Archstone-Smith Trust

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Archstone-Smith Trust

9200 E. Panorama Circle, Suite 400
Englewood, Colorado 80112
U.S.A.
Telephone: (303) 708-5959
Fax: (303) 708-5999
Web site: http://www.archstonesmith.com

Public Company
Incorporated: 1963 as El Paso Real Estate Investment Trust
Employees: 3,300
Sales: $829.2 million (2001)
Stock Exchanges: New York
Ticker Symbol: ASN
NAIC: 525930 Real Estate Investment Trusts

Archstone-Smith Trust, with headquarters in Englewood, Colorado, is the third largest apartment real estate investment trust (REIT) in the United States. The REIT owns nearly 80,000 apartments, representing a total market capitalization of approximately $10 billion. Its Archstone Communities brand operates garden-style units, and the Charles E. Smith brand is dedicated to high-rise properties. The core markets for Archstone-Smith are California, southeast Florida, Boston, Chicago, Seattle, and Washington, D.C. More recently it has staked a claim in the highly competitive New York City market, becoming the first multifamily REIT to purchase an operating apartment property in Manhattan.

Origins of Archstone-Smith Dating Back to 1963

The lineage of Archstone-Smith can be traced back to the 1963 formation of a Texas REIT named El Paso Real Estate Investment Trust. REITs were a new creation, established by Congress in 1960 as a way for small investors to become involved in real estate in a manner similar to mutual funds. REITs could be taken public and their shares traded just like stock. They were also subject to regulation by the Securities and Exchange Commission. Unlike stocks, however, REITs were required by law to pay out at least 95 percent of their taxable income to shareholders each year, a provision that severely limited the ability of REITs to raise funds internally. During the first 25 years of existence, REITs were allowed only to own real estate, a situation that hindered their growth. Third parties had to be contracted to manage the properties. Not until the Tax Reform Act of 1986 changed the nature of real estate investment did REITs begin to gain widespread usage. Tax shelter schemes that had drained potential investments were shut down: Interest and depreciation deductions were greatly reduced so that taxpayers could not generate paper losses in order to lower their tax liabilities. The Act also permitted REITs to provide customary services for property, in effect allowing the trusts to operate and manage the properties they owned. Despite these major changes in law, REITs were still not fully utilized. In the latter half of the 1980s the banks, insurance companies, pension funds, and foreign investors (in particular, the Japanese) provided the lion’s share of real estate investment funds. That period also witnessed overbuilding and a glutted marketplace, leading to a shakeout in the marketplace. With real estate available at distressed prices in the early 1990s REITs finally became an attractive mainstream investment option.

El Paso Real Estate changed its name to Property Trust of America in 1970. It became involved in a wide range of real estate investments, in the 1980s investing in everything from shopping malls to a Holiday Inn located in San Francisco’s Fisherman’s Wharf. Although the REIT was diversified, it also was difficult for investors to evaluate, since its assets were spread across various sectors performing at different levels. Property Trust would attain focus, namely the apartment market in the Southwest, when it became involved with real estate mogul William D. Sanders. Beginning in July 1989 the REIT became the target of a solicited takeover by Sizeler Property Investors Inc., a Kenner, Louisiana, REIT that owned nearly 10 percent of Property Trust. Over the next several months Sizeler sweetened its tender offer in a bid to gain a controlling 55 percent stake, but was rebuffed. The matter finally came to a close in February 1990 when Sizeler gave up and sold off its shares of Property Trust to SWRT Inc., a company created by Sanders for the purpose. At the same time, Sanders reached an agreement with Property Trust on an option to purchase 600,000 new nonvoting, convertible preferred shares. He further agreed to acquire no more than 32 percent of the REIT over the next two years, during which time he would vote his shares with management.

Sanders, a Texas native with a B.S. degree in agriculture from Cornell University, made his fortune in Chicago. In 1968, at the age of 28, he founded LaSalle Partners, today one of the largest asset managers in the country, building it into a prominent real estate advisory and asset-management firm that catered to institutional investors. LaSalle attained global reach and the prestige of a Wall Street financial house despite its Midwest locale. In the late 1980s, at the height of the real estate boom, he sold his partnership stake for an estimated $65 million to the Japanese firm of Dai-ichi Mutual Life Insurance Co. Critics have charged over the years that he sensed the market was about to collapse and that he left the Japanese holding the bag. Sanders maintained that he simply wanted to become involved in the development side of real estate. Retiring to Santa Fe, New Mexico, he pursued a grand strategy of building a vast real estate empire, a one-stop shopping approach that would not only encompass REITs devoted to individual sectors but also a services group, real estate investment banking, consulting, and research. In 1990, with the financial backing of several institutional investors and an assembled team of top real estate talent, he created Security Capital Group to fulfill his vision. His first investment was in Property Trust of America, the first phase in the creation of a family of REITs, each devoted to a different sector.

