The REIT Approach
Despite the shaky performance of real estate investment trusts (REITs) on Wall Street this year, as every commercial real estate professional knows by now, they are here to stay. REITs operate in almost every leading and secondary market throughout the country today as buyers, sellers, and managers in every property segment. Recent figures show that REITs control about $80 billion worth of commercial real estate in the United States, almost 21 percent of which is in office and industrial properties.
Given the expanse of their reach, REITs have changed the way commercial real estate business is done—"institutionalized" it to a great degree.
Many brokers welcome the opportunity to do business with REITs, but as institutions, they often are harder to approach than a local investor who has a face, a name, and a personality. As property prices have risen and markets have tightened, some REITs may have put the brakes on the buying binge of the last year or so, but they are still very active purchasers in many markets. The question is, how can brokers successfully approach REITs with properties to buy?
The answer comes from one who has been there and done that: "Be proactive," says Mark E. Douglas, CCIM, SIOR, senior vice president and partner of Morton G. Thalhimer/Oncor International in Richmond, Virginia. "Take a very proactive approach."
Since October 1997, Douglas has sold seven office buildings and two parcels of land zoned for office development worth a total of $38 million to Liberty Property Trust, a $3.2 billion REIT that specializes in office and industrial development and investment-grade acquisitions. In addition to selling property to the REIT, he also has completed about 12 office leases with Liberty in the last 12 months.
Based in Pennsylvania, Liberty owns and manages 583 properties in nine states and the United Kingdom. According to Douglas, it is an "aggressive, self-administered, broker-friendly REIT that has proven to be a pleasure to work with both from the acquisition side as well as the leasing side of the business."
Finding the Deal
Specializing in class A office leasing and investment sales, Douglas was familiar with the REIT’s activities in the Richmond area—"Liberty was in the process of buying a package of buildings in the Tidewater [Virginia] markets, which has proven to be a logical step for them," he says. He characterizes Liberty as "a very viable but busy purchaser in the marketplace that needed a streetwise broker to act on its behalf in securing investment-grade properties."
Douglas’ initial contact at Liberty was senior vice president Alan T. Lingerfelt, who has been "a known player in the office and industrial development market in the greater Richmond area since I got into the business in 1984," Douglas says. Because Lingerfelt’s transition from another company to Liberty was "so smooth," Douglas was able to work with Liberty in "a business-as-usual capacity."
After arranging a meeting with the REIT’s acquisitions managers, Douglas’ team presented them with detailed information on multiple properties. "We just compiled a list of every class A office building in the area and put together a marketing piece on each with photos and estimated NOIs [net operating incomes]," he says.
This approach of finding the deal instead of waiting for one to happen is a distinctive strategy for dealing with REITs. As Douglas indicates, because REITs operate in many markets, making frequent purchases, they often don’t have the time to develop an in-depth feeling for a local market. Instead, they rely on local brokers who have a good understanding of a specific market or property type. This need for good market data and what Douglas calls a "streetwise broker" is even more important in today’s tight office markets, where bargains no longer are there for the picking.
Douglas’ in-depth knowledge of the Richmond market is a result of 14 years of commercial real estate experience. At the time Liberty was looking to buy last year, the Richmond metropolitan office market was "less than 2 percent vacant for class A properties, with a desperate need for development of class A office space," he says. "In the last two fiscal years, we have absorbed almost 1.8 million square feet of office space."
This year, according to Thalhimer’s mid-year market report, "investment demand remains high as REITs and other investors are now looking to the class B market for purchase opportunities."
Doing the Legwork
Liberty was ready to buy, so Douglas went to work. "My initial approach was to contact owners of leased office buildings on behalf of Liberty Property Trust as a buyer. This project was originally started in the greater Richmond area but then we diversified and moved into the Newport News, Hampton Roads, and Virginia Beach submarkets. The project began in early 1997 with our first sales closing in third-quarter 1997."
Since none of the properties sold to Liberty was formally listed on the market, Douglas relied on the contacts and customer base he built through his association with Thalhimer. "We called on Thalhimer’s clients, customers, and relationships during this project, letting them know we had a buyer interested in their buildings. Knowing Liberty Property Trust and its appetite for quality investment-grade product, we were able to purchase these buildings very often at cap rates north of 10 percent, yet at a below-replacement-cost basis."
In all, Douglas’ $38 million sale to Liberty, which consisted of seven buildings and two parcels of land zoned for office use, was worth more than half of his sales production of $46 million for the last fiscal year. He has seven more properties under contract totaling $26 million scheduled to close in 1998. Three of the seven properties are under contract to Liberty for a total of $14 million.
Rising property prices and falling cap rates have given REIT investors second thoughts, lowering REITs’ total return on investments. Further complicating the scenario is the recent stock market tumble, which lumps REITs with other Wall Street investments, for better or worse.
But regardless of the outcome, REITs have changed the face of the U.S. real estate industry. Because they offer the benefits of liquidity, security, and performance, these institutions will continue to influence property markets in a number of cities, determining how property is bought, sold, and managed.
As commercial real estate professionals adapt to the new realities of REIT-ruled purchases, those who are willing to work hard and take a proactive stance likely can profit by serving this customer base. But those who plan to approach REITs with product offerings should heed the Boy Scout motto: Be prepared.
"Know your market, vacancies, and where rental rates are going. And be prepared to work," Douglas says. He experienced no pitfalls in dealing with Liberty, he says, but found the company to be extremely thorough in the due diligence process. "As a publicly traded organization, Liberty Property Trust left absolutely no stone unturned during the due diligence phase," he says. However, Douglas and his colleagues adapted to this need creatively. "Even given the extreme depth of investigation into all aspects of the income and expense breakdowns, after the first sale, we were able to develop a very successful and detailed reporting process and checklist that we worked off of [with each property] to ensure that we did not miss any detail, no matter how minor," he says.
The only problems came when "the NOI provided to us by sellers often varied from the actual NOI number calculated during the due diligence period." With regard to that, Douglas cautions others to "spend extra time reviewing all NOIs prepared by others." In all cases, he tried to get "at least the last three years of working numbers where possible."
The result definitely was worthwhile. "The high point was earning the trust and keeping the trust of Liberty Property through this process," Douglas says. "I have been able to create a strong relationship with a very valuable player in the marketplace.