By Phillip Britt
Proactive stance, guaranteed occupancy
and local management
keys for Liberty Property Trust's
success in soft market
Like its peers in the office and industrial sectors, Liberty Property Trust (NYSE: LRY) had the daunting challenge in 2003 of dealing with continued market and economic softness. The fact that Liberty managed to weather this storm is a testament to the company's proactive business strategy, but it is even more of an accomplishment when you consider the company lost its founder, former chief executive officer, chairman and driving force Willard G. "Bill" Rouse III to lung cancer in May 2003.
Analysts applauded the company's seamless transition to current chairman and CEO William Hankowsky, who joined the company as chief investment officer in January 2001.
"Mr. Rouse was a charismatic figure with a devoted following within the company, so Mr. Hankowsky had big shoes to fill," according to an Oct. 27, 2003 report from Green Street Advisors. "In our view, he has done so very effectively by maintaining the company's strategy, as well as its tradition of ‘straight shooting' with investors."
| LIBERTY PROPERTY TRUST |
HEADQUARTERS: 65 Valley Stream Parkway,
Malvern, PA 19355
PHONE: 610-648-1700
WEB SITE: www.libertyproperty.com
CHAIRMAN, PRESIDENT AND CEO: William P. Hankowsky
EXECUTIVE VICE PRESIDENT AND COO: Robert E. Fenza
TICKER SYMBOL: LRY
52-WEEK HIGH: $38.90 (12/31/03)
52-WEEK LOW: $29.31 (01/27/03)
CORE MARKETS: Mid-Atlantic, Southeastern
and Midwestern states
|
While Hankowsky has assuaged any succession concerns, analysts remain cautious when looking at Liberty due to lingering market challenges expected to last until at least 2005. More specifically, some analysts point to lack of job growth and softness in some of Liberty's local markets as reasons for their caution on the REIT.
Liberty has "a lot of positives going for it, but in the short run, we still rate the shares as underweight," says Christopher Haley, managing director at Wachovia Securities. Haley points out that the underweight recommendation comes despite the fact Wachovia conducts business with Liberty and he personally owns shares in the company.
The primary reasons for the negative recommendation, according to Haley, are concerns about the economy in some of Liberty's core markets—suburban Philadelphia, suburban Detroit and suburban Jacksonville. The softness of the economies in those markets outweighs any strength that might be found in Liberty's 13 other geographic markets, Haley says.
Yet BB&T Capital Markets upgraded its rating on Liberty to a buy in January, citing a better market for Liberty's properties, which tend to be in secondary markets, than for those in primary markets. In its upgrade notice, however, BB&T pointed to expected strength in 2005 as another factor. This year is still expected to be "challenging."
TJX Distribution in Philadelphia |
Occupancy Guarantee
Liberty officials agree with that analysis. Hankowsky sees 2004 "as a year of transition," in which the company will try to grow in the areas that appear to be rebounding from the recent recession, and guarantee occupancy in those areas that are recovering more slowly.
Following the strategy of guaranteeing occupancy while giving up some rental revenue helped Liberty weather the recession better than some other office/light industrial REITs, according to analysts.
From 2001 through 2003, Liberty's business strategy was that occupancy was king, Hankowsky says. "We were interested in leasing the space, rather than in getting higher rents."
While cutting rental rates about 10 percent two to three years ago was a bitter pill for Liberty and its investors, making the move early in the economic downturn prevented Liberty from slashing rents some 15 percent to 20 percent as some other office REITs had to do when the economy stayed soft early in the decade, says Louis Taylor, senior analyst at Deutsche Bank Securities.
Viking Drive in Eden Prairie, Minn. |
Liberty Follows Regional Philosophy
The company did not merely set a broad rental rate cut across the board. Instead, Liberty's proactive regional-based philosophy was critical in determining changes in local lease agreements, Hankowsky says.
"We follow a city manager model; the managers are a very empowered group of people in each market they're in," Hankowsky says. This gives them the benefit of operating a local business with the attributes of a large company."
Haley also applauded Liberty's "top caliber" regional management team. "They run the business in the local markets like it's their own. The central office is there for operational support if needed. Liberty officials don't feel like they operate in an ivory tower. They're very responsive to the brokerage community and to their tenant base."