Focusing on Apartments in the 1990s

A year after Sanders bought into Property Trust, the REIT hired a Sanders-controlled company, Southwest Realty Advisors Inc., to serve as its advisor. It also announced that it planned to acquire and develop multifamily housing in the Southwestern markets, thereby beginning the REIT’s emphasis on apartments, especially on the low-income market. Property Trust began making public offerings to fund expansion, in June 1991 raising $22 million. Also in that month C. Ronald Blankenship was elected chairman of the REIT, replacing Tad R. Smith, who had resigned in the wake of his indictment regarding alleged securities fraud involving El Paso Electric Co. Blankenship had been managing director of Southwest Capital Group Inc., part of the Sanders Security Capital group of companies. Fueled by additional offerings, Property Trust over the next three years aggressively acquired and developed properties in Arizona, Colorado, New Mexico, Oklahoma, and Texas. The focus on apartments proved lucrative for its investors, as reflected by the REIT’s 20 percent annual growth in funds from operations over the period 1992–94.

In 1994 R. Scot Sellers became Managing Director, responsible for the REIT’s investment strategy and implementation. Only a few months later, in December 1994, Property Trust agreed to acquire another Sanders-controlled REIT, Security Capital Pacific Inc., for $139 million in stock and the assumption of $128 million in debt. Security Capital Pacific concentrated on apartment projects generally located in the Northwest, including markets in California, Washington, Oregon, Utah, Colorado, Nevada, and Idaho. Because of the Sanders connection to both REITs, the deal generated some controversy, with critics charging that Property Trust shareholders were getting a better deal than Security Capital Pacific shareholders. Properties owned by Security Capital Pacific were considered of higher quality and located in markets that were about to enter an economic upswing. Moreover, analysts noted that because the Pacific Northwest market was lagging some two years behind the Southwest, which was likely to cool, Property Trust would be in a position to sell off properties at the height of the market in the Southwest, the proceeds of which could be used to buy properties in the Northwest at the bottom of the cycle. The transaction was completed in March 1995 and Property Trust changed its name to Security Capital Pacific Trust. The REIT then raised $217.2 million in a new offering, the money earmarked to pay down $203 million in debt.

In 1995 Sellers initiated a strategy to reposition the REIT’s portfolio in an effort to concentrate on protected markets, areas with limited land and more difficult to develop because of strict regulations and other factors. In such markets the REIT could benefit from a tight housing situation. At this point in its development of Security Capital Pacific Trust, almost 70 percent of its portfolio was concentrated in the states of Texas, Arizona, and New Mexico. To achieve Sellers’s goal the REIT would have to sell off almost all of its assets and then reinvest in new communities. The wise selection of markets to enter led to robust growth for Security Capital Pacific Trust. It began to invest in the San Francisco Bay area in 1995, then in 1996 made a major push into the southern California apartment market, altogether investing more than $400 million in the state just as it entered into a period of record growth. Sellers was named chairman and CEO in June 1997, and then in 1998 took the REIT into the Boston market just as it was beginning to enjoy strong growth, again to the benefit of the bottom line.

Sanders, in the meantime, took the parent corporation, Security Capital, public in September 1997, but his dreams of a multifaceted real estate empire were already beginning to dissipate. The offering raised almost $600 million at $28 a share, but almost immediately the price began to erode, a situation that would only be exacerbated by an industrywide slump in the price of REITs over the next two years. Security Capital dropped below $12 by September 1999, which forced Sanders to make significant changes to his real estate interests, perceived by many investors as too complicated.

Company Perspectives

Our mission is to leverage the talents and resources of our organization to reinvent our industry and create value for our shareholders, customers and associates. Our innovative approach to the apartment business is what sets Archstone-Smith apart from the competition.

While some of Sanders’s REITs struggled, Security Capital Pacific Trust continued to grow. A general slump in REIT share prices led to a period of consolidation in the industry, as pressure mounted on smaller companies to join with larger rivals in order to compete. For Security Capital Pacific Trust, greater size provided an efficient way to create a national platform through which it could execute a capital recycling strategy. In 1998 it merged with Atlanta-based Security Capital Atlantic Inc. in a $1.1 billion stock swap. Again, it was a deal between two Sanders-dominated REITs that engendered some criticism. Unlike the thriving Security Capital Pacific Trust, Security Capital Atlantic had failed to perform up to expectations since its initial public offering in 1996, yet both were equally valued in the merger. Although Sellers had long eclipsed Sanders in the running of Security Capital Pacific Trust, the latter remained a focus of media attention in the deal. According to Business Week, for instance, “Pacific shareholders griped that Sanders bailed out a loser with a winner at their expense. Sanders, who defends the deal, claims he had nothing to do with the pricing because it was decided by the individual boards.” Once the transaction was completed, the resulting REIT assumed the name of Archstone Communities. The Archstone name was coined by Lippincott & Margulies, one of the nation’s leading branding firms involved in the naming of numerous new products, including Starbucks. Armed with a new name, the company was ready to create the industry’s first national brand in apartments. If Archstone was able to develop brand loyalty among tenants, it stood to realize a number of benefits, including high occupancy rates, reduced turnover, and more referrals, as well as the ability to charge higher rentals. With more than 90,000 apartments in 19 states and Washington, D.C., the REIT was well on its way to achieving nationwide penetration.

