With a track record of success, joint ventures between REITs and pension funds are becoming more common. But will shareholders share in the spoils?

Toward the end of 2002, Liberty Property Trust (NYSE: LRY) entered into its first joint venture as a public company. The Malvern, PA-based real estate investment trust that operates primarily in the eastern half of the U.S. formed a joint venture with the Public Employees’ Retirement Association of Colorado for Liberty’s entire southern New Jersey industrial portfolio.

In the deal valued at $123 million, Liberty contributed 28 distribution buildings totaling 3.1 million square feet and approximately 50 acres of developable land. In return, Liberty realized proceeds of approximately $110 million. In addition, the company will receive development, leasing and property management fees from the joint venture.

The move is part of an increasing trend for REITs and leading pension funds to engage in what they see as win-win joint venture deals. For Liberty, the transaction allowed it to pull cash from some of its investments while retaining an ownership interest. On the other side of the transaction, Colorado PERA was able to broaden its investments in the industrial sector.

As for REIT shareholders, there are some concerns but, for the most part, investors seem to respond favorably to companies entering into these types of joint ventures.

“Joint ventures are an attractive source of capital in an environment that is difficult for many REITs to issue equity,” says Keith Pauley, managing director with LaSalle Investment Management Securities. “Also, the returns REITs can earn from a joint venture are enhanced by the fees that they can charge. We would much rather see a REIT adding a joint venture partner to execute its development program or value-added acquisitions.”

However, with transparency a critical issue for all publicly traded companies, disclosure concerns still surround joint ventures. “Joint ventures are an issue (in terms of disclosure); they will always be an issue. So, the more that a company can show, the more it puts everyone at ease,” says Richard Moore, senior vice president and real estate analyst with McDonald Investments. “Some REITs have done a good job of putting out the fundamentals, showing details. In their annual report, some companies have a supplemental page for each joint venture that tells all the pertinent information.”

A Means to an End

These types of joint venture arrangements are not a new phenomenon in the REIT industry. REITs have been doing joint ventures with institutional investors since the late 1980s, but the pace of deals picked up considerably in the late 1990s when the publicly traded companies discovered Wall Street had turned off the equity financing spigot. Needing capital to expand, REITs turned to insurance companies and pension funds looking to increase their investments in real estate.

Joint ventures continue to be formed because they accomplish a number of goals for the REITs:

• A way to expand portfolios without the necessity of raising capital in the public market.
• As in the case of Liberty Property Trust, REITs are able to re-deploy capital.
• REITs can gain a greater presence in a market, or do a development deal on a large project, that might otherwise be too expensive to do on one’s own.
• A way to gain additional fees.

The joint venture works because it creates solutions to the needs of both parties, observes Paul Meyer, an attorney in the Chicago office of Mayer, Brown & Platt, a national law firm that has worked on a number of real estate joint ventures. “It unites one group (REITs) with experience and no money and another (pension plans) that has money but no experience.”

By teaming with a pension fund, REITs can liquefy their investments, Meyer adds, then acquire new assets from the gains.

Colorado PERA had worked with its real estate advisor, Chicago-based Heitman Financial LLC, for a year to put its deal together with Liberty Property. Heitman, a multi-national real estate investment management firm, makes investments in commercial real estate directly or in REITs. The company not only has advised pension systems in 15 joint venture deals over the past eight years, but is also putting together an investment fund that will do joint ventures.

“Joint ventures have always been part of the real estate investment industry, but the nature of the structure changed dramatically in the 1990s as the public markets evolved,” says Maury Tognarelli, Heitman’s chief executive and president.

Well-managed real estate companies always look at the various alternatives to capitalize their business plans, Tognarelli adds, “and it is in their best interest to have relationships not only on the tenant side of the market, but with the larger institutional players that look for investments.”

The joint venture concept appeals to many pension plans because it provides access to operating expertise and strategies that the plan might not have, notes Tognarelli.

“Depending on the joint venture, the pension fund has an opportunity to buy property that isn’t on the market and to create a diversified portfolio, ” Tognarelli adds. “The pension fund also benefits from being aligned with a partner that has substantial capital invested in the venture.”

Among the numerous REIT and pension plan deals accomplished since the late 1990s were: Keystone Property Trust (NYSE: KTR) and CalEast Industrial Investors LLC (California Public Employees Retirement System and LaSalle Investment Management Inc.) teaming up in 2001 to acquire $300 million of industrial properties; Post Properties Inc. (NYSE: PPS) and New York State Common Fund’s 2001 joint venture to develop a $75 million apartment community in Pasadena, CA (the third such deal between the two); and Crescent Real Estate Equities Company’s (NYSE: CEI) $47 million joint venture in 2002 with the General Electric Pension Trust for a Houston office building.

