From Heirloom to Commodity

Another Mainland owner displaces a family estate on our list – how will that

November, 2004

By all accounts, the offering resulted in a feeding frenzy rarely seen since the Japanese sell-off of hotel properties in the mid-1990s. Unlike those deals, this one highlighted Hawaii investment opportunities beyond hospitality and retail properties.

The frenzy made Massachusetts-based real estate investment trust HRPT Properties Trust (NYSE:HRP) – which has $4.5 billion invested in commercial office and industrial properties – Hawaii Business’ 12th wealthiest landowner (see list on page 40). The deal also expanded perceptions of Hawaii real estate investment opportunities. Like many Mainland investors, HRPT’s first foray into Hawaii involved the visitor industry. The firm acquired the Kauai Marriott (a Marriott-managed property) three years ago under a separate Real Estate Investment Trust (REIT), Hospitality Properties Trust (NYSE:HPT). The Damon Estate purchase represents HRPT’s largest industrial acquisition, with a 2003 tax-assessed value of $585 million. By comparison, HRPT owns 32 million square feet of Class A office space in 30 states.

Kirk Belsby, vice president for endowment for the state’s wealthiest landowner, Kamehameha Schools, says, “The purchase was well reported in the Mainland media, and it opened eyes among people who hadn’t realized what was happening here. This was a decisive purchase that gave them confidence in Hawaii’s economy.” Andres Albano, vice president for CB Richard Ellis, says, “When these investors looked at the Damon Estate assets, quite a few of them went out to buy other properties, then the word gets out to the East Coast: ‘Hey, you’ve got to take a look at Hawaii.'”

The interest in Hawaii may also bring new potential development partners here. “There were 20 institutional buyers who showed up, and while ultimately there was one winner, the state was exposed to the other 19. We expect they will come back,” says Belsby.

Ethan Bornstein, vice president for Reit Management and Research (the investment manager that manages all properties owned by HRPT Properties Trust), says the scale of the Damon Estate offering and its primary location – between downtown Honolulu, Honolulu Harbor and Honolulu Airport – attracted the company’s attention: “This was a rare opportunity to acquire 9.8 million square feet of land, much of it contiguous, in the strongest industrial market in Hawaii,” says Bornstein.

Larry Taff, managing partner of the Shidler Group, and one of the bidders for the property, says, “There’s such a concentration of land that the opportunity for someone to buy that much property in a single transaction doesn’t come along in Hawaii very often.”

Boosting the Damon property’s value, Bornstein says, is that “Hawaii has high barriers to entry, strong demand from investors and users and a limited land supply, which are typically catalysts for real estate appreciation.” He says the continued growth of Hawaii’s economy, lack of new supply, near 100-percent occupancy, the stability of long-term leases and the nature of tenants, who earn their primary incomes from the properties on the lands, also made it a secure investment.

Most experts predict that the transition from a family estate to a publicly traded trust means more capital investment and big changes to Hawaii’s landscape. Case in point: General Growth Properties’ development of former Victoria Ward properties. Bornstein says that some of the Mapunapuna land has already increased in value due to high tenant demand. In the near term, the company will evaluate opportunities to either help existing tenants with renovations, finance new projects or build its own buildings to lease back to potential tenants.

According to Bonnie Oppermann, Hawaii area manager for Reit Management & Research LLC, one example of this business strategy is the recently built, HRPT-owned Malolo Business Center at 120 Sand Island Road, most of which is leased to Malolo Beverages & Supplies, Ltd. Oppermann, who was formerly the assistant operating officer for Damon Estate, says, “This is a new industrial building that we own in fee. We get the entire rental stream for the building, rather than just the leased fee portion.” This is more in line with HRPT’s commercial properties on the Mainland. Bornstein says HRPT considers acquiring leases “an excellent way to increase portfolio yield.”

Because the pay-off for a publicly traded company, such as HRPT, is usually measured in years rather than generations, Steve Sofos, president of Sofos Realty Corp., says, “I think they’re going to have some pressure at some point to sell, and they’re going to start dumping their real estate … For the most part, [Mainland owners] look at real estate as a commodity and not an heirloom. Previous landowners looked at property and said, ‘I’m going to own this for the next 50 generations.'” In contrast, he adds, “The Mainland guys come in and look at it as pure dollars and cents, and if somebody wants to buy the land, they’ll say, ‘Fine, we’ll sell it to you.'” Jamie Brown, president of Hawaii Commercial Real Estate LLC, says that, in some cases, the turnover period can be as short as five years.

Taff says that was the Shidler Group’s plan with the Damon Estate land: “Our plan was to buy it and actually sell it off to the owner-users. We didn’t intend to hold the property. I think the property is worth more to the owner-users than to an investor.” Despite the change in ownership, he says, HRPT’s buy-and-hold strategy may not result in any significant improvements, because tenants generally don’t make improvements to benefit their landlords. Sofos says that owning the fee is what gives small businesses pride of ownership, and the ability to obtain long-term financing to improve their businesses.

However, Bornstein says setting lessees’ rents through the end of their lease terms can have the same stabilizing effect: “This allows businesses to plan for the future and obtain bank financing, which is difficult to get with unknown rent terms.” Oppermann adds, “Some lessees choose not to exercise that option,” acknowledging that some may be wary of negotiating long-term fixed rent, fearing a repeat of the Japanese real estate bubble. But, looking forward, she says, “It’s difficult to borrow the funds to build without knowing what your rent will be for the next 10 to 20 years.”

Bornstein says that, despite Sofos’ prediction of a sell-off in the short term, HRPT’s refusal to sell the fee is an indication of its long-term investment horizon: “Selling fee interests is not part of our business plan, since we believe property values will increase in the future.” Oppermann adds. “As a real estate investment trust, our shareholders receive small benefits from short-term gains compared to long-term appreciation at higher levels … I can look at least 50 years into the future,” she says, “There are 20- to 50-year leases out there.”

However, because of this long-term horizon, HRPT has the tough job of addressing the property’s infrastructure problems. “It doesn’t make sense to invest in a property and do business as usual,” she says. The challenge is the patchwork of regulations over different areas on the same property. For example, the flood-prone intersection Ahua and Kilihau Streets belongs to the City and County. Nimitz Highway belongs to the state, and the nearby stream is partly owned by both and a separate private owner.

Oppermann says, “The solutions are more complex … It’s hard enough to work with either the city or the state; it’s harder to get them to work together.” She says that while government entities may prefer that the new landowner fix the problems, “That’s not the right solution, when we and the lessees pay almost $6 million in property taxes annually.” Bornstein says the company plans to work with local government to come up with long-term solutions.

Despite the challenges, Bornstein says that HRPT is looking for more opportunities to invest in Hawaii: “There is nothing planned at the moment, but we are anxious to acquire other commercial office or industrial properties in Hawaii that will complement our existing portfolio.” Chances are, they’re not the only ones. The only certainty is, as more Mainland institutional investors turn their attention to Hawaii, the hand-off among landowners will increasingly be, not to the next generation, but to the highest bidder.

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