Alan Leventhal and Real Estate Deal Making

On February 23, 2004 Alan Leventhal, Chairman and CEO of Beacon Capital Partners, visited HBS at an event sponsored by the Real Estate Club and co-sponsored by the Venture Capital and Private Equity Club. In 2003 Beacon Capital purchased the John Hancock Tower in Boston for $910 million. This deal was the largest single asset transaction ever done in Boston and was later named “Deal of the Year” by Institutional Investor. The transaction was conducted through Beacon Capital’s third fund which closed with $740 million in equity last summer.

Beacon Capital is a Boston-based private real estate investment firm that has acquired or developed commercial properties valued in excess of $2.6 billion in the past five years. Mr. Leventhal said the firm targets opportunistic returns of 18-20% and has a proven track record with three of its four closed-end, commingled funds hitting 40% returns (the fourth is on track for 19%). The firm invests only in large US cities with some limit to new supply and seeks to invest in unique assets in lieu of commodity buildings.

After surveying the audience’s interests, Mr. Leventhal presented his view of the state of the commercial real estate markets nationally and locally.

He pointed out that the fundamental drivers for the office market have not changed over the decades. “There is no new paradigm in real estate,” he said. In the 80s and 90s, lower cost locations in the southeast and southwest were expected to draw businesses from established but higher cost areas such as Boston. Telecommuting was also expected to make traditional office space obsolete.

Despite doomsday scenarios like these, the Boston market has been very resilient and has grown over the long-term. Then, just as it is now, it was driven by knowledge companies and institutions that benefit from the proximity of universities such as Harvard and MIT. This knowledge capital environment creates unique assets and opportunities in the real estate market here and in other US cities.

When asked if prices in real estate markets are irrational, Mr. Leventhal explained the increasing gap between market fundamentals, which have deteriorated over recent years, and prices, which have generally trended upwards over the same period. While this by itself does not seem rational, Mr. Leventhal noted that investors view real estate as just one asset class in a broader context. In expectation of low or even negative returns in the equity markets many investors turned to real estate where they could still expect better returns on a relative basis despite higher prices. Therefore, when viewed as one investment alternative, the real estate market still behaves rationally.

Mr. Leventhal spoke about the rationale behind the Hancock Tower deal, a deal which at first glance is somewhat contrary to the investment philosophy of his firm. Traditionally Beacon Capital targets value-add opportunities, but Hancock Tower is clearly a trophy asset. Mr. Leventhal pointed out the following facts that make the deal a good investment: 1) the average per-square-foot cost of the tower is $307, which is about 30 percent under replacement cost 2)a strong tenant roster of top-credit national firms, with leases significantly under current market rates and long-term leases and 3) an immediate 12% cash-on-cash return.

Mr. Leventhal responded to the question about the effect of rising interest rates on the investment climate in the following way. “Interest rates don’t rise in a vacuum.” While rising rates would have a negative impact on valuations mostly through higher cap rates, higher interest rates will only be present when some combination of inflation, job growth and a strong economy are present. “Higher interest rates will be good for real estate,” he said, explaining that the driving factors behind rising interest rates will push valuations upwards on an absolute basis offsetting the direct effects of higher rates.

Mr. Leventhal closed with a summary of the business, saying that “Real estate is highly imperfect and highly illiquid. It is very much a business of relationships.” In explaining how important relationships, trust and reputation are, Mr. Leventhal described how the Hancock Tower deal was closed in seven days based on a verbal agreement and commitment to write the $910 million check. Now that is a serious commitment.