Liberty cites the following example: A company had a 70,000 square foot requirement, and had identified a particular sub-market where the firm wished to locate. A competitor had a property ready in the exact location the company needed, and negotiations started. However, the tenant's operations required a somewhat specialized building—one that was primarily office but had elements of a high-bay warehouse. While negotiations stagnated, Liberty's local manager secured a competing site and proposed a building that met all of the tenant's requirements, with fairly easy modifications already designed should the tenant need to vacate at some time in the future. The modifications would bring the building back to a standard, easily marketable product. The tenant signed a 15-year lease with Liberty.
"We've tried to create some flexibility for our local managers to operate so that they can write a [lower-priced] lease in order to get a deal done," Hankowsky says. "That matters in a down cycle. One of the biggest challenges in a tough real estate market has been increasing vacancies and decreasing rents."
However, Hankowsky adds that office REITs in general, and Liberty in particular, have weathered the latest downturn in the sector better than real estate companies did in the mid-1980s or early 1990s.
In the early 1990s, inflation spiked along with the economic upturn, stalling the rebound of the sector, according to Hankowsky. In the mid-1980s, the office sector had to overcome the tax law changes. The new tax law in 1986 made once profitable real estate investments a losing proposition due to the changes in the treatment of passive investment losses.
There were no such tax law changes this time, and to date, inflation has yet to return. Once leases expire and demand strengthens, as Hankowsky and analysts expect in 2005, Liberty will be able to raise rents.
"We see most of 2004 as a time when companies will focus on the fundamentals of their businesses," Hankowsky says, adding that these companies won't look for additional office/industrial space until their fundamentals are more solid.
UPSIDE-DOWNSIDE
Samplings of what analysts are saying about
Liberty Property Trust.
BB&T Capital Markets
Rating: BUY (1/9/04)
12-Month Projected Target Price: $41
"In terms of valuation, Liberty is also attractive, in our opinion. Based on our revised 2004 estimate of $3.20, LRY trades at a 4 percent discount to the average REIT but at a 9 percent premium to its Office & Other (sector) peers. We believe the quality and predictable nature
of its industrial rents is driving its premium relative to its direct competitors, and would expect this premium to widen further."
A.G. Edwards
Rating: HOLD (12/15/03)
12-Month Projected Target Price: $36–$43
"We believe Liberty's main opportunities are the lease-up of its existing portfolio, and acquisition and development opportunities, specifically the downtown Philadelphia office project. LRY has sufficient liquidity and balance sheet strength to be able to ramp up its development activity and acquire sizable portfolios of property. We anticipate that LRY will continue its focus on meeting the real estate requirements of its top tenants, which may take LRY to new markets in the future."
Deutsche Bank Securities Inc.
Rating: BUY (12/11/04)
12-month Projected Target Price: $42
"At 6 percent, Liberty's current yield is still 60 bps above the REIT average of 5.4 percent. As we stated when we upgraded the shares, LRY's fundamentals aren't great, the payout ratio is high, but the dividends are likely to be paid one way or another."
Credit Suisse First Boston
Rating: neutral (2/11/04)
12-month Projected Target Price: $37
"Liberty is beginning several speculative development projects (zero pre-leasing), which could add to the company's overall risk profile. Helping to offset this risk, LRY senior management has a long, successful history in the ground-up development business, although we note that leasing remains challenging in most office markets across the country." |
Making Strategic Acquisitions
Whenever the economic recovery does take hold, Liberty is prepared to capitalize by understanding that different regional markets will recover at different rates, Hankowsky says. Liberty plans to acquire properties in markets perceived to be rebounding more quickly.
Liberty acquired more than 300,000 square feet of office and flex property in Hunt Valley, Md., in the fourth quarter of 2003, all of which is 95 percent or better leased to take advantage of what company officials believe to be long-term strength in that market. Liberty also acquired four office buildings in Horsham Business Center, adjacent to Liberty's significant holdings at the Pennsylvania Business Campus, to leverage the company's existing strength in this market. The properties total nearly 160,000 square feet of space, and are 55 percent leased.
Liberty officials also expect to finally benefit from its December 2000 acquisition and development of a 90,000 square-foot site in downtown Philadelphia when nearby large companies have leases expire between 2005 and 2007. The site is currently empty.
The speculative development, One Philadelphia Plaza is suffering from the overall weakness of the Philadelphia office market the last couple of years, Taylor says. To date, the company has already expensed or capitalized $64 million of costs associated with the project, Taylor says.
