COVER STORY, NOVEMBER 2005

REIT ACTIVITY IN THE NORTHEAST
Two REITs talk to Northeast Real Estate Business about how their markets are performing.
Interviews by Nicole Thompson

Despite a tough acquisition market, REITs in the Northeast are still performing well, turning to other options for growth, including development of new projects.

Northeast Real Estate Business Editor Nicole Thompson talked to two REITs in the Northeast to find out how markets are performing. NREB interviewed Mitchell Hersh, president and CEO of Mack-Cali Realty Corporation, which has more than 30 million square feet of Class A office and office/flex space, and Cindy Morse, executive vice president of asset management at Equity One, a REIT composed of mainly grocery-anchored shopping centers with more than 19 million square feet of space.

NREB: On a general basis, what trends are you seeing in the REIT market across the nation?

CINDY MORSE (Equity One): In general terms, REITs are going to a more urban markets, going into vertical, mixed-use type developments with components outside of retail — some are going residential, some are going office.

REITs have delivered returns — basically, we've outperformed the Dow Jones Industrial Average across the board. REITs continue to be a little bit more conservative in this crazy acquisition market, and I believe we'll continue to outperform other types of investments.

MITCHELL HERSH (Mack-Cali): If we're talking about capital markets issues, REITs have continued to perform very well in the equities market as a result of the predictability of the fixed-income element, along with the fact that, as has been demonstrated over what has been a difficult economy over the last 3 or 4 years, REITs have performed well. The cash flows in general have done well, and the stocks have done well, so investors have realized their goals and objectives, which is to have an element of fixed-income yield at a pretty healthy level, generally speaking, the 4 to 7 percent range for the majority of REITs, and a fair amount of capital appreciation based on the rise in price of the stock, so from a capital markets perspective, the REITs have done well. From a real estate perspective, I think that generally speaking, REITs are performing well, given market conditions.

NREB: Are there any differences for REITs as far as the Northeast is concerned compared to the rest of the nation?

MORSE: I believe that, for example, Boston-area retail properties have significantly higher occupancy rates than other markets in, the South, for example, and when you look at that type of an occupancy, that drives rental rates up, and those locations are what we would refer to as irreplaceable land opportunities.

I think all of the urban markets within the Northeast are very high-growth markets. That's where we want to be.

When you're looking at the NE, and urban markets, you rely less on car traffic, and it's much less of a parking-lot scenario than you see in typical retail development. Our groceries are coming around to the same thinking as the property owners in the fact that a large parking lot isn't all that welcome any more. When you have area where land is so dense and desirable, the opportunity to improve and use the streetscape itself is just so very different than it would be in other markets of the country.

You also have opportunities within urban markets for brownfields, where in a suburban market you would probably avoid those opportunities.

NREB: What strategies and guidelines does your company follow in regard to investing in new projects?

HERSH: We're certainly involved in a number of initiatives right now, and hopefully all of them will come to fruition over the next several months, and these are value-added opportunities where we have been able to deploy some advantage as a result of a couple of things. Number one, the relationships — a couple of deals are based on long-term relationships between myself and leadership at several companies, where the comfort factor and past track record will be clearly demonstrated. And number two, the fact that we have some very valuable currency in the form of Mack-Cali's UPREIT stock, which are commonly referred to as OP units — we're helping a group of owners realize their objectives to be able to sell property and manage their stakes with a tax-deferred instrument, which is a essentially a share of stock in Mack-Cali, but held in the UPREIT, which has certain tax-deferral benefits.

MORSE: We're very cautious right now about the acquisition environment. Equity One has made a decision not to pursue acquisitions to the lowest point just to develop growth in that area. Because acquisitions are so challenging right now, we have been outbid on a lot of projects over the last previous year. There's so much capital and so much demand for shopping centers, we've probably sat on the sidelines a little bit more than we're comfortable sitting.   Where we used to be among the very few buyers, now we have pension funds, we have non-real estate investors, everybody chasing these retail properties. We've had to turn more to development and redevelopment projects as an alternative.

NREB: Is your company facing competition from private owners?

MORSE: Prices have escalated to levels that are making it tough for REITs to acquire properties at good cap rates, or return. We have a board of directors to answer to, when you have non-real estate investors, or private investors, they don't answer to anyone outside of their own criteria. So you're seeing, for example, 2 years ago, you might have seven offers at the max on any individual project. Now you have 37.

HERSH: You have a lot of buying constituencies out there that are deploying huge levels of leverage, and certainly many of them have taken advantage of the low interest-rate environment. You're going to see a lot more change in that, because I think that many debt holders are getting concerned about rising interest rates, and they may want to lock rates, and that may present certain issues and certain challenges for them, and maybe some opportunities for us down the road.

NREB: What are some of your company's goals for the next 2 to 5 years, including development opportunities?

MORSE: We're looking to expand in markets that we feel are high growth, much like acquisitions that we made in Boston. Equity One is looking at markets between Raleigh-Durham and Boston.