Track Record of Success

Numerous REITs across a wide variety of sectors have entered into joint venture deals for one reason or another. Three of the more active companies have been General Growth Properties Inc. (NYSE: GGP), AMLI Residential Properties Trust (NYSE: AML) and ProLogis (NYSE: PLD).

General Growth, which owns and manages large regional malls, has always understood the benefit of having a co-investor to help share the expenses for either development or operation, says Bernard Freibaum, General Growth’s executive vice president and chief financial officer. “We would rather own half of 50 malls, than all of 25 malls. Currently, we get 27 percent of our net operating income from joint ventures.”

In August 2002, General Growth formed a 50/50 joint venture with the Teachers’ Retirement System of the State of Illinois to buy four enclosed regional malls.

“Where we are able to leverage the talent and market experience of the partner, we find it beneficial,” notes John Day, assistant executive director and interim CIO of the $21 billion Illinois Teachers Fund.

Perhaps, the most significant joint venture General Growth has been involved in was its 1995 deal with the New York State Common Retirement Fund to buy Homart Development Co. and its portfolio of malls from Sears, Roebuck and Co. for $1.85 billion.

Another REIT that has been an active player in joint ventures for a long time is AMLI Residential Properties Trust. By the end of 2002, AMLI had already been involved in 50 deals, and the formation of joint ventures has become embedded into corporate policy. As Allan Sweet, president and co-CEO, notes in his company’s annual report, “joint venturing has always been a cornerstone of our business plan . . . .Our commitment to co-investment differentiates us and provides us with a replenishable reservoir in an industry that thirsts for capital.”

AMLI signs joint ventures for acquisitions and new developments. Most of its partners are either pension funds or insurance companies.

What Sweet says he likes most about joint ventures is that AMLI not only gets to expand its portfolio, but also with each new investment comes co-investment fees. “It is a question of the cost of money being paid for your expertise rather than just for your capital. By bringing in a partner we get paid fees. That allows us to earn returns outsized compared to what would happen if we only get paid with capital,” he says.

The list of these fees can be fairly extensive, including acquisition fees, asset management fees, development fees and disposition fees, or as Sweet says, “anything you negotiate with your partners.”

An Entry into Foreign Markets

The financial engineers at ProLogis have pushed the joint venture to a higher plane. The Aurora, CO-based industrial REIT joint ventures into “funds,” especially as it expands its properties and investor base overseas. The company’s eight funds usually have multiple investors instead of one, although its Japan fund is with one investor.

The fund ProLogis has for its European properties boasts 19 institutional investors. And then there is a fund of Australian investors, but the properties are all in the United States.

Generally, these joint ventures work the same way as those done by other REITs. ProLogis contributes its own properties to the deals, retaining a 20 percent interest in the ventures.

ProLogis opted to expand internationally because it needed to follow important customers, says Walter Rakowich, the firm’s chief financial officer. “A lot of our business is customer driven and they were telling us back in 1995 that we needed to be in Europe as distribution markets were going to change. The same thing happened in Japan; DHL came to us and said the market was highly inefficient there from a logistics point of view and needed to be more efficient.”

The problem was that to expand globally costs billions of dollars. “It is a capital-intensive business, and we felt raising public equity or debt would dilute shareholder value, so the best way to do that was to access the private equity market which loved to own industrial product,” Rakowich adds. “The funds were really a matter of customer relationships, growing globally and accessing a very strong capital base of private equity sources.”

Camden Takes Cautious Approach

While AMLI and General Growth actively seek out joint venture deals, Camden Property Trust (NYSE: CPT) has only been involved in one such deal and remains cautious about entering into another.

The Houston-based multifamily REIT acquired a company called Oasis, which at the time was the largest apartment owner in Las Vegas. As a result of the merger, Camden became overweighted with assets in that one city, so to make the deal work, it formed a new company to acquire about 50 percent of the Oasis portfolio. Called Sierra-Nevada Multifamily Investments, the new company was a joint venture between Camden and an unnamed corporate pension fund. Camden kept a 20 percent interest in Sierra-Nevada, plus received fees for property and asset management.

However, Alison Malkhassian, Camden’s senior vice president of acquisitions and dispositions, says her company has not done another joint venture for a number of reasons, one of which is fees. “In many cases institutional partners are not making a distinction between us as a partner and us as a fee manager. Potential investors have not been willing to provide adequate compensation for asset management, which we still have to provide in terms of handling the venture, accounting, reporting and everything else including managing the office.”

Additional Concerns

The two other reasons why Camden has not attempted any new joint ventures: portfolio concentration and shared risk. In regard to portfolios, Camden hasn’t found a partner willing to take a portfolio concentrated in one city such as in the Oasis deal.

