Bloomberg News

Empire State Building IPO Challenged by Legacy Investors

August 22, 2012

Empire State Building IPO Challenged by Tangle of Legacy Holders

Half a century later, that complex ownership structure may stand between Wien’s successors, Peter Malkin and his son Anthony, and their plans to form a real estate investment trust and take the Empire State Building public. Photographer: Andrew Harrer/Bloomberg

Al Weiner’s stake in New York’s Empire State Building came to him by way of his grandfather’s death in a 1950 train crash in Richmond Hill, Queens. His grandmother sued the Long Island Rail Road, and her lawyer was Lawrence Wien, a family friend.

The money from the settlement made the Weiners a natural call when Wien was reaching out to his network of friends and business associates in the early 1960s to buy what was then the world’s tallest skyscraper. The family and more than two thousand others purchased shares of the Empire State Building under a syndication orchestrated by the lawyer and his partner, real estate investor Harry Helmsley.

Half a century later, that complex ownership structure may stand between Wien’s successors, Peter Malkin and his son Anthony, and their plans to form a real estate investment trust and take the Empire State Building public (ESB:US). The Malkins, who need 80 percent approval from the 3,300 units held by the legacy investors, are facing opposition by stakeholders like Weiner, who say they will be shortchanged in the deal and lose a steady income stream that is poised to jump in value, sacrificing safety for the vacillations of the stock market.

“My grandma said don’t ever sell these,” said Weiner, 53, who runs a business out of Jericho, New York, that sells artisanal cheeses to restaurants. “The checks come in like clockwork.”

Creating ‘Confusion’

Peter and Anthony Malkin, Wien’s son-in-law and grandson, respectively, have taken notice. The entity they control, Malkin Holdings LLC, has filed four documents with the Securities and Exchange Commission in the last month disclosing efforts to reach out to stakeholders and saying that the dissident holders’ conclusions can’t be relied upon.

“We believe certain individuals are creating an environment of confusion through incorrect statements about” their company and the proposed transaction, the Malkins wrote in an Aug. 6 letter to investors. Distributions probably will increase more over time as part of the deal than if the Empire State Building was left as a standalone investment, they said.

The Malkins declined to comment for this story because of the quiet period for pending IPOs.

REIT Formation

They are seeking to form the REIT, to be known as Empire State Realty Trust Inc. (ESB:US), to gain greater efficiencies and access to capital, and because the Helmsley estate is liquidating its holdings following the death of Harry Helmsley’s wife, Leona. In addition to the 102-story tower, the REIT would include 18 other properties, ranging from midtown Manhattan office buildings to a development site in Stamford, Connecticut, that would be added to the legacy investors’ holdings.

The Malkins’ valuation firm, Duff & Phelps Corp. (DUF:US), estimates the value of the entities that hold all the buildings to be included in the REIT at $3.99 billion. About $2.5 billion is from the Empire State Building.

The share sale stands to be the highest-profile REIT IPO since the 1990s, when big office landlords such as Boston Properties Inc. (BXP:US) and SL Green Realty Corp. (SLG:US) went public, said Lawrence Longua, director of the REIT Center at New York University’s Schack Institute of Real Estate.

“There have been a number of IPOs but nothing of this scale or visibility,” he said. “This is in a class by itself.”

$330,000 Value

Small investors such as Weiner own stakes in an entity called Empire State Building Associates LLC, which holds the deed to the Empire State Building. The investors are entitled to about half of the tower’s value -- one of the points of contention -- because the other half is assigned to the building’s sublease holder, according to an evaluation by Duff & Phelps.

The firm’s appraisal of the Empire State Building at $2.5 billion indicates that each of the 3,300 units, priced at $10,000 in 1960, would be worth about $330,000 today.

The small investors may lose close to half that amount after taxes should they take shares of the REIT, and then would have trouble finding an alternative place for their money that offers the same dependable returns, said Richard Edelman, a grandson of an original investor who receives payments as part of a trust. The Malkins have come up with an alternative to address the tax implications.

Phone Calls

Edelman runs a website, www.empirestatebuilding investors.com, that tracks the IPO process. He, Weiner and several others have formed a loose group of unitholders who have been telephoning and e-mailing investors. Edelman estimates they have reached about half the stakeholders, and said they have encountered enough opposition to block the REIT deal.

“I speak to people one on one, just trying to educate them on the investment and the goodness that it’s been for the last 51 years, and the fact that this might not be the best deal for us at this point in time,” Weiner said. “If they agree, that’s great. If they don’t, they have that right to do so. We’re trying to be mensches about this.”

