The View from America's Biggest Landlord


In November, 2001, Richard D. Kincaid became something of a local business celebrity in the Windy City. The chief financial officer at Equity Office Properties Trust, Kincaid was named by editors of Crain's Chicago Business as one of the city's up-and-comers in its annual "40 under 40" list. Little did they know. A year later, on Nov. 18, Kincaid was promoted to president of Equity Office (EOP), and next Apr. 1, he will become CEO, succeeding the company's billionaire founder and chairman, Samuel Zell.

Kincaid, who just turned 41, may need all the youthful energy he can muster. With nearly 750 buildings in 34 metro areas, Chicago-based Equity Office has grown into the nation's largest private-sector landlord through a series of big acquisitions. Its $7.3 billion purchase of Spieker Properties Inc. in mid-2001 is the largest takeover ever in the commercial real estate industry.

That in itself is plenty to manage. But market fundamentals are also working against Kincaid. The Spieker purchase greatly lifted Equity Office's holdings in San Francisco, Silicon Valley, and other West Coast markets that were white hot. Since then, however, vacancy rates in these regions have soared, while rents have skidded. Today, metro San Jose's vacancy rate in metro San Jose is 22.9%, vs. 8.1% in 2001.

As a result, Equity Office has warned that its 2003 earnings will fall as much as 12.5% from 2002, and industry analysts, who only a year ago were high on the stock, now are advising clients to steer clear. Equity Office closed on Dec. 19 at $24.92, down 17% for the year.

Kincaid, who has worked for Zell for 12 years, recently had coffee with BusinessWeek Senior Correspondent Michael Arndt in Equity Office's headquarters to talk about the company's future, which he insists is as bright as ever. Here are edited excerpts from their conversation:

Q: How do things look for Equity Office in the next few months?

A: I think some West Coast markets are actually stabilizing or improving. Seattle, for example. You've got a little more activity in some parts of Northern California. But this is by no means cause for celebration. It's going from really bad to just plain bad. Everywhere except Chicago. Of all the new construction getting delivered in 2003, it seems it's all coming here. The other areas where I think there are more shoes to drop are markets heavily dependent on financial services.

Q: Does that suggest that New York is also going the wrong way from a landlord's perspective?

A: Yes. We have seen in our most recent leasing calls that rents are starting to be impacted in New York. Downtown has a high vacancy, and the city has fiscal problems, which led to the recent 18.5% increase in real estate taxes. What impact that will have on business formation is another question.

We still like New York, but I think it's getting hit last. By the way, Washington, D.C., is by far the best market in the country.

Q: The government never goes out of business, does it?

A: Something tells me the Homeland Security Act is not going to mean less jobs. That's just a hunch.

Q: Are you at Equity Office doing less development and less building as well?

A: Absolutely. It doesn't make sense to build. The returns don't make sense at market-rate rents.

Q: Lately, in fact, Equity has been selling property, hasn't it?

A: We absolutely are selling. I think we have taken advantage of a very frothy private market to exit noncore assets and noncore markets. The first nine months of this year, we've sold about $340 million in assets and exited places like Nashville, Anchorage, and Albuquerque. And we've got another $225 million teed up. Part of our job as management of this company is to realize where there's arbitrage. Right now, we can sell in those markets and buy back our stock.

Q: Explain to me how it is that vacancy rates can be rising and rents can be sliding, yet you can sell buildings for a premium. Why would anyone be buying in this market?

A: I can only tell you that it appears to be the age-old adage of chasing historical performance. Money always goes into where it has worked before. Real estate has held up far better during this economic down cycle than anything else. So, if you're an institution and your stock portfolio has gotten hit hard, some of the yields in real estate look good, even at today's numbers.

Q: Let's talk about the Spieker deal. It really did come at a bad time, just as West Coast markets had crested. Any regrets?

A: Well, we certainly wish the overall economy would have done better. But I think part of that transaction is a little misunderstood. One main point is that we picked up about 3.5 million square feet in San Francisco, and we picked up about 6.5 million square feet in San Jose. But we picked up a ton of square footage in Southern California, which has worked really well.

The other element that people miss is that markets are weak almost everywhere, not just Northern California. Atlanta is 20% vacant. Dallas is 26% vacant. Chicago O'Hare is over 30%. Boston including its suburbs is 18.6%. I could go on. All I'm saying is that this corporate earnings recession has been extraordinarily broad-based.

Q: Real estate investment trusts as a whole have had two years of double-digit returns to shareholders and are outperforming the market again this year. Can they do it again next year?

A: It depends on your market assumptions. If you listen to someone like Warren Buffett, who predicts that equity returns are going to be in the 6% to 7% range from now on, and we've got an 8% dividend, I could argue that that's not a bad bet.

These are never going to be home-run stocks. What they are is very steady and stable. My instincts tell me that's going to be a winner in a normal stock market.

Q: Did you ever think you'd end up CEO of Equity Office?

A: Not in my wildest dreams. The beauty of working for Sam Zell is that he really does run a meritocracy. He doesn't care where you went to school. He doesn't care how old you are. I mean he could have picked anybody to be his CFO. I was 33 years old at the time. I had never been a CFO. Yet he chose me.

Q: One of the things that has happened over the last year is the role and responsibilities of a CFO have grown because of new regulations and laws and shareholder demands. As a CFO, what's your take on this?

A: I think that much of what they've done has made the whole process of being a public company so much more expensive that it just might stifle a lot of people from going public. I'm not here to defend any of the excess of the WorldComs or Enrons. As a CFO, I simply can't fathom what they were thinking. But I worry about the overall impact that this extra layer of burden could have on our economy.

Maybe there will be some moderation over time. But right now there's so much pressure on people to do something that, as is often the case, they might have gone too far.


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