Liberty Property Trust continues to expand in Virginia

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by Paula C. Squires

On many counts, fall 2007 wasn’t the best time for a big real estate deal in Northern Virginia. Losses from subprime mortgages were beginning to pile up like angry commuters on the Capital Beltway.  Home values were taking a plunge. And some of the large office buildings along Dulles’ technology corridor sat empty. 

But when a major portfolio came on the market — 23 suburban office properties owned by Republic Property Trust — William P. Hankowsky saw opportunity. The chairman and CEO of Liberty Property Trust had been looking for an opening in Northern Virginia for years. The $6 billion, publicly traded real estate investment trust (REIT) already had a
presence in Maryland. Plus, Malvern, Pa.-based Liberty owned and operated office and industrial properties in Richmond and Hampton Roads. 

“Our goal was to get in Washington, D.C., and Northern Virginia. Here was an opportunity to buy 2.6 million square feet of space in one fell swoop,” recalls Hankowsky. 

In fact, Liberty’s $913 million purchase was its biggest transaction last year. To spread the risk of owning and managing the Republic portfolio, it concurrently sold the properties into a joint venture with New York State Common Retirement Fund. The fund holds a 75 percent interest in the properties while Liberty has a 25 percent stake. 

With the deal came a series of office parks in Herndon, Fairfax and Chantilly that are 91 percent leased as well as a redevelopment project in Washington.  Ask if Liberty caught a price break since the buy came just as the economy was beginning to sour, and Hankowsky laughs. “No, no. no.  I would say that was full pricing at the time.”

Still, he considers it a strategic move. The portfolio expands Liberty’s footprint in the mid-Atlantic and boosts its square footage in Virginia to more than 9 million square feet, or 12 percent of the company’s 75 million-square-foot portfolio.

‘Stable anchors’
Hankowsky likes Virginia. “It’s not as hot a market as, say, Phoenix,” he notes. Yet Virginia is attractive for investment because of consistent population growth and a strong government component in each of the locations where Liberty operates. “You’ve got the federal government in NOVA, state government in Richmond and a strong concentration of military defense agencies in Hampton Roads. These are very stable anchors in those markets.”

By picking long-term growth markets and gaining national recognition as a leader in “green” sustainable building, Liberty continues to put projects in play during a sluggish economy, although at a slower pace. Complete or under construction are 36 LEED (Leadership in Energy and Environmental Design) projects, more than any other commercial developer in the U.S. 

Like other REITS, though, Liberty has cut back on new development. “The fundamental collapse of the housing industry, what’s happening in the financial services sector, the credit issues, liquidity in the markets. There’s still a fair amount that has to play out. We could see another 10 percent decline in housing prices before it bottoms out,” says Hankowsky.

While the industry waits for capital markets to calm, Liberty’s Richmond office confirmed the chief executive’s confidence in Virginia. In 2007, Richmond outperformed Liberty’s other 22 offices, winning the company’s annual Rouse award for outstanding contributions to fiscal success.  It had a better showing than offices in larger cities such as Charlotte,
Chicago and Philadelphia. Hankowsky came to town recently to pay tribute to Richmond’s 16-member team and Jay Kraft, its vice president and city manager, for winning the award (named after Liberty’s founder, the late William G.  Rouse III).

In 2007 the Richmond office leased more than 1.7 million square feet of warehouse, flex and office space. It maintained low operating costs and came in $550,000 ahead of targets for projected net operating income. That’s no small feat considering that 2007 was a tough year for U.S. REITs. “After seven straight years of solid performance, REITs took a
dive in 2007 and finished the year down 15.6 percent,” says Ron Kuykendall, a spokesman for the National Association of Real Estate Trusts in Washington.

Build-to-suit projects
Kraft credits “good management and customer services as the reason we were able to come out on top.” Things are looking good this year, too. “We’ve been active with our leasing,” says Kraft. “Our first-quarter results showed us $530,000 ahead of expected net operating income for the quarter.”

Boosting Richmond’s performance in 2007 were two build-to-suit projects and $3 million worth of tenant improvements. Liberty built Eastport VII, a 149,040-square-foot industrial building in Richmond for Interline Brands, a distributor of maintenance, repair and operations products. Another client was Northwestern Mutual. In May, it moved into Westerre
IV, a 76,128-square-foot office building in Henrico County. Designed to achieve LEED silver certification, it is Liberty’s first sustainable building in Richmond. Two months after opening, it was 59 percent leased.

Altogether, Liberty owns, leases and manages 42 properties in the Richmond area, providing more than 5 million square feet of space.  It gained a foothold here in 1995, after merging with Lingerfelt Development, which owned a portfolio of 3.5 million square feet.

Two years later, Liberty entered Hampton Roads. Today, it’s the area’s largest commercial landlord. In 2006, it introduced the region’s first commercial LEED-certified office building, a 75,000-square foot project at Liberty Executive Park in Chesapeake.

Advantages in rocky times
By year end, Hankowsky expects Liberty to spend $300 million to $400 million on new development, less than half the $823 million the company invested in 2007.  “There are still customers looking for office, industrial and flex space, but there are less of them.” Plus, he adds, the number of people buying or selling a building this year is down by
about 80 percent nationally. “Buyers can’t get the money to buy. They can’t get mortgages, they can’t get financing, so transaction volume is way down.” 

So far, commercial real estate hasn’t suffered the huge casualties that have occurred in the housing market as a result of the subprime mortgage mess. Yet, Virginia has seen foreclosures and slowdowns on some projects — none of them related to Liberty. Fortunately, commercial real estate markets are not oversupplied during this slow economic cycle, says Hankowsky. Still, he’s not looking for an economic recovery until mid- to late-2009. “Until then, I think it’s sluggish across the board.”

There is one advantage for REITS even in rocky times; they’re a dividend play. By law, REITs must pay a quarterly dividend to shareholders. Generally yields don’t decline despite tough market conditions. For instance, Liberty’s stock price of about $35 a share in late July was $10 less than a year ago, but the yield on the shareholder dividend was more
than 7 percent. 

Created by Congress in the 1960s, REITs allow individual investors to add commercial real estate to their portfolios. Before 2007, they were solid performers, with the average annual rate of return for U.S. equity REITS at 14.3 percent for the five years that ended on June 30 and 11.4 percent for the past 20 years.

So far this year REITs are outperforming other major assets. However, for the first half of 2008, all the major indexes were down; REITS just weren’t down as much. According to the FTSE NAREIT Equity REIT index (which includes 108 REITS), the total return for the first six months was -3.59 percent, compared with -11.9 percent for the S&P 500 and -14.4
percent for the Dow Jones Industrials.

Kuykendall describes REITS as “a drive-by casualty” of the subprime residential mortgage crisis. “Constriction in the credit markets has caused investors to pull back from REITS, so 2008 continues to be a difficult year.”

While the markets shake out, Hankowsky continues Liberty’s push to green. An early proponent of the U.S. Green Building Council’s LEED standards, Liberty has spent more than $1 billion on green development. Recognizing its leadership, the National Association of Industrial and Office Properties named Liberty the 2008 developer of the year.

“We can say to our clients that in our LEED buildings, the energy costs are a third less. We think that’s a powerful place to be,” says Hankowsky.  Moreover, “It’s the right thing to do. We think it’s good business.” 

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