Douglas Emmett (DEI)

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Anichya G

Douglas Emmett (DEI) is a Real estate investment trust that leases office space and multifamily properties to businesses and wealthy individuals in Los Angeles County and Honolulu. DEI focuses on these geographic areas because they have limited real estate supply, high barriers to entry, and strong economic and population growth. Ironically, the same characteristics that make the Los Angeles and Honolulu markets attractive to DEI, have also been a limiting factor in the company's growth. The company has very little inventory (land and buildings) that it can develop, and until early 2006, the high prices in DEI's core market have made acquiring additional real estate prohibitively costly. As a result, much of its growth through 2006 was focused on increasing revenue from existing properties.

In early 2008, continued job losses and a tightening of lending standards among banks began to drive down prices for commercial real estate. ^[1] In this case, the real estate market downturn has been accompanied by slowing economic growth as well, leading to lower profit margins for many of DEI's customers. The leases for over 25% of these customers expire in 2008 and 2009, providing them with an opportunity to negotiate lower prices or seek other office space. In the short term, however, lower real estate prices create important buying opportunities for DEI. The Los Angeles real estate market has been hit hard with a 19.4-percent year-over-year decline compared to a 12.7-percent overall drop among 20 metropolitan areas measured by the Standard and Poors/Case-Shiller Home Price Index.^[2]

Financial/Operating Metrics

DEI owns 11.8M square feet of rentable office space with 95% of it located in the Los Angeles area. It also owns 2,868 multifamily units in Brentwood, Santa Monica and Honolulu.^[3]

In 2007 DEI made two acquisitions totaling $116M and invested in renovations and improvements to over 3.1M rentable square feet.^[4]In 2006, DEI engaged in the $114M aquisition of The Villas at Royal Kunia and invested 18 buildings totalling 4.6M rentable square feet in renovations and re-structuring.^[5] Thus, DEI's results over the past three years have been skewed by these acquisitions and renovation activities. DEI expanded rapidly after its October 30, 2006 IPO, aquiring six office properties and three multifamily properties. Thus net income shown losses during this period of investment and renovating of properties that will yield income in the future.

Trends and Forces

Douglas Emmett (DEI) has high exposure to Los Angeles and Honolulu Government Regulations

• Rent Control - The City of Los Angeles and Santa Monica have strict rent control policies, and portions of the Honolulu multifamily market are also subject to rent controls. Such laws and regulations limit DEI's ability increase rents, evict tenants or recover increases in operating expenses. Any failure to comply with low and moderate-income housing regulations could result in the loss of certain tax benefits and the forfeiture of rent payments. Although under current California law DEI is able to increase rents to market rates once a tenant vacates a rent-controlled unit, any subsequent increases in rental rates will remain limited by Los Angeles and Santa Monica rent control regulations.As of December of 2007, properties exposed to Rent Control risks (multifamily portfolio) account for $69,474M out of $518,220M of DEI's revenues.^[8]

Douglas Emmett (DEI) is Extremely Susceptible Changes in LA and Honolulu

Because DEI is solely based out of Los Angeles County, California and Honolulu, Hawaii, it is exposed to greater economic risks than other REITs with geographically dispersed portfolios. Changes in the Los Angeles economic or regulatory environment will have a disproportionately high effect on DEI.

DEI's geographic concentration limits development possibilities

DEI has no excess land or buildings for redevelopment. The same characteristics that make Los Angeles and Honolulu attractive, limited availability of land and high barriers to entry also make acquiring new property prohibitively expensive. Most of the firm's growth through 2006 has been driven by growth in rents on existing properties.

Market downturn affects both Residential and Office portfolios

Although DEI generates a majority of its revenue from office properties, the company also receives nearly 15% of its revenue from its Multifamily properties. In 2007, the housing downturn in Residential Real Estate in 2007 and began spreading to the commercial real estate market in early 2008. In March of 2008, PricewaterhouseCoopers reported that employment cutbacks were beginning to have an effect on office space demand, and analysts are forecasting declines in commercial real estate values of 20% or more. ^[9] Lower real estate prices, however, also present a buying opportunity for DEI which is looking to expand its presence in the Los Angeles markets.

DEI has less floating debt than its peers

• DEI has much less floating debt than its peers. As of December 31, 2007, approximately 94.1% (or $2.90 billion) of DEI's total outstanding debt of $3.08 billion, were fixed at relatively low interest rates (under 6%). As a result, DEI has only $18.5 million in debt exposed to floating interest rates.^[10] DEI has $180.45M in debt retiring in the next one to three years.^[11]. Changes in interest rates do no have a substantial impact on its interest payments.

Competition

DRE faces competition from numerous developers and real estate companies both private and public. Many of its competitors are focussed on individual upscale cities. Even if they are not located in the same city as DEI, they compete with DEI for investors and tenants looking for luxury real estate.

The table below provides competitive data comparing DRE with some of its close competitors:

Footnotes

1. ↑ The Los Angeles Times March 23, 2008: He Quietly Built an Empire
2. ↑ China View: Home prices decline in Los Angeles area among worst in U.S.
3. ↑ DEI 2007 10K, Item 2, pg. 20
4. ↑ DEI 2007 10K, Item 6, pg. 29
5. ↑ DEI 2006 10K, Item 1, pg. 6
6. ↑ DEI 2007 10K, Item 15, pg. F-5
7. ↑ DEI 2007 10K, Item 6, pg. 28
8. ↑ DEI 2007 10K, Item 6 , pg.28
9. ↑ The Los Angeles Times March 23, 2008: He Quietly Built an Empire
10. ↑ DEI 2007 10K, Item 7A , pg.37
11. ↑ DEI 2007 10K, Item 6 , pg.35
12. ↑ DEI 2007 10K, Item 1, pg. 4
13. ↑ WRE 2007 10K, Item 1, pg. 3
14. ↑ KRC 2007 10K, Item 1, pg. 1