L.A. developers hit Wall St. with wave of REIT offerings.

IPO market for real estate investment trusts booms

Cash-hungry Los Angeles developers are looking eagerly to Wall Street, where investors are in the midst of a real estate shopping spree.

In the last six months, the market for initial stock offerings through real estate investment trusts, or REITs, has exploded. And many Los Angeles investment bankers and attorneys say they are working on new issues for local firms ranging in total asset size anywhere from $25 million to $1 billion.

"I've been working in the REIT area since the early 1980s and I've never seen anything like this," said Jim De Bree, national director of the REIT advisory group for accounting firm Deloitte & Touche in Los Angeles. "You name any developer in this town with $50 million in assets and they are looking at a REIT."

Reportedly, the hot deals in Los Angeles include an estimated $80 million special purpose REIT of medical properties for Triangle Properties, a spinoff of Beverly Hills-based G&L Development. Watt Industries is said to be in the early stages of trying to raise an estimated $40 million to $100 million through an initial public offering for a spinoff company called Pacific Southwest Housing Corp. Santa Monica-based American Golf Corp. is reportedly looking at an estimated $200 million REIT through which to sell interests in the firm's golf courses.

Heavyweight underwriters such as Merrill Lynch & Co. are rumored to be working on a $1 billion REIT financing for an L.A.-based development firm. A spokesperson for Maguire Thomas Partners -- one of few local firms boasting a portfolio of that magnitude -- denied that Maguire Thomas is considering the REIT route. Merrill representatives didn't return phone calls.

Sources cited a plethora of arguments in favor of exploring a REIT issue.

"For anybody in the real estate market today who wants to expand or do refinancings, it's the only capital market that's open," said Stephen Berini, managing director and head of real estate for Gruntal Capital Markets in Los Angeles. Gruntal is working on 10 financings and expects to file with the Securities and Exchange Commission for two REITs, one in San Diego, the other in Los Angeles County.

Under the REIT structure, a company manages a real estate portfolio to earn profits for shareholders. The portfolio may include an array of real estate including shopping centers, industrial parks, apartments and hotels. To avoid corporate taxes, a REIT must distribute 95 percent of its taxable income to shareholders.

REITs come in three asset-specialty varieties: equity investments, mortgage loans and a "hybrid" that includes a mix of the other two.

With traditional lenders such as banks, insurance companies and pension funds still shying away from real estate, REITs are attractive to developers because they allow a company to tap the capital markets for cash without taking an entire company public. A REIT allows a company to sell some assets and retain flexibility.

Investors like REITs because yields typically range from 7 to 9 percent, shares are generally quite liquid -- most are traded on stock exchanges -- and share values are known.

So with bonds and other fixed-debt instruments yielding relatively low interest returns and traditional real estate capital sources continuing in a "crunch" mode, Southern California property owners are preparing to jump on the REIT boom despite the local real estate recession.

"There is an incredible volume of behind the scenes activity of people, primarily property owners, that are preparing REITs," said Michael Meyer, managing partner with accounting firm Kenneth Leventhal & Co., which is working on a $1 billion REIT for a California developer, according to Meyer.

Indeed, as Main Street has shied away from lending money to developers, Wall Street has been gobbling up hundreds of millions of dollars in securitized properties in the past six months.

The National Association of REITs reported that $962.2 million in new REIT issues were offered during 1992, including $552.8 million during the fourth quarter alone. Including investments into existing REITs, the entire REIT industry raised $6.6 billion last year, smashing 1986's record of $4.7 billion, according to NAREIT.

Hence, REITs represent an alternative financing vehicle local developers can't ignore. The trusts are the wave of the future, many sources agreed.

"I do believe future financing for our industry will come from the public," said L.A. commercial developer Jerry Snyder, president of JH Snyder Co.

Snyder Co. management is "just now looking into" the REIT alternative with accountants Deloitte & Touche, and a team is "planning to go to New York soon to meet with investment houses," Snyder explained.

While REITs are "the vehicle of the future," they are not an option for every real estate company, said Kathleen M. Connell, president of Connell & Associates, a Los Angeles-based investment banking firm which specializes in real estate.

"What we are finding is that people what to get educated about the REIT vehicle. Some want an exit strategy, but this is not a way to escape their problems," she cautioned. "If you are bleeding to death today, a REIT is not the medicine for you to get healthy," said Connell, who is working on several REIT deals.

One major local commercial developer who feels it's too early to jump on the REIT bandwagon is John Kilroy, Sr., founder of Kilroy Industries. From a developer's perspective, changes pending in Washington might significantly affect the viability of establishing a REIT, Kilroy noted.

Uncertainties Kilroy mentioned include the fate of federal legislation allowing pensions to invest more heavily into REITs; the extent to which "passive losses" restrictions on real estate investments are eliminated; and potential bank reserve requirement policy changes.

Sources also suggested that REITs of Southern California properties, no matter how strong, may face market perception problems on Wall Street, because of the severity of the real estate downturn in California.

"Southern California clearly has a stronger marketing challenge than other areas of the country," said Connell. "There are still some very strong portfolios here, especially in apartments and retail. The key is pricing."

Daniel Alpert, head of real estate investment banking for Oppenheimer & Co. in New York, agreed, saying that "one has to expect some sort of discount for a California-based REIT. I think there are people who will point at Southern California and ask 'why, if we have a choice of all the other areas, would we invest in that area?'"

To package a portfolio of L.A. properties into a REIT, an owner "would need long-term leases with credit tenants or it would be perceived as just too risky," said Leventhal partner Richard Klein. "It would still be difficult to sell but not necessarily impossible."

As expected, some idled L.A. developers hope to use REIT issue proceeds to fund future developments. But there's no guarantee the market will buy into their aspirations.

"I don't know if REITs tied to future development sites are doable yet," said Snyder. "But we feel it's doable to combine several existing properties with a couple development sites."

Klein isn't quite convinced. "You would be disappointed if you expect to raise construction financing for future developments in L.A. (through a REIT) unless you have an exceptionally strong reason for developing."