Arden preparing for more acquisitions.

At a time when real estate prices have skyrocketed and interest rates are rising, Arden Realty Inc., the biggest owner of office buildings in Los Angeles, has embarked on a new strategy of selling off as much as 25 percent of its portfolio while simultaneously buying higher-priced properties throughout Southern California.

Arden, which already had all of its holdings in Southern California, is doubling up its bet on the local economy, which executives believe is poised for strong job growth and higher rents in the second half of 2005.

The company plans to raise $757.2 million in both debt and equity to fund new purchases, according to a filing with the Securities and Exchange Commission.

Richard Ziman, Arden's chairman and chief executive, said the company is poised to make a slew of new acquisitions even though prices are at all-time highs.

"Ultimately, we'll be ahead of the game because we'll have buildings that are more efficient, newer and easier to manage-and as rents grow, these rents will grow higher," he said. "This is a great market to be selling in, especially for smaller properties."

The new strategy comes as analysts cast a gimlet eye toward real estate investment trusts because many have thrown off average returns of 30 percent in the past two years, thanks to historically low interest rates.

But commercial office REITS like Arden have lagged the market, thanks to persistently high vacancy rates.

Ziman's actions are being closely watched because he has a reputation for impeccable market timing. In 1989, he sold 5 million square feet of office space--his entire portfolio at the time--just before the real estate market crashed. Then, when prices were hitting their nadir in the '90s, he came back into the market and snapped up many properties at ridiculously low prices.

In the past year. Arden has sold off $225 million worth of properties and bought $240 million worth. The trick to the deals is matching sales with purchases because, by, law, REITs must distribute 90 percent of their taxable income--including gains on sales--to sharebolders through dividends. With like-kind exchanges, much of the gain, and thus the distribution, can be avoided. This helps maintain the company's asset base.

Buying and selling

Earlier this month, Arden bought the Washington Mutual Tower in San Diego for $48 million from Shidler Group, and then sold Shidler 10 properties, including the Glendale Corporate Center, Whittier Financial Center and South Bay Technology Center, for $142.7 million.

In October, Arden bought the Warner Corporate Center on Victory Boulevard in Woodland Hills for $64.5 million.

Though not among the strongest REIT performers, Arden shares have jumped 27 percent over the past year, to $34.92 as of Jan. 20.

But shares have fallen 8 percent in January alone, off a 52-week high of $37.89 on Jan. 3. Many analysts are concerned about job growth in Southern California and the potential for a burst of the housing bubble.

Arden's recent moves have been generally welcomed on Wall Street, though not without quibbles. Some investors complain that the company was too conservative during the latest downturn, taking baby' steps at acquiring properties in hot local markets like San Diego-even as competitors such as Kilroy Realty Corp. were more aggressive.

Analysts also have criticized Arden for bulking up on office properties ahead of its initial public offering in 1996. That left the company with a mixed bag of properties that now need to be sold.

'Long, hard slog'

David Shulman, senior REIT analyst at Lehman Brothers in New York, said that while Southern California office properties are doing better than the rest of the country. "it's still a really long, hard slog.'"

"We've been telling them to sell their non-strategic assets for a long time but they didn't like the pricing they were seeing on the sellside," he said. "'The conundrum they're facing is you have to sell something to buy something, and now prices are very high."

Jim Corl, chief investment officer for real estate securities at fund group Cohen & Steers, Arden's largest shareholder, admits that the sell-off and purchases will dilute earnings in the short run.

"It's absolutely the right thing to do," he said. "It's a case of addition by subtraction. By getting rid of lower-quality stuff, you can buy an asset with growth attached to it, which will be accretive to their long-term growth rate. Frankly, I'm glad to see the activity level is picking up."

The fourth quarter of 2004 gave landlords like Arden a bit of good news: Rents have slowly started rising to an average $2.42 per square foot, according to Grubb & Ellis Co. The brokerage firm thinks landlords will stop offering concessions altogether this year, with rents spiking by mid-2005.

That's a turnaround from the last three years, when asking rents have been in the doldrums. To attract tenants, landlords have also been forced to ante up steep rent concessions.

Victor Coleman. Arden's president and chief operating officer, said he's seeing increased activity by tenants looking for office space--an augur of improved job growth.

"Demand for office space is as high as it's been since 2000," he said. "Job growth is out there and we're seeing it in several sectors including entertainment, health, education and defense-related industries."

Others are downright bearish. Shulman believes Southern California's housing bubble will burst in 2006 at the latest, and job growth will shrink as a result.

Another uncertainty is pricing. Real estate buyers have run up prices on office buildings by investing $4.14 billion in commercial properties last year--a record not seen since the late 1980s, according to trade publication Real Estate Alert.

Howard Stern, Arden's chief investment officer, admits real estate purchases can be challenging, particularly since private investors and pension funds from Europe, Canada and Australia have descended on Southern California looking to snap up properties while the dollar remains undervalued.

"They all want to penetrate Southern California, so the competition is fierce," he said. "We know the owners of every building and what we do is roll up our sleeves and it's really like going back to Sales 101."

Even so, yields have been falling. Five years ago, buyers could expect a 9 percent yield on a typical office purchase. Today, returns on commercial property in Los Angeles are averaging just 7 percent, according to trade publication Real Estate Alert.

"The market has moved to Arden because prices for lower-quality assets have risen significantly and a year ago that wasn't true," said Jim Sullivan, senior analyst at Green Street Advisors Inc. in Newport Beach. "But it is tough to find bargain purchases of high-quality assets. If it's an equal trade, it's worth doing."

Staff reporter Andy Fixmer contributed to this story.