Many of the investors are retirees in their 80s and 90s, or are second- and third-generation holders like Edelman and Weiner. Many of them don’t have computers, so the group sent them postcards inviting them to call a toll-free 800 number answered by a live operator.

Many investors regard their stake as an “heirloom” to be passed down to the next generation, Edelman said.

‘Human Aspect’

“They were the Jewish middle class, who knew these guys through one relationship or another,” said Benjamin Polen, a principal with property-investment adviser Polestar Realty and until recently a senior research associate at Baruch College’s Newman Real Estate Institute in Manhattan. “They were not sophisticated investors. There’s an interesting human aspect to this story.”

Another group of investors has sued, alleging “an imbalance and disparity of knowledge and economic power” between the Malkin and Helmsley interests and the small investors. Five separate lawsuits were consolidated into a single class action on June 27 in New York State Supreme Court in Manhattan. The lawsuit is “baseless,” Hugh Burns, a Malkin Holdings spokesman, said in an e-mail.

The Malkins first filed plans for the IPO in February. The REIT application is undergoing review by the Securities and Exchange Commission. There is no specific timetable for its approval, or for when the share sale would occur.

Resolving ‘Overhang’

“I’ve been in other IPOs where there’s litigation and there’s incredible pressure to resolve it, because you can’t take a company public with that kind of overhang,” said Boris Dolgonos, a partner in the New York office of the law firm Jones Day, who has worked on several share sales and isn’t involved in the Empire State Building IPO. “Whenever there’s any kind of dissent or litigation the sponsor wants to have that resolved before taking it public.”

The IPO plan has supporters among the legacy investors.

“To me it’s like a bonanza, like it fell out of the sky,” said Leon Jonas, 85, a retiree in Delray Beach, Florida, and a $10,000 original investor. “I would welcome it in a minute.”

Malkin Holdings, in its most recent revised offering statement, said benefits to going public include “liquidity, enhanced property diversification, increased growth opportunities, enhanced operating and financial abilities.” It also cited governance under the standards for a regulated public company, with a board of independent directors, except for one member of management (ESB:US), Anthony Malkin, who would be chairman, chief executive officer and president. It would also create a more straightforward corporate structure.

Proxy Service

“We are aware that you may have received mailings and/or phone calls from individuals offering to guide investors through the proposed transaction” and “raising questions about our proposed transaction,” Malkin Holdings said in a July 23 letter to investors. “We suggest that you rely on our SEC filings, and letters” on the planned deal “rather than on these individuals’ interpretations.”

The Malkins have hired a proxy service, Mackenzie Partners Inc. of New York, to, among other duties, to assist them in reaching out to investors and fielding incoming calls from them.

The calls to investors explain the benefits of REIT status, including enhanced liquidity and a regular quarterly dividend, according to a script filed with the SEC. REITs (BBREIT) are required to distribute at least 90 percent of their taxable income to shareholders.

Combination Benefits

“Consolidation reduces your present risk in relying on a single building, and provides a broader base for stable operations to pay you quarterly dividends,” Malkin Holdings said in its Aug. 6 letter. “We believe the potential benefits of the combined portfolio are greater than for ESB standing alone.”

Once approved by the SEC, the offering statement will provide estimated dividends for the first year after the IPO, according to the Malkins’s Aug. 6 letter.

“Based on our experience with all the properties in the proposed consolidation, we believe your protection against downside risk and your potential for increased distributions will be greater as a REIT investor than as an ESBA participant,” they wrote.

Tax Adjustment

The Malkins have also addressed complaints about the tax consequences, offering investors “operating units” that would defer the gain instead of cash or shares. The units could be traded through a national securities exchange and give investors “the exact same tax treatment” that the Malkins would receive for their interests.

Edelman, an expatriate New Yorker who lives in Solana Beach, California, says that most unitholders want their stakes for the dividends, and don’t need to be able to easily buy and sell shares.

“People who own the building own it for income,” he said. “That’s important to understand. There’s only a small minority who want liquidity.”

Bert Jacobson, a $5,000 original investor who now lives in Beverly Hills, California, said his annual returns ran as high as $2,500. In recent years it has dwindled to about $50 a month, since the Malkins embarked on a $590 million renovation program for the tower, he said.

Unitholders received $1,179 in 2011 per $10,000 originally invested, according to the building’s annual report. In 2008, that amount was $5,230.

Lease Signings

Returns may be poised to increase as the renovations at the Empire State Building attract more tenants. Last month, the professional networking site LinkedIn Corp. (LNKD:US) agreed to take an additional 10,400 square feet (966 square meters) in the tower, bringing its space to 42,400 square feet. In May, Coty Inc., the beauty-products company, added 120,000 square feet, bringing its occupancy to almost 320,000 square feet.

