By Michele Lerner

Colonial Properties Trust's live-work-shop strategy keeps the company on course

Colonial Brookwood Village in Birmingham, Ala.

There are roughly two-dozen REITs classified as having diversified operations—meaning they own or manage properties in more than one commercial real estate sector. For Colonial Properties Trust (NYSE: CLP) the concept of diversity is a corporate mantra. The Birmingham, Ala.-based REIT owns and operates more than 100 properties, including more than 19,000 apartment units, 6.5 million square feet of office space and 15.6 million square feet of retail shopping space. The company varies its holdings among multiple sectors in mid-size cities in nine Sunbelt states and finds ways to diversify within those sectors by serving as operators, developers and managers as well as buyers and sellers of properties.

"Our strategy since the company was founded has been the live-work-shop concept and the expansion of mixed-use developments," says Thomas H. Lowder, Colonial Properties' chairman, chief executive officer and president. "Our strategy of diversity allows us to play offense and defense at the same time."

COLONIAL PROPERTIES TRUST

HEADQUARTERS: 2101 6th Avenue North, Suite 750 Birmingham, AL 35203 PHONE: 205-250-8700 WEB SITE: www.colonialprop.com CHAIRMAN, PRESIDENT AND CEO: Thomas Lowder COO: C. Reynolds Thompson, III TICKER SYMBOL: CLP (NYSE) 52-WEEK HIGH: $39.15 (12/1/03) 52-WEEK LOW: $30.77 (03/12/03) CORE MARKETS: Alabama, Florida, Georgia, Mississippi, North Carolina, South Carolina, Tennessee, Texas and Virginia.

On offense, the company's involvement with several market sectors allows it flexibility to capitalize on more opportunities to deploy its capital, Lowder says. "For instance, we bought lots of retail a few years ago. Now it would be a hard time to employ capital there because everyone wants to be in retail now," he says. "In the multifamily sector things are slower at this time, but we expect that sector to pick up in the next year or two, so we'll be employing more of our capital there."

On the defensive side, the company's diverse portfolio ensures that it doesn't put all its eggs in one basket, which offers shareholders a chance to avoid the low point of any one market, according to Lowder.

"We're able to keep our dividends in good shape this way. Investors can look at our company as a lower beta stock," Lowder says. "We won't ever be as challenged as some other stocks, but we also may never be as high as companies with concentration in any one market. We're less volatile, which makes for lower risk. We give investors an opportunity to play in the real estate market in a safe way."

Analysts also recognize the advantages of sector diversity. John Arabia, analyst with Green Street Advisors, says there are certain synergies in being able to offer the three property types within one development.

"In the publicly traded REIT arena, there are only a handful of companies that can create a successful multi-use property. Colonial Properties, because they have experience in all three sectors, is well-suited to do a multi-use project," Arabia says. "So if you come across a project which needs this type of synergy, then this company has a better opportunity to provide in-house expertise in all areas."

Ross Smotrich, analyst with Bear, Stearns and Company, agrees that Colonial Properties' strategy does go against conventional industry wisdom that a REIT should specialize in a given property type.

"In Colonial Properties' case, the company is differentiated by the fact that they have bona fide capability in each of its three asset types," Smotrich says. "The negative side of this is that two out of its three sectors are fundamentally challenged. We're looking negatively at multifamily and office right now because each requires job growth as a catalyst for incremental demand."

Sector Performance

Colonial Properties' third quarter financial report bears out this analysis of the three sectors, but overall, the company's 2003 third quarter numbers report that total net operating income (NOI) was down 2.1 percent for the quarter and up 3.1 percent year-to-date compared to the same periods in 2002.

		Colonial History Colonial Properties Trust has been a family-run business since the 1950s when it started building homes in Montgomery, Ala.

According to Lowder, "The retail division is having the best operations during this cycle of the economy, because this has been more of a business recession than a consumer recession. We're looking for the multifamily sector to return and improve during the next year or two. The office sector hasn't reached bottom yet, it may be 36 months before we see improvement there. We've been investing in the retail side of the business the past few years, and have sold multifamily down to 25 percent of the company. Our view is that that's going to be increasing, so we'll employ more capital in the multifamily sector."

Multifamily NOI was down 5.9 percent for the third quarter of 2003, while the office sector, the weakest of Colonial Properties' sectors this quarter, was down 14 percent.

We’re looking for the multifamily sector to return and improve during the next year or two. The office sector hasn’t reached bottom yet, it may be 36 months before we see improvement there. —THOMAS H. LOWDER

Paul Earle, executive vice president of the multifamily division, agrees, "We've seen a softening in all our markets since 2001, with vacancies and concessions increasing, but we think we've reached the bottom now. We're seeing some positive signs in San Antonio, Tampa, Fla., Orlando, Fla., and Birmingham, Ala. Occupancy rates are increasing in those places, job growth has turned positive, concessions are starting to decline and building permits are up. In the multifamily division we have short leases of six months to a year, so when the economy recovers our sector gets the benefit first."

