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COVER STORY, JUNE 2005
ARDENT OFFICE LEADER
With skill and foresight, Arden Realty sets the example in the Southern California office market.
Brian A. Lee
As Southern California’s largest publicly traded office landlord, a REIT with a 19 million-square-foot portfolio and an owner-operator of 50 percent of California’s Energy Star office properties, Arden Realty could be excused if it chose to rest on its laurels. But that’s not how the company reached its elite and influential status in the industry.
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Arden Realty recently acquired the 608,000-square-foot Sorrento Mesa Corporate Center in San Diego for $185 million. The four-building office complex also features 53,000 square feet of retail space (foreground).
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The 300-person, full-service real estate investment and development company strides into the second half of the decade with its proven and proactive approach to office real estate and an energy reflecting the opportunities that await in a reinvigorated market. The company, of course, also has a plan.
“Our strategic plan and vision is to upgrade our portfolio through pinpoint acquisitions of properties that are of top grade in our core submarkets and through disposition of properties that are no longer core to the portfolio, that are smaller, capital intensive and have matured in marginal geographical locations,” says Richard Ziman, chairman and CEO.
Arden Realty acquires “contemporary and modern” office buildings in Ventura, Los Angeles, Orange and San Diego counties and adds value through its time-tested operational efficiencies and leasing expertise.
“Barriers to entry are important factors in virtually all of our markets,” says Victor Coleman, president and COO of Arden Realty. In that regard, Southern California’s office sector used to be driven by submarkets like Beverly Hills, Santa Monica and West Los Angeles. However, that is not the case anymore with the tremendous resurgence in popularity of the San Diego marketplace, the over-growth in Orange County in the early 1990s and the new growth in the west San Fernando Valley. These conditions, job growth and Southern California’s strong, diversified economy suit the region’s biggest office landlord just fine.
Arden Realty has recently acquired the 608,000-square-foot Sorrento Mesa Corporate Center for $185 million. With an occupancy level just shy of 75 percent, the four-building property, which includes 50,000 square feet of retail space, holds substantial leasing potential for its new owner. Arden Realty also acquired 5670 Wilshire Blvd., a 409,000-square-foot office property adjacent to Beverly Hills, for $93 million.
The company has disposed of all of its Inland Empire holdings because they had matured, good cap rates were attainable in the sales and the market with its still-plentiful land did not offer strong enough barriers to entry. Other targets for disposition within Arden Realty’s portfolio include its Bakersfield, California, properties and Long Beach assets that are adjacent to the coast, not the airport. As for new office projects — never more than 5 percent of the company’s total portfolio, says Ziman — Arden Realty is constructing a 160,000-square-foot spec building at its Howard Hughes Center in West Los Angeles and is negotiating an approximately 300,000-square-foot build-to-suit property for two large prospective tenants.
Always Thinking: What’s Next?
Arden Realty’s wholly owned subsidiary, next>edge, is an impressive example of the company’s proactive nature and keen vision, which enable it to anticipate future challenges and turn them into robust opportunities.
Did you know that Arden Realty’s energy strategy was being formulated around the same time the EPA itself was coming up with its Energy Star program? That Arden Realty’s energy efficiency plan was a reality 5 years before California’s energy crisis started making headlines in 2001? That the company’s energy initiative has reduced 9 megawatts of power demand from its office portfolio or the equivalent of enough energy to power 6,700 homes? All of this is embodied in next>edge, Arden Realty’s turnkey provider of fully integrated energy efficiency and power generation solutions for all types of commercial properties.
“Back in 1996, when Arden went public, I think we started with something like 4 million square feet [in the office portfolio] and ramped up to 20 million square feet in about 18 months,” says Scott Lyle, president of next>edge. “You can imagine the challenge. Besides looking at just best practices from an operational standpoint, Arden has looked at energy and energy efficiency, recognizing that was one of the main costs that had gone uncontrolled historically in real estate.”
The initial impetus for Arden Realty’s energy program, and eventually the creation of next>edge, was partially borne out of the frustration that Arden’s facility management people experienced when working with outside vendors. These contractors had their specific skill sets, but were unable to see the big operational picture and adopt the comprehensive approach that is so integral to the office owner-operator’s success. In response, Arden Realty formed its own internal operations and energy efficiency team, developed its own methodology for evaluating energy and energy consumption, and created its own systems management software.