Mix of Office, Light Industrial
The fourth quarter acquisitions add to Liberty Property Trust's operations in 11 states in the Mid-Atlantic, Southeast and Midwestern U.S. Liberty also has a large project under construction in the U.K., along with nine other operational U.K. properties.
Liberty's mix of properties includes more than 21 million square feet of industrial distribution space. These properties are built primarily for the warehousing and distribution of consumer products, not for heavy industry like manufacturing. These properties generally range in size from 50,000 square feet to 300,000 square feet, although larger and smaller sizes are not uncommon.
Liberty also owns 16 million square feet of first-class office properties in prime suburban locations. They generally range in size from one to five stories, and are often located in Liberty-owned office parks. Additionally, Liberty owns nearly 13 million square feet of flex buildings. Flex or office showroom buildings, are built to house a myriad of activities, including warehousing, office, research, assembly and light manufacturing.
This mix of office and light industrial properties puts Liberty in a favorable strategic position, according to Haley. "Liberty has a consistent record of above average returns on invested capital, which is one of the best metrics from an operating perspective," Haley says. "Liberty has operating skill and the willingness to invest in redevelopment."
Taylor and Haley agree that Liberty is better positioned than some other REITs to bounce back when demand for office/light industrial space returns.
"From the top down, we still think office stocks are going to be a little sluggish and recovery will take longer than it will for the economy as a whole," Taylor says. "REITs with industrial and office space are doing better than those with just pure office space. There was a lot of empty office space going into the recession."
The cost to lease light industrial/warehouse space is lower than the cost of office space to begin with, and the lease prices for the former didn't fall as far as that of office space at the beginning of the recession, Taylor says.
 "We've tried to create some flexibility for our local managers to operate so that they
can write a [lower-priced] lease in order to get
a deal done. That matters in a down cycle.
One of the biggest challenges in
a tough real estate market has been increasing vacancies and decreasing rents."
—WILLIAM HANKOWSKY
|
Though Taylor agrees with Haley that some of Liberty's properties are in soft economic areas, he adds that there are much weaker geographic areas like northern and southern California and Seattle, where Liberty has no exposure. REITs serving those Western markets will take longer to recover, according to Taylor.
Taylor also adds that Liberty had a better balance between office and light industrial space before the recession than similar REITs. With light industrial demand expected to recover before pure office space, Liberty is positioned to recover more quickly than some other REITs.
Because of these conditions, Taylor says the stock is fairly priced at current levels. As of his February 10 report he rates Liberty as a buy. Liberty closed 2003 at $38.46, near its $38.81 high for the year and for the life of the REIT. The low for 2003 was $29.13.
Liberty's dividend has increased steadily from 52 cents per share at the beginning of 2000 to 60.5 cents in the middle of 2003, marking eight straight years of dividend increases.
A Promising Forecast
In its upgrade, BB&T says it expects total returns from dividends and price appreciation to be 15.5 percent, with a 6.3 percent funds from operations (FFO) growth in 2005. Liberty officials are also optimistic.
"Now the economy is starting to heat up without the coinciding effect of rising inflation," Hankowsky says, adding that he expects interest rates and inflation to stay low throughout 2004.
Even when inflation and interest rates rise again, Hankowsky expects many investors to hang on to REITs rather than cashing them in for other equity investments.
"There's a stickiness to investing in REITs," Hankowsky says. "Having a little bit of money in REITs is a good portfolio management strategy. There's the stability aspect of the sector. With dividend growth and stock increases, REITs are something you should have in diversified portfolios."
As the economy and the office/light industrial sector of the REIT market strengthens, Taylor expects to see Liberty add more properties, though occupancy rates will drop somewhat.
"They did that very successfully coming out of the last recession," Taylor says. "I think they'll focus in Richmond, Va., and in the Lehigh Valley of Pennsylvania, where Liberty already has its strongest presence.
"Liberty is a good company that's doing well," Taylor says. "Now they have to wait for the economy."
That wait might take a while, but isn't far into the future, Taylor adds. The market for office/light industrial REITs and the economy as a whole seems to be recovering, despite flat job growth in 2003, which compared favorably to a 2 percent decline in 2001. Job growth will mean more demand for office and industrial space.
Phillip Britt is a freelance writer based in suburban Chicago.
