When does a real estate investment trust become a dot-com?
Probably never, but a handful of REITs are quietly betting on the future of tech stocks by accepting equity stakes in start-ups in lieu of cash rents, security deposits and new tenant fees for space improvements.
A noncash component of rent is nothing new: Private landlords have been cutting such deals for decades. However, when a public REIT trades current cash flow to gamble on the success of a Silicon Valley start-up, investors might be wary. "REIT investors should be cash-flow driven," says
portfolio manager Ken Statz. "We are very suspicious of those who would give up cash flow today for the potential home run."
Some might say REITs are only following the lead of other companies that have cashed in on high-tech investments and warrants. After all, both
came away fat and sassy after
cashing in early investments in
. Tech behemoths like
routinely reap the benefits of investing in tech start-ups.
While nobody questions the ability of a landlord to occasionally hit the ball out of the park, judging the viability of tech companies is another matter. "How many REIT managers could pick winners from losers with any consistency?" asks
Craig Silvers. "That's not their business."
Most REIT executives feel the same way. "I'm just as willing as the next guy to make $100 million," says Michael Brennan, president and CEO of
First Industrial Realty Trust
, a REIT that is consciously reconfiguring its industrial real estate portfolio to capture clients in the burgeoning e-commerce business. "I'm very good at industrial real estate, not at picking technology upstart winners." Brennan says First Industrial has not considered an equity stake from tenants in lieu of rent.
While most of the "equity-for-rent" action appears to be from private developers, at least one Silicon Valley REIT has experienced the upside.
Mission West Properties
realized a $393,000 gain in the fourth quarter by exercising warrants after a high-tech tenant went public. Mission West CEO Carl Berg has been accepting equity since the 1970s, when venture-capital financing was in its infancy. Berg continues to accept equity as part of his lease agreements. "We have about eight deals where we have taken equity," he says. Berg says Mission West holds up to 20,000 shares of certain tenants' stock that it received either as warrants or as directed shares, also known as "friends-and-family" stock.
Another REIT specializing in high-tech property, in this case biotech, has taken equity interests in tenant companies.
Alexandria Real Estate
has taken positions in a handful of biotech companies that are also tenants. However, CEO Joel Marcus says his company does not accept equity as a trade-off for cash rents. "We have taken an occasional equity position, but don't do it in lieu of fair-market rent." Rather, Marcus says, Alexandria has accepted tenant equity as compensation for expenses including customizing space for a biotech company's use.
Alexandria has profited from the decision as well. In 1997 the company accepted pre-IPO warrants in a leading human genomics company that has since come public. "We still own the stock and it has been a very profitable venture," says Marcus. However, he warns that the process has its risks. "Eight out of 10 companies that make the offer we don't even consider," he says, adding Alexandria's management team is uniquely qualified to make those judgments. "Our management team has significant pharmaceutical and biotech knowledge. We have an unusual ability to evaluate our tenants." Marcus spent over 20 years in the pharmaceutical industry before joining Alexandria.
Expertise is at the heart of the issue. While companies such as Alexandria may have the background to evaluate an upstart's potential, most real estate companies would simply be throwing darts. "Certain companies might be able to get away with it, but as a general rule it is worrisome to think real estate professionals are handicapping technology start-ups," says Sutro's Silvers.
Still, the ability to participate in the explosive potential of start-up tenants is alluring. One REIT is considering an approach that executives say provides both opportunity and insulation from risk.
, a Los Angeles REIT with several high-tech tenants, has long avoided taking equity stakes in tenants. "If a company is willing to give us equity in lieu of cash, it's likely not equity we would want," says Arden Chief Financial Officer Diana Laing.
Still, Arden sees potential in partnering with venture-capital firms to help start-ups who need incubator space. "We are looking at the possibility of allocating 10,000 to 15,000 square feet of space to early-stage companies through a venture-capital firm," she says. The venture-capital firm would pay rent -- a combination of cash and equity in the venture capital firm -- and would choose the tenants. "We would get the expertise of someone who knows the business and how to select winners," says Laing, noting the idea is still under consideration. "We'd never do this alone. It's not our business."
While Arden's plan is both well-conceived and intriguing, it represents disciplined thinking not commonly found among most entrepreneurial REIT executives. As such, it's best that REITs avoid the seductiveness of chasing the start-ups. That's not why investors put their money in REITs. "The safety of the cash flow is sacrosanct," says Silvers. "If REIT investors wanted to take the risks, they'd by the dot-coms on their own."
It's a risk that real estate investors typically aren't comfortable with. "It's not like this is cereal-box investing and you're looking for a prize at the bottom," quips Statz, "Real estate is a cash flow-driven investment. Trying to swing blindly for the dot-com fences is something we find a bit nutty."
Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback at