sort of oversupply that we had the last time.