The building’s office space was about two-thirds leased as of March 31, according to the offering document. Its retail space was 89 percent rented.

The Empire State Building’s net operating income should rise an average of 19 percent annually through 2017, to $179.5 million from this year’s $76.9 million, according to a cash flow analysis in the filing.

Martin Cowan, a retired tax attorney from New Rochelle, New York, and a former Wien partner who is among the investors opposing the deal, is combing through thousands of pages of regulatory filings, and more than 50 years of governing documents, to analyze the deal. He sent a letter to the SEC in June saying that investors were at risk of a “substantial reduction in income” if they voted for the REIT.

Transaction Costs

Since then, the Malkins have amended their proposal twice, and Cowan is recalculating his numbers. He continues to say that transaction costs, including transfer taxes and underwriting fees, may dilute investor returns.

John Nester, an SEC spokesman, said he couldn’t comment on information received from the public.

Another issue for the investors is how much of the value of the building the investors should receive. The Malkins said in their filings the holder of the sublease, which was historically controlled by the Helmsleys, is entitled to a roughly 50-50 split with Empire State Building Associates LLC, the holder of the master lease, and since 2002, the owner of the building. The small investors who bought into Wien and Helmsley’s 1961 syndication, and their successors, all hold interests in Empire State Building Associates.

Malkin Payout

In the July 23 letter, the Malkins set the “total amount to be received by all interest holders” in the Associates company at $1.21 billion. Of that amount, the Malkins are entitled to $188.9 million, they said, citing a valuation by Duff & Phelps.

Investors like Edelman say there is no documentation backing up the idea that the Associates should receive only half the value, and want to know why they aren’t entitled to a proportional share of the other $1.3 billion that the Empire State Building is worth. That value would accrue to the Malkins and the Helmsley estate as owners of the firm that controls the sublease -- known as Empire State Building Co. LLC -- when it is liquidated to allow the Helmsleys to cash out.

The Malkins have a 6.7 percent interest in the sublease holder, according to the offering statement. The Helmsley estate owns 63.8 percent.

Joint Venture

The Malkins said in the IPO filing that the splitting of the $2.5 billion is “based on representations of the supervisor” -- Malkin Holdings -- “as to the original intent to treat the two tier entities as equivalent to a joint venture.” Empire State Building Co. is entitled to equal allocation because it has historically shared capital and financing costs, according to the document.

The Malkins’ proposed $188.9 million payout from its stake in the Associates entity includes $110.6 million of payments called “override interests” in the documents, because they override the original terms of the leases. They are payments investors agreed to make to the Malkins for certain services, including profits they would earn for future management work, and for a possible future “capital transaction.”

Edelman and Cowan say that was interpreted by investors to mean a possible sale of the building to outsiders, not an IPO in which the Malkins would remain at the helm. Those who accepted the override will receive the equivalent of $330,850 per unit, according to the offering statement. The minority who didn’t approve the override would receive $366,500, a $35,650 difference. Those numbers could change depending on the proceeds from the IPO.

Override Approvals

In a July 23 letter, the Malkins told investors the overrides “were approved by you or by the investor from whom you acquired or inherited your interests.” The interests were valued by Duff & Phelps “under the same valuation methodology used for all investors.”

The investor group may be underestimating the value of REIT status, said Polestar’s Polen. Large REITs have access to unsecured debt, while closely held real estate companies generally have to depend on property-specific mortgages for deals, enabling REITs to move quicker than their rivals to acquire properties, he said.

“The REIT structure in our day and age is preferable to partnership structures, which are kind of anachronistic,” Polen said.

Since the beginning of 2011, 13 real estate investment trusts have gone public in the U.S., raising a combined $2.9 billion. The shares have gained an average of 7 percent from their IPO dates, according to data compiled by Bloomberg. They have an average 12-month dividend yield of 5 percent, the data show.

“I have to maybe give Peter credit for at least trying to pull this thing into an IPO, but it’s got so many moving parts and so many people involved,” said Longua of NYU’s Schack Institute. “I don’t know how he’s going to do it.”

(The class action is Leon Meyers, et al., v. Empire State Realty Trust Inc., 650607/2012, New York State Supreme Court -- Manhattan.)

To contact the reporter on this story: David M. Levitt in New York at dlevitt@bloomberg.net

To contact the editor responsible for this story: Kara Wetzel at kwetzel@bloomberg.net


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