The high-rise of a REIT powerhouse

In the past three years, Charles E. Smith Residential Realty Inc. has been in high gear on the development front with mergers, new construction and property acquisitions. In May, the Arlington, Va.-based REIT was involved in its biggest deal yet. This time, the company agreed to merge into Denver-based Archstone Communities Trust.

Scheduled for completion this fall, the $9.3 billion merger will create a combined entity called Archstone-Smith Trust. The Smith Residential brand name will be used for the company's high-rise apartment portfolio, while the Archstone name will be placed on the portfolio's other communities.

The new company will own 87,456 units, including 4,899 units under construction, making it the nation's fourth-largest REIT and second-largest multifamily housing REIT. Archstone has nearly 60,000 units in 31 of the nation's top 50 markets. Meanwhile, Smith Residential has nearly 30,000 units in the Washington D.C./Northern Virginia, Chicago, Boston and Southeast Florida markets.

“The combination of Archstone and Smith Residential brings together two of the most respected brands in the apartment industry, creating a company with unmatched reach, resources and opportunity,” said R. Scot Sellers, Archstone's chairman and CEO. “Our complementary platforms will significantly enhance our combined long-term growth rate and allow us to extend the company's urban high-rise expertise into attractive markets.” Smith Properties officials, meanwhile, emphasize that the combined entity will continue the development and acquisition of urban, high-rise properties in Smith's core markets, including Chicago and Boston, and is likely to expand in key West Coast cities such as San Francisco, Seattle and San Diego.

Lou Taylor, managing director and senior real estate analyst for Deutsche Banc Alex Brown in New York, thinks the merger is a good deal for both parties. Charles E. Smith needs access to capital, while Archstone has excessive capital that it wants to sell. The merger will help both companies achieve those goals, he said.

“For example, Archstone wants to sell Dallas assets and invest in Boston. It's easy to sell in Dallas, but the money sits in the bank and drags on earnings because it's difficult to find properties for sale in Boston,” Taylor said. “Smith has the opposite problem. The company had a core portfolio it was reluctant to sell because it would reduce its market position. Smith wasn't pursuing as many transactions as it would have liked.”

Before the merger, Smith Residential had shifted into overdrive with its developments and acquisitions. Last year, it completed five projects totaling 2,054 units. In 1999, this seven-year-old sister company of the privately held Charles E. Smith Cos. went on an acquisition binge that added eight properties totaling 5,693 units. This development and acquisition activity increased the firm's asset base by at least 20% each of the past four years.

Today, Smith Residential has more than 30,000 units and a total of 65 properties, most of which fall under the firm's preferred niche of upscale urban high-rises. “We've done a lot of market research and we've capitalized on the trend toward urban high-rise living,” explained W.D. (Denny) Minami, president of Charles E. Smith Cos. “This concentration has led to solid, stable growth for our shareholders and increased interest from the capital markets.”

The flurry of growth didn't go unnoticed. In April, Smith Residential won five awards at the National Association of Home Builders' (NAHB) Pillars of Industry Awards, including “Multifamily Property Management Company of the Year” and “Development Firm of the Year.” It was the first time one company won five awards in the 10-year history of the NAHB's annual program.

Developing the urban strategy

From its inception in 1994 through 1997, Smith Residential concentrated mainly on 11,500 multifamily units on its home turf in Washington, D.C., and Northern Virginia. To grow, the company agreed that it would be necessary to expand its range beyond the Washington D.C./Northern Virginia market. Company officials also realized that they would need to add management personnel at the leadership level to accommodate growth.

Identifying upscale urban high-rises as its target niche was an important foundation for the then-fledging REIT. This niche, which continues to be fueled by suburban professionals and echo baby boomers who are moving into urban locations, also was a familiar category that many of Smith Residential's existing properties fell under. It also was a good choice from the standpoint that an upscale focus shields the firm from competition found in the more intense middle- and lower-income multifamily housing categories.

“Smith Residential's strategy of focusing on upscale, in-fill locations is something that lenders like,” said William R. Lynch III, vice president of PNC Real Estate Finance, Washington, D.C., a long-time construction financing lender of Smith Properties and a member of the Pittsburgh-based PNC Financial Services Group. “Compared with another company that has garden-style apartment properties all around the country, I think its focus is more insulated from competition and economic downturns,” he said. “Plus, the trend of people wanting to live downtown in a large city appears to be continuing.”

