Jones Lang LaSalle


Investing
By Peter Coy

The Right Time for REITs?

The June 5 acquisition of Trizec Properties demonstrates that private investors still see upside potential in office-building rents

Are office buildings still a bargain, even after a big market gain? Some big investors seem to think so. On June 5, New York-based Brookfield Properties (BPO ) and New York buyout firm Blackstone Group teamed up to buy Chicago-based Trizec Properties (TRZ ), one of the nation's biggest office-building real estate investment trusts (REIT), and its sister company Trizec Canada. The purchase price was $8.9 billion, including acquired debt.

The price represents a 24% premium over the 10-day average price of Trizec on the New York Stock Exchange, suggesting that the buyers are confident that the market was undervaluing Trizec.

A real estate investment trust like Trizec pools investors' money and puts it into real estate, passing all the income back to the shareholders for tax purposes. Trizec adopted the structure in 2002.

EXPIRING LEASES. Ordinary stock market investors have been getting nervous about the value of office REITs because stock prices are historically high in relation to the rental income that they produce (see BW Online, 05/22/06, "Knowing REIT from Wrong").

So what do Brookfield and Blackstone see that the public shareholders don't? Analyst John Guinee of Stifel, Nicolaus & Co. in St. Louis says they're betting that they will be able to raise rents substantially as current leases expire. He says Trizec has a number of "below market" leases that are depressing its current income, but those leases will be expiring before long. The ability to raise rents is what's known in the industry as "upswing potential."

Another big attraction of Trizec is that it, like Brookfield, is heavily concentrated in New York, Washington, D.C., and Southern California, which are hot office markets. Blackstone, for its part, has raised enormous sums of money and is looking for places to deploy it, says Guinee. "They're flush with cash," he says. "They don't get paid if they return the cash to their investors."

The Trizec deal comes on the heels of another big acquisition. On May 2, General Electric (GE ) announced the completion of its $4.8 billion acquisition of Arden Realty. Trizec itself acquired $1.6 billion worth of Arden's properties in that deal.

RISING CONSTRUCTION COSTS. In a recent note before the Trizec deal, Standard & Poor's equity analysis group said it was neutral on office REITs at current prices. But S&P's Royal Shepard said: "Long term, we think fundamentals for office REITs are more positive. S&P's forecast of steady economic and employment growth through 2008 is likely, in our view, to increase demand for new space relative to supply, particularly in light of rising construction costs."

Even before the latest pop in its stock price because of the acquisition, Trizec was a great investment for its shareholders. Its wealthy Canadian chairman, Peter Munk, said in a news release that he was "extremely proud" that the company had delivered a total return to shareholders of 185% over the past three years.

Trizec will be dissolved in the deal. Of its 36 million square feet of office space, Brookfield will manage 18.5 million, Blackstone will manage 5.4 million, and another 12.1 million will be sold to Blackstone and others.

RISING CONFIDENCE. For now, the deal puts under one roof -- one very big roof -- such choice office properties as Brookfield's World Financial Center in New York City and BCE Place in Toronto with Trizec's Bank of America Plaza in Los Angeles, Renaissance Tower in Dallas, One Alliance Center in Atlanta, and 1200 K St. in Washington, D.C., among others.

Analysts say that it's likely that there will be more acquisitions in commercial real estate, especially office properties, as long as private investors remain more confident in the future of the business than public shareholders.