Future predictions for the multifamily market also look healthy to Earle because of the anticipated downsizing by the 75 million baby boomers who are looking for the no-maintenance lifestyle, along with the 85 million echo boomers who will be entering the workforce and needing their first apartments in the next four to five years. Adding to the anticipated demand for apartments are the continuing immigration numbers, a demographic group with a tendency to rent for a few years before they purchase a home.

Earle also points to the cross-marketing benefits of clustering several product types together.

"In every case where we have two or three product types we have higher occupancy rates," Earle says.

Although Arabia looks at Colonial Properties' retail division as one of the company's weak spots, this sector is the only one to hold its occupancy steady, up just 0.1 percent for the quarter.

"They are one of the smaller mall owners and generally operate in tertiary areas," Arabia says. "Because of this, they aren't able to have any sort of leverage over the large national retailers in order to dictate which malls they'll go into. Larger mall owners have a competitive advantage because they can tell a national retailer that they can go into one mall as long as they also take space in another, which might be less desirable to the retailer."

The retail division has Colonial Properties' largest percentage of the total asset value, but it's also been the most recent source of trouble for the company, according to Arabia. "Occupancy in their strip malls has been well below the sector average, partly due to the loss of Kmart stores," he says. "We do believe, though, that they'll be able to make improvements in the occupancy in the future. Their mall occupancy rates are about average with the rest of that sector."

Colonial Properties anticipates significant growth over the next five years in its retail division, which is the company's largest totaling 45 percent to 50 percent of its assets.

"Retail has been under a lot of pressure the last 10 years as shopping habits have changed," Daryl Mangan, executive vice president for the retail sector, says. "We recognize that in retail we have two customers to satisfy: the retailers themselves and the customers of those retailers. We've focused on knowing the competition, making sure we're in a market that's growing, and enhancing our malls. For instance, one current project is in Myrtle Beach, S.C., where a Kmart went dark. We knew that the area has a strong population base as well as an important tourist market, so we aggressively pursued Kmart and bought back our lease. We're building a brand new Bass Pro Shop, plus an Islamorada Fish Company restaurant, along with a 14-screen, stadium-seating movie theatre and remerchandising some of the smaller shops in the mall."

Smotrich says he expects Colonial Properties' focus going forward to remain concentrated on redeveloping its assets, especially in the retail sector. He adds that the company is likely to become more aggressive in its asset management.

"The truth is, we're in a challenging real estate market that's not unique to Colonial Properties," Smotrich says. "But Colonial Properties is characterized by a relatively stable income stream by virtue of its diversified portfolio, which makes it a good choice for income-oriented investors."

UPSIDE-DOWNSIDE Samplings of what analysts are saying about Colonial Properties Trust. Bear, Stearns & Co. Rating: PEER PERFORM (10/28/03) 12-Month Projected Target Price: $39 "We believe that the dividend yield of 7.2 percent, coupled with some earnings growth, makes Colonial stock attractive to income-oriented investors, especially given its diversified asset base. ...We believe that the dividend is relatively secure based on [estimated] payout ratios, but wouldn't expect to see dividend increases until there is an improvement in earnings growth." Wachovia Securities Rating: UNDERPERFORM (10/27/03) 12-Month Projected Target Price: $34–$35 "We now expect negative FFO growth in 2004, and a cash shortfall of about $10 million. We do not expect the company to reduce its dividend, but we believe the shares are overvalued based on our new 2004 estimate, which is 6 percent lower than the Street. … Our rating reflects our expectations for continued weak leasing results and soft real estate fundamentals within key southeastern markets in which CLP operates." Legg Mason Wood Walker, Inc. Rating: HOLD (10/28/03) 12-month Projected Target Price: $35 "We continue to expect the company will complete about $64 million of sales [in 2003], leaving $30 million of assets to be sold in the fourth quarter. We still expect the company will lighten its load in retail, which constitutes 47 percent of NOI, to more evenly distribute its asset types, particularly as cap rates in the retail sector have been improving." Standard & Poor's Rating: HOLD (11/10/03) 12-month Projected Target Price: $36 "Although CLP's residential properties could struggle with record single-family home sales and a glut of new development, and its office properties face slow job growth and declining rents, we look for results to stabilize in the coming 12 months. Lease-up of completed projects should provide a boost to earnings, and we look for income from CLP's retail properties to improve, as strong retail spending drives occupancy."