The results have been impressive, with Arden Realty achieving both economic gain and industry acclaim. The EPA named the REIT Commercial Real Estate Partner of the Year three consecutive times — the only company that can claim that distinction — and recognized it as the industry leader in the agency’s Energy Star program. Lyle says that Arden Realty spent $25 million to $30 million on reaching green or energy efficiency goals and was receiving payback on that investment over the entire portfolio in less than 5 years. It’s not hard to extrapolate what kind of operational savings such an approach would mean for other commercial real estate owners.
“Frankly, it’s an investment in your assets,” says Lyle. “It doesn’t matter if it’s a manufacturing facility, a convention center or a hotel. You’re investing a lot of money in your facility. On a project-for-project basis, the returns are anywhere from a low of 20 percent to literally over 80 percent. There’s a lot of low-hanging fruit in the energy efficiency side of a real estate asset that can be obtained with fantastic and quick results.”
The marriage of energy conservation and green programs with reduction in operational costs and increased return on property investments is a win-win formula for the commercial real estate industry. This rings especially true in California, which was dealing with an energy crisis long before the latest rise in gas prices.
“At the end of our project implementation, the energy crisis [in California] started,” says Lyle. “We started to see regional blackouts in 2001, issues concerning where we were going to purchase power, utilities heading into bankruptcy and energy costs starting to skyrocket. We quickly realized when the REIT laws changed that here was an opportunity to create a taxable subsidiary that could go out and support other landlords in achieving what we already achieved.”
The president of next>edge estimates that the dollar volume of the subsidiary’s projects from its first year to the present has increased thirty fold. With its turnkey approach, next>edge maintains the perspective of the owner-operator looking for the return on investment, but also manages the quality of the entire “envelope” and ensures the proper level of training for a client’s facility management staff. It’s not a segmented, piecemeal approach, meaning that the goals of energy conservation and power generation are reached comprehensively through system-to-system, system-to-facility and system-to-staff integration. The importance of next>edge’s services becomes even more apparent when you consider that the large pension funds CalSTRS and CalPERS have begun mandating that any real estate organization worthy of their investment dollars monitor energy issues and focus on conservation.
“Energy conservation is not just about the green aspect,” says Lyle. “These projects literally have incredible economic returns. In an industry that’s excited about 10 percent returns, 20 percent and above is significant. Operational costs in the area of energy are just going to continue to increase.”
Prime Position
Arden Realty has always held quality office assets and employed exceptional people and market strategy. Now, market conditions are falling in line.
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6040 Center Drive, a 160,000-square-foot office building, will be Arden Realty’s latest development project at its 70-acre Howard Hughes Center.
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“We have sort of slugged through the last 5 years of this latest cycle,” says Coleman. “At this time in Southern California, we have the most diverse economy that we’ve had in real estate in the last 20 to 25 years. Before it was aerospace, after that it was entertainment, then it was technology. Now, every aspect of business is flourishing. As a result, this is the time in our markets and in our leasing markets specifically when we now see the increase in competitive rental rate growth. In specific markets, you’re seeing such a lack of new space coming in and such a lack of quality vacant space, as we’re now reaching a point of stabilization. It really is becoming a landlord’s market and that’s the objective as an owner of real estate in any cycle.”
Ziman agrees, saying, “We’re seeing in some areas that it has become a landlord’s market. Once it turns, it turns pretty quick. In most of our submarkets, we’re getting down to 12 and 11 percent [office] vacancies. Once you get down to the low double-digits, the world changes. We believe that Southern California as a whole and many of our core submarkets, specifically, are poised for dramatic changes in the concession world and the rental rate world.”
But even with Arden Realty’s office markets in fine fettle, there’s little time to stop and smell the roses. There’s always planning and preparation to do for the next project, and anticipation for the next challenge.
“In our minds, 2005 is already up and running; it’s in place,” says Coleman. “We’re looking at ’06 and ’07 and thinking of where we need to be then. We’re looking at stabilized occupancy, at the next phase of development in our portfolio and then lastly for external growth on the acquisition/disposition side. We’re looking for the next part of the cycle, a rehab cycle — taking the aging buildings that we really want to keep in our portfolio, retrofitting those buildings to make them more efficient (see next>edge), making the buildings much more accessible and amenable to tenant needs, and thinking about where tenants are going to be 2, 3 and 4 years from now.”
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