Liberty Property Trust (LRY)

TOP CONTRIBUTORS

Michael Francis

Thomas Gaffney

Liberty Property Trust is a real estate investment trust (or REIT) that develops, acquires, and manages commercial and industrial properties in the Mid-Atlantic, Southeastern and Midwestern United States. The company focuses on five varieties of properties, including big box warehouses, multi-tenant industrial facilities, flex/R&D buildings, and office space. As of 2006, the company owned over 65 million rentable square feet across 720 properties. Of these around 41% were offices, while 59% were industrial-use.^[1]

The company has been pursuing a strategy of entering high growth markets like DC and Phoenix. It is doing so via both acquisition and development. Acquisition can quickly expose the company to attractive demographics but also greater competition in finding real estate deals at favorable prices. Development, on the other hand, carries the risk of extended periods of no cash flow, despite usually having a superior return for the company in the long run. Nonetheless, LRY has on balance earned some of the heftiest returns compared to peers over the previous five years, evidence of a strategy that seems to be paying off.

LRY is at the whim of the US economic cycle, both because of the impact of variables like interest rates on the value of properties owned and the occupancy and rental rates of tenants, who are almost exclusively other businesses. LRY also has significant development activity compared to peers, which can put greater financial pressure on the company during periods of economic downturns.

Financial Data

Trends & Drivers

• Growth via acquisition vs. development. As a REIT, the company has two options for growth: acquiring existing properties or developing new properties. LRY chose slightly more of an acquisition bent recently, purchasing Republic Property for $900M and properties in high growth areas such as Washington, DC and Phoenix, AZ. This strategy typically allows the company more immediate presence in any given market, but given the attractiveness of the regions they are looking enter, also could entail greater levels of competition, and, hence, lower initial returns on capital. That said, however, the company continues to earn some of the heftiest five-year average returns on investment compared to its peers, which is largely due to its high growth strategy paying off. Also, despite the acquisition activity, its development projects are nothing to sneeze at: the company has pipeline plans for about $500M of new properties in the next year. As discussed below, development carries its own set of risks.

• The company is heavily exposed to the Delaware Valley and the Midwest. The company's portfolio consists largely of commercial real estate in the Delaware Valley and the Midwest.

^[4]

The rate of job growth, commercial activity, property taxes, zoning requirements and regulations, and other factors within these states can have important effects on the company's bottom line. The lack of geographic diversity exposes the company more heavily to real estate cycles in its operating areas, as real estate values move in tandem within a given region.

• Economic Cycles and development exposure. The company is subject to risks associated with national and local economic cycles. The rate of economic growth, corporate profits, and employment can be predictive of success or failure since the company's tenants are largely corporate enterprises who ultimately, in general, occupy space and pay rent commensurate with the success of their own firms. Industry slowdowns, business relocations, changing demographics, and other macroeconomic variables can have important effects on the company and its ability to attract and retain tenants. LRY's significant development activity (15% of assets vs. an industry average of around 12%) could exacerbate these negative effects: development properties don't generate cash flow, meaning the company would have to sell properties or borrow money more than competitors if the economy starts doing damage to the portfolio.

• National and Local Job Market and Employment. The strength of the labor market is an important predictor for the company. Jobs fuel demand for office space, and strong job growth can drive higher occupancy rates and lead to increased office rental revenue. High unemployment and slow job growth, on the other hand, can hamper the commercial real estate market and, when job growth is negative, the company can experience falling occupancy rates and lower revenue per square foot, which leads to less efficient buildings as the utilization of the office space falls.

• Interest Rates. Rising interest rates have several effects on the company:

1. Other investments become more attractive, thereby hampering demand for real estate investors. This, in turn, decreases the market prices of the company’s properties.
2. Available and existing financing becomes less attractive. Getting favorable terms on any new debt to finance building purchases becomes more difficult. The company’s interest expense on its floating rate debt increases, pressuring margins and increasing financial risk.
3. The stock price can fall as investor’s demand a greater dividend yield. As a REIT, the company must distribute some 90%+ of its cash flow to shareholders in the form of a regular dividend. When interest rates rise, investors demand higher dividend yields on REITs, thereby driving down their stock prices. Furthermore, despite falling interest rates (usually a positive), LRY's stock price has been suffering of late, leading to a high dividend yield, evidence of investor expectations that the company may cut its dividend or fail to continue to grow it at is has in the past given current economic conditions.