The broadening of Smith Residential's market coverage beyond the Washington D.C./Northern Virginia area began with Chicago and was followed by Boston and Southeast Florida. “These are markets where urban living was a trend and we could capitalize on our previous high-rise expertise,” Minami said. “These markets also had similar demographics to Washington, D.C., and we felt they were ripe for either development or acquisition.”

Bull's-eye on Chicago

Targeting Chicago in 1997, Smith Residential's research reported that Chicago's downtown and North Lincoln Park area had a concentration of 20,000 upscale units. However, no new rental buildings had been built since 1991. “Chicago might have been viewed as a bold step, but we liked the job-growth statistics there and felt it was ready for more development,” Minami recalled.

Smith Residential quickly established its presence by acquiring two properties and breaking ground on One Superior Place, Chicago's first high-rise development in eight years. Today, Smith Residential is Chicago's largest REIT owner of residential rental properties with 4,800 units market-wide. Another 480 units will be added when the Park Millennium development is delivered next year.

After Chicago, Smith Residential identified Boston as its next market in 1998. Although Boston had all the requirements to satisfy Smith Residential's niche focus, Minami noted that a shortage of properties and the high cost of most of the properties that become available have made it difficult to expand in that market. Persistence, however, resulted in last year's acquisition of the 225-unit Sagamore Towers.

In two earlier acquisitions, the company also added 469 units. While the acquisition market remains tight, Boston's development opportunities appear lucrative. Smith Residential has announced two more major Boston developments, one of which one will start in the next 12 months.

Smith hits the beach

It was this increased selectiveness, and the large availability of properties with the comparably better price range of $50,000 to $60,000 per unit, that steered Smith Residential to its third new market, Southeast Florida, in 1999. “We like Southeast Florida's dynamics because it appears to be a little later in the cycle than the other urban markets, and it has more legs,” Minami said.

Although Southeast Florida is the newcomer to the portfolio, it already ranks second behind Washington, D.C., with 5,052 units and five properties. Smith Residential already has more high-rise units in Southeast Florida than any other REIT. While the 240-unit New River Village, Fort Lauderdale, Fla., was a new development, Smith Residential's other Florida deals have been acquisitions.

One Florida acquisition was the former Forte Towers, a five-building, high-rise apartment complex with more than 1,300 units in the South Beach area of Miami that Smith Residential acquired for $85 million and has since renamed The Mirador. South Beach is a booming area for acquisitions because it is an urban market that is not only attractive to Floridians, but also a blooming Hispanic immigration market.

The acquisition of The Mirador and the additional $25 million the firm has invested in improvements marks a new direction for Smith Residential — repositioning. The building is being renovated while it is fully occupied. Repositioning The Mirador should yield about a 10% return, according to Minami. “If we choose to sell the property after the repositioning, the improvements would make it easily saleable at a cap rate of about 7%,” he added.

While The Mirador is an example of repositioning, Smith Residential is also quite experienced with redeveloping as well, which fits nicely into the REIT philosophy of holding properties for long-term gains.

Smith Residential's redevelopment aspirations are well illustrated at the historic Alban Towers, a six-level, 226-unit, Washington, D.C., property that was gutted, renovated and completed last spring. The Alban Towers project is the pinnacle of Smith Residential's mission of offering amenities that draw the upscale renter. Alban Towers has a rooftop deck with panoramic views of the District, Maryland and Virginia, a fitness facility with a lap pool, a state-of-the-art business center, landscaped grounds that include a butterfly garden and a residents-only library.

So what future markets does Smith Residential have its eye on? Minami said there is still room for growth in its three newer markets for acquisition and development, especially in Boston, where Smith Residential hopes to accumulate more critical mass. “Our approach recently has been a little more conservative than in the past because we're cautious about the current economic trends in these three markets, even though they appear better than the overall national economy,” Minami said.

Beyond the three markets, the firm is considering moves into New York and West Coast cities such as Seattle, San Francisco, Los Angeles and San Diego because they fit the corporate strategy.

“These markets are interesting, but the bottom line is increasing shareholder value, which means we can't overpay for properties,” Minami said.

John Frantz is a Chicago-based writer.

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