Will Forest City be less development-heavy in its REIT avatar?

Company is slated to convert from C-Corp Jan. 1

TRD New York /
Dec.December 14, 2015 06:20 PM

Forest City Enterprises is reportedly finalizing a deal to offload its stake in the Brooklyn Nets and in the Barclays Center, to Nets majority owner Mikhail Prokhorov.

If the deal goes through, it would mark the end of a long journey for Forest City, whose Brooklyn-based subsidiary Forest City Ratner fought through fierce community opposition and financing challenges to develop the $1 billion arena. And it would also signal to potential investors that Forest City is getting serious about a major transition on its horizon: its conversion to a real estate investment trust.

Converting to a REIT, which Forest City is expected to do on Jan. 1, would bring major tax benefits. But it would also place added pressure on the firm to ditch some of its lower-performing and riskier assets and fuel speculation that it is moving away from its development-driven roots to become more of an operator, thus increasing its liquidity and its appeal to prospective REIT investors.

“The market is anxious about everything we’re doing,” David LaRue, Forest City’s CEO, said during the company’s third-quarter earnings call, amid questions about the prospective sale of the arena, in which it owns a 55 percent stake. He acknowledged the firm had been getting “questions and pushback” as to “whether or not we were committed” to making the necessary sales happen.

“Forest City management told us to expect these asset sales nearly a year ago,” said Sheila McGrath, a REIT analyst with Evercore ISI. “The sale of the arena and the interest in the Nets basketball team makes sense because of the prospects of eliminating debt and minimal positive cash flow.”

In New York at least, Forest City has recently steered away from the kind of development projects that defined it. In November, it sold a development site at 625 Fulton Street in Downtown Brooklyn to Simon Dushinsky’s Rabsky Group. On the acquisition side, it’s only purchased assets with existing cash flow, such as a rental building at 500 Sterling Place, for which it paid $48 million in January.

The sale of the Brooklyn site prompted speculation among industry insiders that, outside of its current work at Brooklyn megaproject Pacific Park (formerly Atlantic Yards), Forest City Ratner will not be eying new development opportunities for the foreseeable future. The company may instead focus on delivering solid returns to its investors through operating assets with steady cash flow, such as the New York Times building at 420 Eighth Avenue and the New York by Gehry rental building at 8 Spruce Street.

Forest City Enterprises is currently operating with a debt to EBITDA ratio of 10, meaning it would take 10 years to pay off its debt at its current revenue. It aims to bring that down to a rate of seven.

“It’s obviously challenging to let go of really good dirt and of an assets like the arena, which is near and dear to our hearts,” MaryAnne Gilmartin, CEO of Forest City Ratner, told The Real Deal. “But it’s hard to argue with the fact that the arena income is not good REIT income.”

Gilmartin insisted, however, that her mandate to maintain Forest City’s development pipeline would not change.

“Do I think we’re going to make different decisions because we’re a REIT or not a REIT? Probably not,” she said. “But, come Jan. 1, we’ll have a healthier balance sheet with stock that will pop.”

Analysts said they expected Forest City’s development activities to continue, albeit in a slightly different capacity.

“I wouldn’t expect them to stop development but would expect them to moderate it,” said Dirk Aulabaugh, a managing director in the advisory and consulting group at Green Street Advisors. “I think they’re probably going to be more selective and look specifically at development opportunities where their particular expertise is beneficial.”

In terms of limiting risk, Forest City may look to limit its exposure by using joint venture structures on most of its future transactions, similar to its recent tie-up with China-based Greenland Group, experts said.

“There is a perception that REITs aren’t developing and that’s not necessarily true,” McGrath said. “The main difference is that I think we’ll see Forest City bring in partners earlier in the development process in order to reduce the required equity investment and to mitigate risk.”

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