“Even when we found a portfolio of properties in three cities, partners wanted the 24-7 cities, or new construction or inside the loop in Houston or in California or Florida,” Malkhassian says. “They want assets that do not allow us to achieve our diversification objectives.”

In addition, Camden has found that domestic pension funds generally are not willing to assume a partnership interest as significant as it requires. In the Oasis deal, Camden found an 80 percent interest partner for the spin-off vehicle, but most pensions really don’t want to do more than 50 percent. “We can do that on our own balance sheet and we can do it less expensively,” Malkhassian adds.

For example, Caisse de depot de placement du Quebec, which manages funds for public and private pension and insurance plans in Canada, has partnered with General Growth since 1997 and the two now co-own 10 properties. Caisse is one group that prefers the 50-50 percent split. “We favor the 50-50 relationship because we like our partners to have as much to lose as we have,” says Andre Collin, president of Caisse’s real estate unit. “We are not 100 percent strict on that but 80-20 is not what we are looking for.”

“Having been on the pension side, it is much easier to sell to the board 50-50 partnerships rather than 80-20 partnerships,” says John Roberts, president of AMB Capital Partners LLC, a unit of AMB Property Corporation (NYSE: AMB).

The San Francisco-based industrial REIT has done five joint ventures with pension systems since 1998. As with Camden, AMB’s goal is for it to have a 20 percent interest and the pension an 80 percent interest, which has happened with all of its joint ventures except one, where it did go 50-50. In 2001, AMB formed a partnership with GIC Real Estate Pte Ltd., the real estate investment subsidiary of the Government of Singapore Investment Corp., to own and operate distribution facilities in the U.S.

GIC committed $75 million of equity to be invested in a portfolio of distribution facilities. AMB contributed $76 million of equity through a combination of cash and a contribution to the partnership of 59 industrial properties.

Funds Look for Diversity

The acquisition of a portfolio such as in the Camden example is just one type of joint venture, and in most cases pension funds do prefer a broader geographic perspective in the deal. Otherwise, pension funds favor this type of deal because they obtain a group of stable properties that provides a steady income, explains Robert Lehman, a partner with Ernst & Young’s Real Estate Group in New York. “They would rather the portfolio be diversified, less reliant on one tenant or one building.”

A better example of this kind of deal was the 2001 acquisition by CalWest Industrial Properties LLC (a joint venture of CalPERS and its real estate investment advisor, RREEF) of Cabot Industrial Trust for $2.1 billion. Cabot’s portfolio included 360 industrial properties in 19 major metro areas around the country.

Similar to the portfolio deal, REITs partner with pensions for development or redevelopment deals, but Lehman notes, “I cannot imagine that kind of structure is very popular today. With the rise in vacancy rates, there’s not a lot of reason to be out there building new properties today.”

Monetize Existing Properties

There’s also a third type of joint venture that’s a bit more complicated, but nonetheless has continued to remain very popular because it allows the REITs to monetize properties already owned.

In this transaction, a REIT will take properties from its portfolio and contribute them to a joint venture. An institutional investor will then pay the REIT a percentage of the value of those properties in cash and give up a minority ownership interest for the remaining value of the property. The REIT not only keeps a minority interest in the joint venture, but also ends up managing the properties. For example, if a property was valued at $11.50 per square foot, the investor would buy the asset at $11.50 per square foot, paying cash for $10 per square foot and give up the ownership interest for the remaining percentage of the cost.

“These deals make perfect sense because the REITs don’t really want to sell the properties as it would generate taxes,” explains Lehman. “It allows the REIT a cash return without losing control of the asset. The pension plans get a good income stream and a preferred position on the portfolio of assets.”

In August 2002, CarrAmerica Realty Corporation (NYSE: CRE) formed a $422 million joint venture with the New York State Teachers’ Retirement System in which it contributed five suburban office parks consisting of 2.5 million square feet of stabilized properties, 461,000 square feet of office projects under development and land that can support approximately 1.5 million square feet of office space. The Washington, D.C.-based office REIT will retain a 35 percent interest in the partnership.

“One of the reasons we did this particular venture,” explains Karen Dorigan, CarrAmerica’s chief investment officer, “was that these were newly constructed buildings that were leased. We had created a significant amount of value in the parks and we decided to pull out some of the value.”

In addition, the assets were still viewed as strategic for CarrAmerica, and the company wanted to keep a long-term interest in the properties.

“Doing a joint venture allowed us to recognize some of the value created in the parks and pull out some of the money, which we could use to reinvest in our own stock and in new
acquisitions,” Dorigan adds. “It also allows us to continue to lease, manage and own, in part, those assets for a long time.
Also, [it allows us to] continue the remaining development of those parks.”