An Investor Bullish on the ‘Burbs

Can Dick Ziman do it again?

In the 1980s, Pacific Financial Group--a privately held firm headed by Beverly Hills real estate investor Richard S. Ziman--loaded up on suburban office buildings in Southern California and watched their values steadily rise. Then, sensing the market was overheating and poised for trouble, he sold nearly every property before the 1990s arrived.

Ziman was prescient, of course. The California economy plunged into a severe recession in the early 1990s, and the market for real estate--especially commercial real estate--collapsed.

Now, Ziman and his new firm, Arden Realty Inc., are betting on the market’s rebound from disaster. Since mid-1993 he and Arden’s whiz-kid president, 36-year-old Victor J. Coleman, have been aggressively buying again, and this time they’re taking public investors along for the ride.

In just the last year, Arden has raised nearly $800 million from its initial public stock offering and a secondary sale in order to buy more real estate. Arden now owns about 60 office properties--all of them in Southern California--that have a combined 100 buildings and nearly 9 million square feet of space.

As before, Ziman eschews buying expensive “trophy” office towers in big cities and concentrates instead on suburban office buildings, most of which are just a few stories high. He looks for relatively sound but under-performing properties in good locations.

His reasoning? Buildings like that cost less per square foot to buy and improve than luxury skyscrapers, thus giving him a better chance of earning a handsome return on Arden’s investment.

“We do have some trophy properties, but they’re suburban trophy properties,” Ziman, 54, said during an interview in his unpretentious seventh-floor office. “For instance, we have the finest property in La Palma” in Orange County. “It’s a gorgeous 600,000-square-foot complex, and for that market it’s a trophy.”

And lest one think suburban office buildings are small potatoes, consider: Arden’s total stock-market value now exceeds $1 billion, and Ziman’s stake alone has a current market value exceeding $45 million.

Also, despite sticking with smaller buildings and smaller leases (its typical lease covers less than 5,000 square feet), Arden is still one of the biggest office landlords in Southern California.

For investors, Arden is also one of the few investment plays that are focused primarily on the region’s surging commercial real estate market. (Another is El Segundo-based Kilroy Realty Corp.) And so far Arden is profiting nicely from the market’s upswing.

Arden (the name comes from a street in Beverly Hills) is a real estate investment trust (REIT), which means it avoids most federal taxes in exchange for passing along most of its earnings to its stockholders in the form of dividends.

The company’s average occupancy rate has climbed to 91% from 85% last year, and its average rent is up 10% this year alone, to about $20 a square foot. Arden’s stock, which went public at $20 a share a year ago, is up a sparkling 60% since then to a recent $32 on the New York Stock Exchange (helped along by a strong rally in real estate and REIT stocks in general this year).

Why focus solely on Southern California? Three reasons, Ziman said.

First, the local economy is a lot healthier, which means growing businesses are demanding more office space. Second, the available space is becoming more scarce because there’s been very little construction of office buildings for the last five years.

Even though the economy is better and rents have been climbing, rents still aren’t high enough to persuade builders to break ground. So, for now, firms such as Arden are exploiting the scarcity of existing office space.

“The strength of this market is the economy,” Ziman said. “The additional strength is that there’s no construction. There are no cranes in the sky.”

Significant new office development “is at least two years away, which should allow existing properties” such as those owned by Arden “to increase rents by as much as 25% to 40%” during that time, said Burland East, an analyst at Everen Securities Inc. in Chicago, which has helped underwrite Arden’s stock offerings.

“We’re in a period where you can almost raise rents at will, subject to when the leases roll over,” he said.

The third reason Ziman sticks to his backyard is “we know the market, we live in this market,” he said. Unlike national real estate investment firms, “we know the major tenants, the investment sales brokers, the leasing brokers,” all of which helps Arden buy properties at favorable prices and fill them with tenants, he asserted.

Plus, Arden keeps its expenses down by not having properties strewn across the nation, properties that would each require on-site teams of managers and maintenance help.

“Everything else being equal, the regional guys should beat the pants--in the long run--off the national guys” who own properties in lots of different regions, he said.

Perhaps. But with all of its eggs in one regional basket, isn’t Arden an investment risk by lacking diversification?

After all, if the Southern California economy goes into the tank again, it will take Arden’s buildings with it. Indeed, the prospectus on Arden’s latest stock offering, in July, even raised that red flag.

Ziman is undeterred, for now.

“We have the strongest economy and a more diversified economy than Southern California has ever had,” he said. “If you take a four- or five-year view, I don’t see a hiccup, a serious hiccup” in the economy over that period.

But if need be, Ziman leaves no doubt he’ll bail out again and sell Arden’s buildings--and maybe even the whole company--to protect his company’s profit.

He said, “If it gets crazy like it got in ‘88, ’89 and ‘90, not only would we sell certain properties, but if someone should come along and, if the price is right . . .” Ziman’s voice then trailed off, so a visitor finished the sentence: “and sell the whole company.”

“We don’t want to do that,” Ziman said, “but we have a fiduciary duty to our shareholders.”

It’s that posture--the willingness to sell out--that appeals to Everen’s East.

“Dick has proven his ability to divorce himself emotionally from the business,” East said, “and to sell assets when the time is right.”

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Arden’s Ascent

Since going public a year ago, Arden Realty Inc.’s stock has risen sharply, spurred by a rebound in the Southern California commercial real estate market, where Arden focuses its investments. Tuesday close: $31.75

Source: Bloomberg News