Real-Estate Investment Trust
Loads Up on New York Properties

While other real-estate investment trusts have been selling office buildings amid record sale prices, SL Green Realty Corp. of New York is looking to buy.

Don't be surprised by the contrarian stance. During the slump of 2002 and 2003, when most other REITS shied away from New York, SL Green gobbled up $2 billion of property, often at below-market prices. In the process, SL Green has grown from a minor player with side-street properties to compete head-to-head with closely held Tishman Speyer Properties and another REIT, Vornado Realty Trust, as Manhattan's largest landlord of office buildings.

But it is SL Green's performance -- not its size -- that has impressed investors. In total returns to shareholders -- including dividends and a rising share price -- SL Green licked all other publicly traded office REITs, topping the list for the year-to-date, the past year and the past three years, according to SNL Financial, a Charlottesville, Va., research company.

The question for investors now: Should they also continue to buy? The short answer: yes.

Fundamentals in the New York office market -- such as occupancy and rental rates -- are looking great and are expected to continue improving. Joseph Betlej, portfolio manager for Advantus Capital Management of St. Paul, Minn., whose real-estate funds have $845 million under management and invest in SL Green, points out that the company's office buildings are worth more than is reflected in the stock price, based on recent sales prices of similar buildings in New York.

As with nearly every REIT stock today, SL Green is worth a look in this fevered deal atmosphere in which REITs are being acquired at a premium to their trading price. Shares of SL Green rose 69 cents to $112.01 in 4 p.m. composite trading yesterday on the New York Stock Exchange, giving the company a market value of about $4.8 billion.

SL Green's dividend payout ratio is 73.4% of the company's 2006 estimated adjusted funds from operations, of FFO, a financial metric excluding capital expenditures. That makes it more secure than the 98.3% for their office peers, according to data compiled by BMO Capital Markets. The lower the ratio of dividend to FFO, the easier a time REITS have making the payout.

While SL Green's stock trades at a relatively high multiple of FFO compared with its peers -- 22 times 2007 consensus FFO a share compared with 16.7 times for competitors -- SL Green has an FFO growth rate that is predicted to be higher than its peers for 2007, BMO data show.

Location is undoubtedly part of SL Green's success. Many of its properties are scattered around New York's Grand Central Terminal, an area valued by corporations as the city's doorstep for wealthy commuters. As the Midtown market continues to tighten, SL Green is underwriting a 25% to 30% increase in rent rates over the next three years.

While today's higher interest rates make for more expensive mortgage loans, they usually accompany an improving economy, which pays off for REITs in the form of lower building vacancies, higher rents and other revenue improvement.

SL Green isn't just in the right place at the right time. Sri Nagarajan, senior analyst of REITs for RBC Capital Markets, estimated how much of the company's success is based on location and how much is the business model. From January 2002 to April 2006, all office REITs, regardless of location, averaged annual total returns of 17%. New York landlords, public or private, averaged annual returns of 20% -- a bonus for being in one of the best markets. SL Green's returns averaged 38% over that time. Mr. Nagarajan has the equivalent of a "hold" recommendation on SL Green's stock, believing it is fully valued at present. RBC doesn't own shares of SLG nor has RBC done business with SLG in the past year.

The company rarely tries to outbid other investors in the brutally competitive New York market. "If you sit back and bid properties, you're either going to overpay or lose. Period. So we don't do it," says Chief Executive Marc Holliday. Rather, SL Green focuses on selling weaker performers and plowing the proceeds into word-of-mouth deals that never formally go on the market or that other companies find too hairy. That is why SL Green, unlike other REITs, will be a net buyer in 2006, just as it has been every year since the company went public in 1997.

Real-estate experts point to the 2005 acquisition of 1 Madison Ave. -- the former MetLife tower that was once the tallest building in Manhattan -- as a typically complex SL Green deal. In pulling off the $920 million transaction, SL Green partnered with Gramercy Capital Corp., a finance REIT of which Green is 25% owner, then courted Credit Suisse Group -- the anchor office tenant in the property. Even though the building belonged to MetLife Inc., Credit Suisse had some negotiating power, so SL Green suggested that the bank become 50% owner of a planned residential part of the project.

In turn, Credit Suisse offered SL Green flexible financing, because the REIT agreed that some parts of the loan structure wouldn't be determined until after closing -- something other suitors weren't willing to do, says Anthony Orso, co-head of U.S. large-loan real-estate finance for Credit Suisse.

Then, in March, SL Green and Credit Suisse sold 60% of their ownership in the famous clock tower to investors who will convert the space to condominiums. "After it's all been sliced up, you end up with a phenomenal return with little capital at risk, which is a very different model than a lot of REITs that might own 100% of a very stabilized asset," says Anthony Paolone, an analyst with J.P. Morgan Chase & Co., who has a "buy" recommendation on the stock of SL Green, which he doesn't own. J.P. Morgan hasn't done investment-banking business with SL Green in the past year.

SL Green has its critics. Green Street, a Newport Beach, Calif., research company, has rapped the company for a long-term incentive-compensation program for executives, approved in 2005, which is tied to a rise in stock price but not to outperforming its peers. On June 28, Green Street determined that the criteria for getting the compensation -- with a potential $50 million payout -- were met in just six months, an unusually short time to earn "long-term" rewards. Mr. Holliday, 40 years old, was among the highest-paid chief executives in the REIT industry, with his total compensation of $10.1 million in 2005, according to data from researcher SNL Financial. Chairman Stephen Green says that, considering the company's returns, Mr. Holliday is worth what he is paid and more.

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