Not Just Location, but Timing, Timing, Timing
A handful of risk-taking entrepreneurs who bought troubled commercial property when the market was down in the early 1990s are emerging as big winners in Southern California’s recent real estate rebound.
These investors are reaping hefty returns as they sell their properties to such deep-pocketed players as real estate investment trusts and pension funds that are under enormous pressure to grow.
“The biggest returns are being made by those investors who were willing to take the most risk and enter into the market at the depth of the recession,” said David Dale-Johnson, director of the real estate program at the University of Southern California’s Marshall School of Business.
These entrepreneurs are, for the most part, locals who were able to read the economic tea leaves sooner than outside investors did, and those who had the money to take advantage of the bargain-basement real estate prices.
In 1994, when many of these firms began buying, office vacancies in the city of Los Angeles were averaging slightly more than 20% and rents had plunged 22% in five years to an average of $19.46 a square foot a year for first-class office space, according to CB Commercial/Torto Wheaton Research.
Gambling that the market was approaching bottom were such speculators as Robert Campbell and U.T. Thompson of Newport Beach-based CT Realty Corp. The onetime developers trusted their ability to spot jewels in the economic rough and tapped wealthy acquaintances to help them invest when times were tough. Since 1994 the company has bought 42 properties from San Clemente to Santa Fe Springs, running the gamut from industrial buildings that had been taken back by banks to office buildings with absentee landlords that required extensive renovations.
Lately they have started selling, garnering returns of more than 20% for individual properties and receiving offers of up to $350 million for their entire portfolio--more than double what they paid for the properties. Although the firm isn’t ready to divest completely, its owners are selling a significant chunk of their assets--about 15 properties--to several investors, mainly pension funds, in coming months. And they have begun developing properties again, including a Santa Fe Springs industrial park that they plan to sell to a big player when it is completed.
“If you want to characterize us, we have evolved [to be] nothing more than a merchant builder supplying product to the major money,” Campbell said.
El Segundo-based Highridge Partners also has made its fortune, selling properties it had purchased in the midst of the slump. The firm predicted a recovery in the Southern California office market as early as 1993 and pulled back from its apartment investing in Texas.
“California wasn’t really losing that many jobs,” said John Long, a director at Highridge. “The message that was being communicated was much more dire.” Using economic and demographic research, the firm persuaded Dutch investment firm ING Group to take a chance on purchasing what at that time were vacant or half-empty properties.
Highridge began its acquisition binge with former aerospace buildings in El Segundo, properties that had been decimated by defense industry cutbacks. From there, it moved on to other deals, acquiring 20 assets from 1994 to 1995, including a portfolio of 13 office buildings from telecommunications giant Pacific Telesis Group, which was spinning off its real estate assets to concentrate on its core business.
Highridge didn’t have to sit on its properties for long. By late 1995, the first wave of Wall Street investors began flowing back into the market, and Highridge began selling them off one by one, getting a big markup for the increased occupancy and rents.
“By the end of 1996 we had sold over three-fourths of them,” Long said. And Highridge had realized a 25% return on its total investment of $160 million.
A major reason such investors as ING Group were willing to gamble on the then-shaky market was that they could purchase the distressed properties for a fraction of their original costs.
But, as the economy continued to surge and REITs and pension funds stepped in with their fat checkbooks, smaller investors, who had to pay more for capital, found they could no longer compete for big office and industrial buildings. Highridge was forced to find another niche, one most large players wouldn’t touch.
Highridge chose grocery- and drugstore-anchored retail centers, small but stable performers that had been overlooked by most big players. Highridge’s goal was to assemble a large portfolio of buildings for companies that didn’t have the staff or the time to haggle with individual property owners.
“We cataloged virtually every center [of that size] in California and picked out 50 that we wanted to buy,” Long said. “We ended up buying 20 in a span of 18 months.”
By the time others caught on to their strategy, Highridge Partners had finished building the portfolio, having spent roughly $300 million. In 1997, it sold the entire lot to San Diego-based real estate investment trust Burnham Pacific Properties for a reported $344 million in cash and stock. It was a good deal to be sure, but one that has tied Highridge’s future to the performance of that REIT for years to come.
With compensation increasingly coming in the form of stock, real estate executives say they now have to make selling decisions based on more factors than the highest price. Long said he picked Burnham because he had confidence in the REIT’s performance and thought it might become a regular buyer for Highridge’s upcoming development projects.
“We now see ourselves as a natural partner for REITs,” he said.
As prices have gone up, other small investors have had to work harder to turn a profit, often putting a little sweat equity into the buildings.
CT Realty now reconstructs rundown apartment buildings in such prime areas as Orange County and northern San Diego County, where there are few vacant sites for new development. And Rubin Pachulski Dew Properties of Los Angeles has switched from buying glamorous but partially vacant Westside properties to investing in massive fixer-uppers in the San Fernando Valley and elsewhere.
These properties, many of which were in foreclosure, have yet to be targeted by larger firms, mainly because of the extensive time and effort required to turn them around.
One of Rubin Pachulski’s latest projects, a two-building complex on a prime corner in Encino, will take nearly a year to upgrade. First the firm had to foreclose on the note it had purchased for $7.5 million. Now it is pumping out $4 million more to put in everything from new restrooms and elevators to courtyards and parking lots.
“A REIT just won’t do that,” Co-President Stuart Rubin said.
The investment company can attempt such big make-overs because of the huge cash reserves it accumulated from earlier, highly profitable building sales. One of them was the Lunaria Building, a 100,000-square-foot structure in Century City. This half-occupied office property with a swanky restaurant, located near a choice intersection, needed little more than a fresh coat of paint and new carpeting to lure additional tenants. And its price was right: The firm picked it up in 1994 for $6 million, or $62 per square foot--a rate some investors pay for less-valuable industrial buildings.
“The market was really at bottom,” Rubin said. “It was so cheap per square foot that we were buying the buildings just for the land [value].”
Two years and several new tenants later, Rubin Pachulski sold the Century City building to Arden Realty Inc. for $11 million--83% more than it originally paid. And as the market gained momentum, Rubin Pachulski found buyers for several of its other properties, including a seven-story building at Santa Monica Boulevard and Fifth Street in Santa Monica that it sold to William Wilson & Associates, and an office and entertainment building on the Third Street Promenade that sold for $30 million, or $8 million more than the investors had put into it.
The group of cardiologists and attorneys in Rubin Pachulski made such high returns because they were extremely conservative in what they would pay for a given building, buying only if the property was profitable at the rents of that time.
“We have to be conservative,” said Rubin, noting that his funds come from his longtime partners and people he knows personally, not from public offerings.
