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UpClose: Lee M. Elman of Elman Investors
GlobeSt.com
May 27, 2003
By: John Salusfri
Lee M. Elman likes to move in B spaces. The investor, president and CEO of New York City-based Elman Investors, says that that class of office property is the target type for most government agencies, so it has become his acquisition target as well. The investment niche is one most investors shy away from, says Elman, because of the risk exposure and their perception that the Fed--and for that matter most local governments--are tough to work for. Wrong on both counts, says Elman. He covers his risk and the Fed has been a surprisingly easy tenant with whom to play ball. There are risks, of course, although not the expected cyclical ebbs and flows of political cutbacks and buildups. Rather, Elman, who founded his firm in 1979, will sometimes invest in a building that he believes a government agency is about to relocate to--such as the gamble he recently took in Dallas. As GlobeSt.com reported in April, Elman snagged the 100,000-sf 8001 N. Stemmons Freeway, which is fully occupied by First Tennessee on a net-lease basis. Elman says the property, leased through May 31, 2005, was bought for the opportunity to lease it down the road to the General
Services Administration. Ringing up at just under $6 million, it wasn't a high-ticket deal, but such transactions are mounting up for the contrarian investor, who is eyeing some $80 million in additional buys before the end of 2003. He sat down with GIobeSt.com recently to explain the genealogy of his niche market.
GlobeSt.com: How did you uncover the governmentbuilding investment niche?
Elman: We originally focused on buying single-tenanted buildings leased to credit-worthy corporations and banks. The first major deal we did was the acquisition of the Marine Midland world headquarters in Buffalo, NY. The purchase price was $52 million, It was in 1996 that we shifted our focus and created the govenment-building niche.
GlobeSt.com: Why?
Elman: Most of the transactions were single- or double-net leased. Everyone was chasing after the single-tenanted buildings, driving cap rates down and prices up. !t was an attractive play to them because most of them didn't want to do any management.
GlobeStcom: It's a good argument.
Elman: We don't mind doing management, and that's the singular differentiating element in our strategy. Most government leases are, for all intents and purposes, gross or modified gross leases. Therefore, there is exposure from a financial point of view, and it becomes more managementintensive. So, because these were not net leases, we had less competition and were able to buy them at better prices.
GlobeSt.com: Are all Fed leases through the GSA?
Elman: The vast majority of them are, but there are certain agencies where the GSA is not involved, such as the Navy and the State Department.
GlobeSt.com: There must be very little wiggle room in lease negotiations with the government, no?
Elman: It's a standard lease--Form 1217--and you basically negotiate the rent and the escalations and the expiration date, which is typically 20 years. But the rest is boilerplate. A lot of people don't like to get involved with government leases because they feel it's a problem.
GlobeSt.com: What problems do they see?
Elman: The basic problem is exposure on expenses. We don't see that because we have a good way to handle that exposure.
GlobeSt.com: Which is?
Elman: We track, through the property management companies we hire, all expenses that get escalated--utilities and janitorial and the like. There is a CPI escalation allowed on expenses anyway, but we want to make sure that our expenses are not more than the escalation is going to be. In terms of how we handle the day-to-day, we farm out building management and we retain in-house asset-management capabilities.
GlobeSt.com: So investors' perception of problems really lies with themselves and not the government.
Elman: Oh, yes. The GSA has been a delight to work with.
GlobeSt.com: Those day-to-day costs are likely to rise now that the government is stepping up its security measures, no?
Elman: We're making the appropriate responses. Where a building needs to be a security-four building, we'll add the additional precautions.
GlobeSt.com: Who picks up the bill, and how much do the upgrades cost?
Elman: That still has to be negotiated. I can't talk costs because the government has picked up the cost on those buildings where the measures have been implemented. But a standard has not been created yet.
GlobeSt.com: Of course, your niche must be very cyclical, growing or shrinking with every change in military or social-services policy.
Elman: We don't necessarily find that. In times of fiscal restraint, there are social agencies that are very much in high demand--Social Security and Health, for instance. There are some fundamental agencies that will always be around, even during a bad economic period, and in an ebullient period, the government is expanding, so they need more space. Government leases are almost recession-resistant. Almost. Also, like any other tenant, if you treat the government well, they keep coming back. We have had no vacancies in our government buildings.
GlobeStcom: What's your buy threshold?
Elman: Our sweet spot is $10 million to $20 million in acquisition price, although we've gone as high as $38 million and below $10 million, especially if we're already in the area, because the management costs will be the same. We like to buy things that offer a 10 cap rate, but with interest rates being down, we'll go into the mid 9s.
GlobeSt.com: What's your typical hold?
Elman: Our mindset is three to five years, but we are willing to hold it longer if it is an interesting deal and we can refinance it, increase the rents and expand. We always buy buildings where there are expansion possibilities.
GlobeSt.com: And when do you decide it's time to sell?
Elman: When the market is very strong in a particular area, when we've held it for three to four years and we can make our IRR, we would be receptive to a sale. Our IRR objective is the high teens. An interesting thing about our IRRs is that most of them are in current returns. We are old-fashioned real estate investors in that we are interested in current returns, not the back end. If the back end happens, fine, but while we wait, we want to make sure we are getting a good return--we're talking anywhere between 11 % to 13 % cash-on-cash.
GlobeSt.com: What does your portfolio look like now in terms of value and square footage?
Elman: We're in 19 states and as of two weeks ago [this interview was conducted May 13.--ed,] we have bought a total of 2.5 million sf, valued at $284.6 million. We bought $96 million last year, and so far in 2003 we have purchased about $17 million. We expect to close another $22 million before the end of June, and in our pipeline we have another $75 to $80 million to close by the end of the year.
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