This past year, we have worked hard to find some quality inventory within Boston, and we've been outbid on projects, but we're mostly looking for large portfolios, which are very difficult to find. One of the things that we've looked at, in a portfolio we own in Boston, are two developments with opportunities for some vertical development. In Quincy, Massachusetts, for example, it's probably a great property for residences. The City of Quincy is permitting a zoning overlay that actually would encourage active development. We will be working with Albertson's on an opportunity to put residential development above that grocery store and retail level. We have another one in Cambridge, Massachusetts, that again, would be a great opportunity for a mixed-use development. We feel that neither of those properties are maximized for what they can cater to the community.

NREB: What areas of the Northeast is Mack-Cali most interested in terms in new development and/or acquisitions?

HERSH: Anywhere from Washington at the present time up north through Fairfield County, Connecticut.

The Mid-Atlantic through the Northeast region is a very important component of our future, and we're very heavily vested in New Jersey. If we went all-in, we could develop approximately 6 million square feet in New Jersey between Harborside and Parsippany and Princeton. We have some development capability immediately outside Philadelphia International Airport.

We're doing some infill development in a couple of areas in the near future in some smaller towns, areas like Monmouth County that are experiencing very high growth and great quality of life, and I think that there will be niche opportunities.

NREB: Are you finding growth for your investors more through development as opposed to acquisitions?

MORSE: In this particular 12-month period, I would say that's correct. Equity One is going to grow more thoughtfully, and we're not going to stray too much from our principal mission, which are the groceries.

As a particular growth technique, though, we might now do a development for a pharmacy, a small strip based around a pharmacy or a discount store, in markets, for example, where we already have quite a few grocery-anchored shopping centers.

HERSH: I think that it will certainly be a combination of acquisitions and development, but we have a land bank in the company to support a half-million square feet, which is fully approved, fully entitled, and it's ready to go. We are in the process, we just got a site-specific approval, in Mercer County, New Jersey,   on a project that is a 120,000-square-foot build-to-suit for a very high-end tenant on a 15-year lease, and that was in part due to a relationship that I had with the tenant, and in part due to the fact that we have a parcel of land on a campus in the vicinity of several existing facilities of this particular company. They wanted to consolidate, and they wanted to get space-age technology in their building, so it was a transaction where not only are we involved in a build-to-suit on our land that was all ready to go in terms of its master plan and land plan, and merely needed a site-plan approval, which we've already gotten, but we're also acquiring their existing property. Our cost basis will sufficiently low where we can redevelop the property, and have a whole new inventory within that community to develop new properties.

As we continue to move into an improving economy with major global companies that really want the latest and the greatest in terms of space efficiency and technology to minimize the cost of occupancy and remain competitive in a global economy, you're going to see a lot more new development. I think that is evidenced in part by, if you look at Manhattan, and particularly Lower Manhattan, so many buildings today are being sold for condo development because the residential market is on fire, and some of these buildings are functionally obsolete and can't be competitive in the marketplace. So, you're seeing new paradigms evolve, and I think that will continue. Those companies that have development expertise, that have land inventory, particularly in high barrier-to-entry markets, like the Northeast, will do well. For example, with prices as they are in New Jersey, given the environmental regulations and constraints, and the transportation and infrastructure issues, even if you could find a piece of land in a decent location, it could take you 2 years to get through the approval process, and you could miss a market, and it could cost you serious money to get that approval in the first place. And so I think the high barrier-to-entry markets will be important markets for companies like Mack-Cali to develop new product, and really create better financial opportunities for the company and its shareholders in the future.

NREB: Are there any other techniques that Mack-Cali is using to find growth for investors in a very challenging market?

HERSH: Well, we do a lot of blocking and tackling. Our occupancies, historically, through the most difficult times, have always had a nine in front of them.

We work really hard, and we have great relationships with a lot of big tenants, and a lot of big tenants who also have small installations. I think we've generally outperformed the broader markets by wide margins.

We're out there fostering these new opportunities to do below-the-radar-screen acquisitions where we can deploy our currency, where we could deploy our land, and our development expertise.

It's a combination of things, and we do everything we do with an eye toward maintaining fluidity and flexibility in our balance sheet. It's second to none in terms of balance sheet strength, we're investment-grade rated, BBB flat from all the agencies, and so we can certainly go out there and deploy capital on a very cost-efficient basis, and we're very focused on property management and client and tenant satisfaction, where we can, it's quality of life at the end of the day.

NREB: If you had to characterize the office market in the Northeast right now, how would you do so?

HERSH: Looking broadly at the Northeast, I would summarize it as a modestly-improving market, which of course really depends on the particular submarket, but we have seen a modestly improving environment. My hope is that will not be altered by the rapidly rising cost of fuel and energy, and its impact on consumer spending and its potential impact of confidence. That's number one. And obviously, we've had some horrific natural disasters, and I'm hopeful that we don't get destabilized because of the federal deficit that's going to grow so significantly to thwart the cost of redevelopment in those areas. Also, at least on a short-term or anecdotal basis, the jury's still out on it, we're seeing higher costs in the construction industry as a result of the immediate need for the goods and services and labor to help with the rebuilding effort.

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