REITs Building Rather Than Buying
Surging prices for commercial real estate are forcing many real estate investment trusts to stop buying old properties and start building new ones. At no company is that shift more evident than at El Segundo-based Kilroy Realty Corp.
The REIT, which spent the last year buying Southern California properties at a rapid pace, has laid off its three-member acquisition team headed by Alan S. Pekarcik and backed out of at least one contracted purchase. It is, however, still going forward with $100 million in new development from San Diego County to Los Angeles.
“Earlier this year we began to de-emphasize acquisition in a marked way,” Chief Financial Officer Richard Moran said. “Prices just have been bid up to the point where it makes more sense.”
Likewise, Menlo Park, Calif.-based Spieker Properties, which had been on a two-year buying spree, is through buying buildings--at least for now. “Why buy an old building when you can build a new one for the same cost?” said Spieker Vice President John Davenport.
In recent months, Spieker dropped out of the bidding war for several prominent high-rises, including a building in tony Brentwood and twin towers in Orange County’s South Coast Plaza area, because it felt prices were getting too steep. Davenport says the Costa Mesa buildings are selling to a private real estate firm for 10% more than his company was willing to pay.
Private firms recently have been able to outbid REITs for many buildings, analysts say, because they have access to cheap capital from lenders and large real estate funds and because they are willing to pay more for buildings on the expectation that rents will rise over the next few years.
Conversely, REITs have had to worry about making dividend payouts and have faced restrictions on the amount of debt they can take on. Now they are having trouble raising money for acquisitions in the public markets.
Kilroy’s stock price has fallen 12.1% this year to close at $25.25 on Friday. Spieker’s stock dropped 7.88% to $39.50 in the same period. Both trade on the New York Stock Exchange.
“REITs are so fearful right now of the way the market is perceiving their acquisitions,” said one big private investor who competes with REITs and asked not to be identified. “Maybe they’re not buying things they should.”
The investor said that although he has paid more for some properties than REITs would, low interest rates and small, efficient management has allowed his firm to realize the same or better returns.
But Spieker officials insist that over the next few years, developments will give a bigger bang for the buck--an 11% or 12% return versus 7% or 8% for an acquisition. The company is submitting plans to four different cities for new office buildings. Already under construction is the Arboretum office development in east Santa Monica.
This gung-ho construction sentiment has concerned some economists and Wall Street analysts who fear communities will become overbuilt, dragging down rents and ultimately REIT returns.
But for REITs buying and developing property in Southern California, overbuilding doesn’t appear to be an overriding concern. Few new buildings have been completed since the 1990s recession began, and expanding businesses are expected to absorb 5.9 million square feet of office space per year until 2001.
Rosen Consulting, headed by Kenneth Rosen of UC Berkeley, predicts that the amount of space being built each year in Southern California--only 3.5 million feet--won’t come close to satisfying that demand.
To finance all of this new development, REITs have started to sell off some of their existing portfolios--often to the same funds and private investors who are outbidding them on other acquisitions.
Spieker has sold about $200 million in properties this year, and Chairman Warren “Ned” Spieker said he expects to sell another $200 million by the end of the year.
REITs are also taking on higher levels of debt. Kilroy, which has traditionally held down its debt ratio to 30%, is now willing to leverage up to 45% of its assets.
“That should give us a couple of hundred million more in development capacity,” Moran said. Analysts, however, don’t expect this development fever to grip the region for more than a few years. Most REITs have purchased only limited amounts of land, and prices for desirable sites have climbed to the point where many development proposals no longer make economic sense.
Some analysts, such as Carl Tash of Los Angeles-based investment firm Cliffwood Partners, think REITs, which typically have less development expertise, will return to purchasing buildings, possibly as soon as later this year.
“The REITs will be just as aggressive buying once their stock prices recover,” he predicted.
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REIT Decline
Stock prices for real estate investment trusts Speieker Properties and Kilroy Realty Copr. fell this year. Both are now backing off of acquisitions in favor of real estate development. Monthly closes and latest:
Spieker Properties
Friday: $39.50
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Kilroy Realty
Fridya: $25.25
Source: Bloomberg News