Economic Impact on Development Decisions

The state of the economy also impacts the choices Colonial Properties makes when it comes to developing projects from the ground up or acquiring properties for redevelopment.

"In the mid and late '90s we purchased lots of properties, and then we changed gears and for the past few years we've mostly been developing projects," Reynolds Thompson, Colonial Properties' chief operating officer, says. "Now we're getting back into acquiring properties again. One thing our company brings to bear is that we can do either one with ease depending on the opportunity in each location. Sometimes we do both, such as at Colonial TownPark, a mixed-use project near Orlando. We developed the project ourselves and now we've added to it by acquiring adjacent land plus an office building."

Orlando Fashion Square in Orlando, Fla.

The ability to buy and sell across the sectors has brought stability to Colonial Properties along with the added benefits of cross-marketing and a smooth path for mixed-use developments.

Colonial TownPark will include nearly 1 million square feet of office space and over 100,000 square feet of retail space, along with upscale apartments. The retail component will eventually include a 12-screen movie theatre with stadium seating, a hotel, a bank, a grocery store and a Main Street-style retail village with upscale shops and restaurants with loft apartments and offices above.

While Colonial TownPark is a primary focus for Colonial Properties now, future plans for the company, according to its third quarter earnings report, focus on the expansion or redevelopment of existing projects, weighted toward the redevelopment of several of its retail properties.

"We don't expect to make a lot of changes, but we'll be trying to solidify our place in the market, particularly in the retail sector which has fared best in the current slowdown," Thompson says.

According to Mangan, "Our strategy in the retail sector is to carry the diversification of our company beyond product type and geography into the retail sector itself. Besides our traditional shopping malls, we're involved with neighborhood centers, larger power centers anchored by stores like Target and Home Depot, and lifestyle centers which are softer, more upscale with more landscaping, like Colonial TownPark. We expect to see growth in all of these sectors."

Tenant Retention Focus

While developing projects has its own importance, Colonial Properties' success also depends in part on the company's ability to attract and maintain tenants in each of its divisions. Third quarter 2003 occupancies for the company's stabilized properties were 91 percent for the office division.

"We're looking for companies that are forward-thinking, those that understand real estate can be an important part of their company," says Bo Jackson, executive vice president for Colonial Properties' office sector. "To measurably increase our client's productivity, we need to understand the key drivers for these companies, whatever they are. We try to become an enabler rather than a facility manager, and we try to run our offices as if they are hotels. Our goal is to anticipate our customer's needs. For example, we look for light bulbs that need replacing and replace them before anyone has to ask us. We know we have to be competitive on the basis of service."

Colonial Properties has trademarked the term "High Performance Workplaces™" for their mixed-use developments, part of the progressive strategy of the company.

“Our strategy in the retail sector is to carry the diversification of our company beyond product type and geography into the retail sector itself.” —DARYL MANGAN

"Looking ahead to 2005, we're expecting baby boomers to retire in greater numbers than ever before, and we're predicting a labor shortage to begin because the Generation-X group is so much smaller," Jackson says. "So you'll have young workers with the power to decide where they want to work. Forward-thinking companies will be looking at their real estate to position themselves to attract workers."

High Performance Workplaces can include such amenities as Internet-accessed benches in an adjacent park so that employees can pick up their laptops and work outside on pleasant days. Colonial Properties has designed these benches, which in the near future will provide wireless Internet access, into Colonial TownPark. This development also has two separate sources for power.

"It used to be that companies' number one desire was a fitness center, but now the number one desire is clean, redundant power sources and multiple providers," Jackson says. "Some companies had to disperse their mission-critical operations out of New York City after September 11, and they cannot risk a loss of power or risk being shut down. We're taking a holistic approach to providing technology, multiple telecom providers and multiple power providers now, even though the office sector is suffering, and we're positioning ourselves for the next cycle when this sector improves."

Service with a smile is also the strategy that attracts tenants in Colonial Properties' multifamily sector, which had a 95 percent occupancy rate for third quarter 2003.

"The biggest source of traffic in our buildings comes not from drive-by traffic, which is the leading source for most companies. Our biggest source is referrals from residents within our buildings or from employees who work in our office buildings," Earle says. "That's because we provide a high level of communication and service to all our tenants."

In the retail division, which had an 87 percent occupancy rate for the third quarter of 2003, attracting tenants depends on several factors.

"Sixty-five percent of our asset base in the retail division is provided by shopping malls, and while you can fix a lot of problems, you can't fix a bad market," Mangan says. "It helps to understand the market and to design a good physical plant and merchandise mix to attract the customers. Then we provide an aggressive property management team to make sure each mall is clean, secure and well lit. The final piece is to provide strong marketing for each facility."