In 1999 Archstone continued to look to revamp its portfolio and expand into new areas of the country. Archstone acquired two Chicago-area apartment communities, the 460-unit Garden Glen Apartments located in Schaumburg, Illinois, and the 125-unit Prairie Court located in Oak Park, Illinois. In addition, the REIT gained a toehold in the Minneapolis market with the purchase of the 196-unit complex in Eden Prairie, Minnesota, situated less than 15 miles from downtown Minneapolis. The cost of these Midwest purchases totaled $72.4 million. At the same time that Archstone was shedding noncore assets, it was selling apartment properties in Birmingham, Alabama; Columbus, Ohio; and Jacksonville, Florida. Archstone also made strides in establishing its brand identity in 1999, launching a number of initiatives, including SafeRent, an Internet application that reduced the approval of new tenants from the industry standard of one or two days to just 30 seconds. Archstone then implemented an instant refund program, providing tenants with refunds on their security deposits on the day they moved out, in contrast with the 30 days industry standard. The REIT also took advantage of computer programs in revenue management, employing forecasting algorithms to help in calculating future demands. In 2001 Archstone launched its Lease Rent Optimizer, a program that individual properties could use to help determine the optimum price of its apartments.

Becoming Archstone-Smith Trust in the Early 21st Century

Sanders finally cut his ties to Archstone in 2001, a development that was welcomed by the REIT’s management, which believed that having a single shareholder controlling almost 40 percent of its equity had held down the price of its stock. This disconnect between the stock price and the underlying value of Archstone’s assets led management to spend more than $550 million in just two years to repurchase about 18 percent of its common shares. For different reasons, Sanders, under pressure from the board of Security Capital Group and outside investors, had begun to buy up shares of the parent company’s stock in order to bolster its sagging price. To simplify Security Capital’s complex structure he took private some of the REITs he had founded. Others, like Archstone, had simply grown much too large to acquire, and he began to sell off his interests. He unloaded the last of his $787 million stake in Archstone in February 2001, which he then used to pay off a $530 million loan. Less than a year later, Sanders’s grand dream for a real estate empire came to a muted conclusion. On Friday, December 14, at the unusual hour of 9 p.m., it was announced that GE Capital Corp. had agreed to buy Security Capital at $26 per common share in a $4 billion deal.

Sellers led Archstone to an even higher level when in May 2001 he brokered an agreement to acquire Charles E. Smith Residential Realty Inc. for $2.2 billion in stock and the assumption of $1.4 billion in debt. Smith Residential was the apartment business REIT of the 50-year-old, family-founded Charles E. Smith Cos. Focusing on the high-rise market, it owned interests in more than 50 apartment buildings, as well as two shopping centers, located in Washington, D.C., Boston, Chicago, and southeastern Florida, totaling around 24,000 units. In addition, the REIT managed another dozen apartment complexes. An affiliate, Smith Corporate Living, offered upscale temporary accommodations for business travelers. Once the acquisition was complete, the resulting Archstone-Smith Trust owned almost 87,500 apartment units, with nearly 5,000 more under construction, and a total market capitalization of more than $9 billion. At the time, it became America’s fourth largest REIT and the second largest multifamily housing REIT. The acquisition was also a major step in shifting the concentration of Archstone-Smith’s portfolio to the top protected markets, with downtown high-rise properties being considered the ultimate in protected assets.

With the business now organized into three sections—the east division, the west division, and the Charles E. Smith division—Archstone-Smith completed the year 2001 posting revenues of $829.2 million and net income of $257.9 million. In the process of turning over its portfolio, the REIT had sold off some $3.6 billion in noncore assets while spending $2.5 billion to acquire apartments, aside from mergers, and another $2 billion on development. Unlike many public companies, it maintained healthy growth into 2002, despite difficult economic conditions.

Key Dates

1963:: El Paso Real Estate Investment Trust is formed.
1970:: The name is changed to Property Trust of America.
1990:: William D. Sanders buys into the REIT.
1995:: Following the acquisition of Security Capital Pacific Inc., the REIT becomes Security Capital Pacific Trust.
1998:: The name Archstone Communities is assumed after the acquisition of Security Capital Atlantic Inc.
2001:: The acquisition of Charles E. Smith Residential Realty Inc. results in Archstone-Smith Trust.

In May 2002 Archstone-Smith announced that it was entering the highly competitive New York City market by acquiring a 506-unit upscale, twin-tower, high-rise apartment property located in Manhattan’s Upper West Side near Lincoln Center at a cost of $210 million. The building, completed in May 2000, featured three levels of parking and first floor retail space. It offered studio and one- and two-bedroom luxury apartments with monthly rents ranging from $2,350 to $8,590. With the financial services industry hard hit by a weak economy and a new supply of apartments about to become available in the surrounding area, some questioned the wisdom of Archstone-Smith entering the New York market at this time. Nevertheless, the REIT achieved one of its major goals and management insisted that time would prove the wisdom of the deal.