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Now Showing: Cinema REIT

The creators of Entertainment Properties Trust hope to produce the blockbuster of theater owners.

With an initial public stock offering last fall that raised $276 million, a newly formed, Kansas City-based company became the first real estate investment trust (REIT) to focus exclusively on cinema megaplexes and the themed retail centers that are cropping up around many megaplexes. Now, its founders say, Entertainment Properties Trust is poised to carry a healthy chunk of the $9 billion or so in new screens projected to open across the country over the next three years.

"As people continue to vote with their feet and their dollar for the megaplexes, we think there's going to be ample demand for us to grow," says David M. Brain, chief financial officer of the new REIT.

Entertainment Properties' creation reflects growing specialization among REITs. Trusts now focus on all kinds of properties, ranging from healthcare facilities to golf courses and prisons. It shouldn't be surprising, however, that specialized trusts are a new arrival to theater properties.

Megaplexes -- theaters that have at least 14 screens and typically include stadium seating, high-quality sound systems and other state-of-the-art features -- arrived on the scene in a big way just within the last three years. So, the race to come out ahead in what amounts to the superstore market for theaters is only now hitting full stride.

That contest is increasing pressure on cinema chains to find the capital to expand rapidly. Brain was puzzling early last year over that very challenge with Peter Brown, president of AMC Entertainment Inc., which is the Kansas City-based parent company of cinema giant AMC, and with Robert "Chip" Harris, who was senior vice president in charge of AMCE's international business.

The problem is that the new complexes are rather pricey. They average nearly $1 million a screen, and exhibitors are under extreme pressure to build more. The National Association of Theatre Owners projects a demand for more than 10,000 new screens by the end of the year 2000. Exhibitors stuck holding a heavy mix of multiplexes -- the earlier generation of theaters with two to 13 screens -- could find themselves at a competitive disadvantage.

At the same time, the capital costs are forcing large exhibitors to weigh down their own books, inhibiting more growth. One obvious solution is to liquify such debt by selling the properties to REITs. "REITs are the most efficient way in the marketplace to carry real estate," Harris says.

Exhibitors complain, however, that such properties are difficult to spin off to broad-market retail REITs due to the perceived risk by investors.

A crucial drawback: Should its original use fail, a megaplex would be far more difficult to convert to a second use than would a big-box superstore.

In investors' eyes, "it defaults to a special-use property," Brain says, adding that REITs often respond to such characterizations by thinking: "That means I have limited resale value. That means I have to price this thing way down."

Brain and Brown concluded that AMCE would be able to get a fairer price for its properties by creating a specialized REIT. To hone the concept, Brown hired Brain as a consultant. Until then, Brain was a senior vice president with George K. Baum & Co., a Kansas City investment banking firm.

When Entertainment Properties was formed in August, Brain was named chief financial officer. Harris was named president and chief development officer. Brown became chairman.

The company's initial stock offering sold in November in the mid-range of its projected price of $19 to $21 per share, raising $276 million. After deducting a $17.7 million underwriting discount, Entertainment Properties spent $248.8 million on a pre-arranged sale-leaseback deal for 12 existing AMC megaplexes. Those megaplexes have a total of 282 screens and more than 54,000 seats.

Initial annual rents on those properties, 10.5 percent of the sale price, will rise annually by at least 2 percent during the leases' terms of 13 to 15 years. The arrangement calls for triple-net leases, where operations, capital improvements and other costs are carried by AMCE.

Harris says such a deal may serve as a model for sale-leaseback arrangements between Entertainment Properties and other exhibitors. Meanwhile, further deals with AMCE may set the table for an emerging market for the new REIT.

On Feb. 2, Entertainment Properties closed on the Gulf Pointe 30 megaplex in Houston, the first of five additional AMC megaplexes for which Entertainment Properties holds options. Along with the theater, the trust purchased three adjacent parcels from AMCE.

