By Michael Fickes
Office REITs usually prefer to hedge their property investments by assembling portfolios from across broad geographic regions. By contrast, SL Green Realty Corporation (NYSE: SLG) has chosen to build its portfolio across a half dozen or more Manhattan sub-markets—which has proven equally successful.
Since going public in 1997, the SL Green portfolio has grown from 2 million square feet to 15 million square feet. Revenues reached $309 million at the end of 2003, a 30 percent increase for the year. Net income rose 8 percent during 2003 to $62.8 million. Over the past five years, SL Green's funds from operations (FFO) have grown by about 15 percent per year, reaching $3.48 per share in 2003.
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AGE: 66
FAMILY: Married, three children
EDUCATION: Hartwick College, Bachelor of Arts. Boston College Law School.
HOW HE GOT INTO REAL ESTATE: "In the late 1970s, I sold a business and was looking for something else to do. I invested in condos in Florida, but didn't like Florida. So I came to New York City and bought a few loft buildings. That led to office buildings. And here I am."
HOBBIES: Squash. "I was a nationally ranked squash player when I was younger. The national squash championships for professionals and amateurs alike are called the SL Green Open. I funded that."
FAVORITE SPECTATOR SPORT: Football. Favorite team is the New York Giants.
FAVORITE MOVIES: "The Graduate," "Chariots of Fire," and "Memphis Belle."
FAVORITE BOOKS: I love James Clavell, all his books: "King Rat," "Shogun," and the others. Recently,
I read "The Devil's Banker," by Christopher Reich, a fabulous book.
COMMUNITY ACTIVITIES: I work with Street Squash, the Starlight Foundation and a number of non-profits.
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The company's growth has paid off for investors, too. Quarterly dividends have increased from 35 cents per share in 1997 to 46.5 cents at the end of 2003. With a market capitalization of nearly $1.6 billion, SL Green stock currently trades in the $40 range, up from less than $30 per share in March 2003.
SL Green's largest individual shareholder is Stephen L. Green, the company's founder and chairman. Recently, Green discussed the company's unique strategy with Real Estate Portfolio.
Portfolio: How did SL Green's single-city focus develop?
Green: It's a function of what we know and what we are good at. While it works in New York City, it won't necessarily work in Boston. New York City is a huge market with more than 400 million square feet of office space. The next five largest central business districts in the country combined have less office space than New York City alone. To understand the New York market, you have to understand the sub-markets.
Portfolio: How would you characterize Manhattan's various sub-markets?
Green: There's the Grand Central area, which has a lot of commuters from Westchester. The area around Penn Station serves commuters from Long Island and people working in the garment industry. Then you have the Plaza district in the 50s, between 3rd Avenue and the Avenue of the Americas, Mid-town South, the Chelsea district, and others. Each district has different types of tenants and rental points.
Portfolio: In a word or two, how would you describe your company's property strategy?
Green: Value-added. We buy older buildings that haven't been taken care of, renovate them, upgrade the tenancies, and raise the rents up to a market level to reflect the upgrades. It's a way of using creativity and efficient capital to create value. In addition, we work mostly with small tenants. Although we have one tenant with 1.2 million square feet, our average tenant leases about 7,500 square feet. Since no one tenant dominates our market, we've been able to keep our vacancy rate low.
Portfolio: What is SL Green's vacancy rate?
Green: Right now, it is around 4.5 percent, compared to 11 percent or 12 percent overall in New York.
Portfolio: You also employ a unique three-prong
financial strategy that includes wholly owned properties,
co-ownership with institutional partners, and structured
finance investments. Many REITs own properties themselves and with partners, but few seem to use your third strategy of structured finance.
Green: We've done this for a number of years. Today, others are starting to follow suit. As the returns on owning buildings have declined, the only way to make a decent return is
by taking an exposed piece of the debt, a junior position.
By adding this strategy to owning and co-owning, we have been able to balance the components of our portfolio to
take advantage of each stage of the business cycle.
Portfolio: Please elaborate.
Green: When interest rates rise, we can buy more buildings, because we have efficient equity capital. But when interest rates are low, as they are today, debt is king, and people can use cheap debt to finance 80 percent to 90 percent of their buildings. REITs can't compete with that. Our mandate is not to have a debt-to-equity ratio higher than 40 percent to 50 percent.
However, some debt today looks almost like equity, the
B-pieces on CMBS issues for example. We'll buy this
exposed debt, whether it is mezzanine financing or the junior piece of a first mortgage. We work with several banks that look to us when lending on certain types of properties. If we like the property and the price, we'll take the junior position—we're not afraid of taking delivery if there should be a problem with the property.
Portfolio: What do you see lying ahead for the office
market overall, as well as in New York City specifically?
Green: We have told our shareholders that we don't expect to see a huge change in rental rates during 2004. We expect to see some absorption as the economy improves. Although, as you know, a jobless recovery like what we've seen so far is not going to create great space absorption. Once quarterly annual earnings, annual earnings, and then jobs do begin to come back, I would expect to see increases in rents, maybe in 2005 and certainly in 2006. That's the period that I believe pricing power will return to the office market.
New York City will probably be one of the first markets to come back. I say that because our vacancy rates never reached the levels that you have seen in other cities.