Market Share

Market share is listed by 2007 revenues.^[5] In 2007, LRY held 7% of total U.S. office REIT market share, by revenues. There are 14 U.S. exchange traded REITs focusing on office properties.^[6] Of those, the top three Boston Properties (BXP), Brookfield Properties (BPO) and SL Green Realty (SLG) accounted for just over half of Market Share by 2007 revenus.

• Boston Properties (BXP): BXP owns 138 properties in just five areas of the United States: Midtown Manhattan, Boston, Washington D.C., San Francisco, and Princeton, N.J. The company operates high end class A buildings and its largest tenants are the legal and financial service Industry. BXP also owns two hotels, an industrial center, and a land bank in the Northeast with 10 million square feet of space for development.^[8] As of May 21, 2008 BPO had a market cap of $11.85B.^[9]

• Brookfield Properties (BPO) BPO develops, owns and manages U.S. commercial office properties and develops residential land. The company's commercial property portfolio consists of interests in 109 properties totaling 73 million square feet, primarily located in New York, Boston, Washington D.C., Houston, L.A. and Toronto where its buildings can lease to a tenant base of government, energy and financial companies. As of May 21, 2008 BPO had a market cap of $8.25B.^[10]

• SL Green Realty (SLG) SLG owns and leases office space to corporations in Manhattan. The company owns more than 30 New York City office properties totaling over 22 million square feet.^[11] In 2007, SL Green cemented its position as the Big Apple's largest landlord when it acquired Reckson Associates Realty Corp. The transaction added a total of 9 million square feet to its portfolio, including over 5 million square feet of suburban offices and 4 million additional square feet of prime Manhattan office space.^[12] SLG faces a particular risk from the subprime crisis. By weakening the financial sector, the heart of the New York economy, it threatens to crimp demand for office space in the company's core market. As of May 21, 2008 SLG had a market cap of $5.71B.^[13]

Competition and Market Share

LRY faces heavy competition within each of its markets. Commercial real estate operators compete for tenants, financing, and acquisitions of properties. They compete on several factors, including rents, services provided for tenants, and location. Competitors range anywhere from other REITs to pension funds to individual and foreign investors. Some competitors include:

• Vornado Realty Trust (VNO) is one of the largest owners and managers of real estate in the United States with a portfolio of approximately 64 million square feet located in the Washington D.C. and New York areas.^[14]
• Equity Office Properties Trust (EOP) is a privately held REIT headed by real estate tycoon Sam Zell. EOP owns more than 125 office buildings in about 15 metropolitan areas. EOP was recently acquired by the Blackstone Group for almost $40 billion after a fierce bidding war with Vornado in one of the largest private equity transactions ever.^[15]
• Boston Properties (BXP) owns primarily first-class office space, a hotel, and retail properties^[16] located mostly in Boston, Manhattan, San Francisco, and Washington DC.^[17]
• Brookfield Properties (BPO) owns nearly 50 million square feet in commercial properties across the US and Canada.^[18]
• Brandywine Realty Trust (BDN) operates commercial properties in the largely suburban areas of western and northern Pennsylvania, New Jersey, California, Virginia, and Texas.

Below are comparisons of relevant operating information for similar commercial real estate investment trusts.^[19]

Footnotes

1. ↑ 2006 LRY 10-K, "Business," pg 4-5
2. ↑ 2006 LRY 10-K, "Selected Financial Data," pg 20
3. ↑ Compiled from 2006 LRY 10-K, "Selected Financial Data," "Business"
4. ↑ 2006 LRY 10-K, "MD&A," pg 24
5. ↑ Google Finance
6. ↑ InvestinREITs.com
7. ↑ All Taken From Google Finance
8. ↑ BXP's Investor Relations Website
9. ↑ Google Finance
10. ↑ Google Finance
11. ↑ http://slgreen.com/about/ SL Green- About Us
12. ↑ http://slgreen.com/about/company-history/ SL Green- Company History
13. ↑ Google Finance
14. ↑ VNO company website
15. ↑ Yahoo Finance: Equity Office Properties Trust company overview
16. ↑ Boston Properties company website
17. ↑ Hoovers: Boston Properties company overview
18. ↑ Hoovers: Brookfield Property company overview
19. ↑ Data compiled from company annual reports