Entertainment Properties is soliciting similar themed restaurants for the other two properties, Brain says. If those restaurants are built, the company will have developed an entertainment-themed retail center, a concept that takes megaplexes one step further by offering consumers an additional reason to spend time and money at the complex.

More tightly planned entertainment-themed retail centers also are targets for Entertainment Properties purchases. Last year, AMCE and Planet Hollywood announced the formation of a joint venture, Planet Movies at AMC, that will typically include two theme restaurants and other retailers, as well as a megaplex. Entertainment Properties officials expect to help develop the complexes, which are projected to open at a rate of up to 10 per year, beginning in 1998.

Brain sees the REIT growing at a pace of 125 to 150 screens per year over the next three years. That would give the company around 5 percent of the country's new screens over that time.

We're looking into the evolution of the market," Harris says, "and clearly the megaplexes are what's pushing the rescreening of the United States."

Larger complexes are able to exhibit most of the popular movies on the market during any given week, to stagger their showtimes and to show them in a variety of theater sizes. Economies of scale also allow megaplexes to offer stadium seating and state-of-the-art sound systems that give megaplexes a competitive advantage over multiplexes and older theaters.

That translates into higher per-screen revenues for megaplexes. In the fiscal year ending last April, for example, AMCE reported an attendance of 63,600 patrons per screen at multiplexes vs. 88,200 at megaplexes, and revenue of $5.95 per patron at multiplexes vs. $6.54 at megaplexes.

The industry's enthusiasm in the megaplex is expressed in the concept's sudden growth. While only 100 megaplex screens -- or less than half a percentage point of the nation's 24,000 screens -- existed in 1992, more than 2,700 megaplex screens are now open, nearly 10 percent of all screens, reports the Motion Picture Association.

"Most major exhibitors have seen the light," Harris says.

Although entertainment-themed retail centers have less of a track record, Harris argues that the company is placing its money on a fairly safe bet by sticking to megaplexes, which are invariably located in large, high-growth markets. "We're looking for dominant theaters in the major markets," he says.

Entertainment Properties also plans to buy theaters from third-party developers. Unlike exhibitors, which seek to liquify their debts through such transactions, developers that hold megaplex properties may seek shares in the REIT, so that they can take full advantage of the REIT's tax deferments.

So far, however, Entertainment Properties has finalized deals only with the theater chain from which it sprouted. The company projects that AMCE-managed properties will account for more than half its income through the year 2002. Entertainment Properties' biggest challenge may be to demonstrate its independence from AMCE.

The REIT's relationship with AMCE has its advantages: It ensures that Entertainment Properties can purchase a steady stream of real estate from a company that has jumped aggressively and successfully into the megaplex market. AMCE currently leads the industry in overall domestic revenue, although a pending merger of Act III, Regal Cinemas and United Artists Theatre Group is expected to eclipse AMCE this year.

But Entertainment Properties' "captive" status also holds drawbacks. Goldman Sachs and other analysts note that relying heavily on one company exposes the trust to AMCE's ability to stay healthy and to operate its theaters. They also fear that share appreciation could be limited by investors' perceptions of potential conflicts of interest. Concerns over the relationship may be one factor in a relatively low price of the company's stock as a multiple of its projected return.

"We have that issue to deal with, without question," Brain acknowledges.

The REIT seeks to allay such concerns by including three independent directors on its five-member board of trustees. Although Brown, AMCE's chief executive officer, is the trust's chairman and owns shares in both companies, he is not described as an active manager. Both he and Harris, a former AMCE officer, are excluded from negotiating transactions between the two companies. Neither company owns an interest in the other, and only Brown holds stock in both companies, Brain says.

"We have a very good and significant customer in AMCE, and that's where it ends," Brain stresses. "We continue to tell the market that we are interested, and we are in dialogue [with other exhibitors]."

Ken Edelstein is an Atlanta-based freelance writer specializing in real estate and land use.

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