Posted on: Sunday, December 21, 2003

$480 million land sale introduces major player

By Andrew Gomes
Advertiser Staff Writer

Damon Estate Samuel Mills Damon, son of a missionary, was an owner of Bishop & Co., forerunner of First Hawaiian Bank. He died in 1924;
his will established a private trust to administer his assets. The estate's most valuable O'ahu holdings were 235 commercial/industrial acres, including land in Mapunapuna and Kalihi Kai. It owns the 117,636-acre Kahuku Ranch on the Big Island and more than 3,700 acres in Moanalua, including Moanalua Gardens. The estate sold its residential lands in Salt Lake and Moanalua in the 1950s and '60s. Advertiser library photo
HRPT Properties Trust's purchase of land in Mapunapuna, an aging industrial area prone to flooding at high tide, raised questions with some stock analysts. But the firm says the area is well-located near the airport and harbor. Rebecca Breyer • The Honolulu Advertiser

When the Damon Estate sold 224 acres of its O'ahu commercial property to a Massachusetts-based real-estate investment firm earlier this month, more than 100 Hawai'i businesses inherited a new landlord.

As HRPT Properties Trust gets ready to take over management of new Hawai'i assets concentrated in Mapunapuna and Kalihi Kai, many in Hawai'i still don't know much about the company that became a major landowner with its $480 million purchase.

HRPT, a real-estate investment trust traded on the New York Stock Exchange, has been in existence for 17 years and gained a reputation as a conservative company that invests mainly in office property rented to high-quality tenants with long-term leases.

As a REIT, the company generally doesn't pay federal income tax on net income distributed to shareholders, the biggest of which are institutional investors such as Vanguard Group, Warren Buffett and Goldman Sachs.

The Damon portfolio of mostly industrial land with long-term ground leases was HRPT's highest-cost purchase and its only substantial land investment. The O'ahu assets now represent about 12 percent of company annual revenue in excess of $400 million.

The deal surprised some analysts, though HRPT has a history of making divergent real-estate acquisitions.

HRPT was formed in 1986 as Health and Retirement Properties Trust to invest in retirement communities, long-term care facilities and other healthcare-related property.

In 1995, the company formed a subsidiary to acquire 21 Courtyard By Marriott hotels from Host Marriott Corp., and quickly spun off the business into a separate company called Hospitality Properties Trust, which two years ago bought the Kaua'i Marriott.

In 1997, Health and Retirement Properties diversified again, investing in office buildings leased to federal government agencies, then changed its name to HRPT in 1998. By last year it had paid $3.1 billion for 212 office buildings in 27 states and Washington, D.C.

Today, HRPT is more accustomed to leasing property to government agencies — its largest tenant — and large corporations including Motorola, Comcast and Wachovia, in contrast to former Damon tenants, such as Ken's Auto Fender, Hawaii Nut & Bolt and Moo's Machine Works.

Moreover, HRPT was more apt to buy gleaming office towers with names such as One Memphis Place and Mellon Bank Center, than nondescript warehouse complexes in deteriorating industrial communities prone to flooding.

Damon buy questioned

John Stewart, vice president of research and economics for Merrill Lynch Global Securities, which owns HRPT stock and has a banking relationship with the company, said he was "not overly enthused" about the Damon purchase.

Stewart said the Damon portfolio, like other HRPT assets, is well located and has long-term, triple-net leases, which means tenants pay for operating expenses such as property taxes, utilities and insurance. But he was concerned the company had strayed from its core competencies.

"For them, it represented a new property type in an unfamiliar market which is 5,000 miles away from their headquarters," Stewart said. "It's very different than collecting rent checks from the U.S. government."

Stewart also said in a research report that one of his reservations was the purchase price, about $49 per square foot, a "full price" at about market value, even though it's a bulk purchase of land that has some environmental cleanup risk.

The purchase price rekindled a regular criticism of HRPT for its management setup. The company, in a unique arrangement for a REIT, employs a separate firm to prospect for and manage investments, and pays the firm based on the value of assets.

Analysts cite the arrangement as a conflict of interest, because the management firm, Reit Management & Research LLC, is led by HRPT managing trustees and employs HRPT officers and directors, creating incentive to buy property for the sake of maximizing assets and management fees, regardless if whether the deal is in the best interest of shareholders.

HRPT shareholders, however, did not react negatively to the Damon deal, as HRPT stock more or less climbed from November as word of the deal spread. On Friday, HRPT stock closed at $10.11 a share, down 4 cents from a 52-week high a day earlier.

"They do not seem to have been penalized because of this deal," Stewart said.

'Great opportunity'

Ethan Bornstein, a Reit Management vice president, said the Damon purchase was not a stretch for the company.

"We do not see this as a challenge, but as great opportunity," he said. "We will have a strong management team on the ground in Honolulu along with the support and resources of our headquarters in Newton, Massachusetts."

Bornstein added that before the purchase, HRPT owned about $250 million of industrial/research and development property.

To help manage the O'ahu portfolio, Reit Management hired Bonnie Oppermann, Damon's former assistant operating officer, as area manager. The company anticipates hiring at least one or two more people in Hawai'i.

Additional employees may be hired as needed, as the company plans to acquire more Hawai'i property, Bornstein said.

The Damon portfolio, put up for sale earlier this year, interested HRPT because the property is among the best-located industrial land in the state, near the airport and Honolulu Harbor.

The former Damon leases will generate about $37.5 million in average annual revenue under long-term leases.

"We are long-term holders and believe that this is a solid investment with limited downside and substantial upside potential," Bornstein said.

Longer leases sought

HRPT's O'ahu portfolio includes about 3 million square feet in Mapunapuna, about as much in Moanalua and nearly as much in Kalihi Kai. It also includes Salt Lake Shopping Center, the Safeway at the corner of Pali Highway and Vineyard Boulevard, and property in Waipahu.

There are 137 tenants leasing about 99 percent of the land under 186 leases, which run 22 years on average. No lease expires before 2009, so little is expected to happen before then.

HRPT said its business plan is to work with existing tenants to offer extended lease terms in return for higher rent at a longer fixed period. As leases expire, HRPT said it expects to offer the parcels for lease, sale or redevelopment.

Several tenants on the former Damon land said they had yet to meet their new landlord, and therefore preferred not to share their expectations or concerns.

Steve Sofos, president of local real-estate firm Sofos Realty Corp., said he expected HRPT to continue business as usual in the short term, then try to increase the return on its holdings by redeveloping or selling property.

Almost half of HRPT's O'ahu leases expire within 20 years. "If these guys' big picture is wait out the leases, then get the leases back and redevelop (the property), then that's great," Sofos said.

Other local real-estate executives believe HRPT will be more of a passive investor reluctant to redevelop or sell property.

"It's going to be a learning process," said Andres Albano, a vice president with real-estate firm CB Richard Ellis Hawaii Inc. "They have time on their hands."

Reach Andrew Gomes at agomes@honoluluadvertiser.com or 525-8065.