By Keat Foong, Executive Editor
Lehman Brothers filed for Chapter 11 bankruptcy on Sept. 15, 2008, “and all the folks at Lehman were immediately furloughed on that very same day,” recounts Peter P. DiLullo, LCOR president and CEO. “There was no one for us to speak to, no one to whom to direct questions.”
At that time, Lehman was a majority owner of LCOR. It was a matter of months before LCOR could even find a contact at its owner’s company. The company offered to buy back the development business from Lehman, says DiLullo, but Lehman was under a mandate that prevented it from selling into a depressed market. “That was the start of a very uncertain time for us. The company that owned 60 to 80 percent of our assets was gone,” said DiLullo. What the developer did not see at the time, however, was that the Lehman bankruptcy would in unexpected ways benefit LCOR.
As it turns out, the bankruptcy sustained LCOR during the depths of the Great Recession. Lehman realized that because of its ownership interest in LCOR, it would in fact obtain 60 cents back for every dollar it paid out in management fees if it gave its increasing inventory of problem loans to LCOR to asset manage. The result was that LCOR obtained a pipeline of asset and property management assignments. At a time when other developers were suffering, LCOR doubled its asset management department to take on the additional business, hiring 10 additional employees and managing as many as 23,000 apartment units for Lehman at one point.
On May 23, 2012, Lehman sold its interest in LCOR to CalSTRS—the nation’s largest teachers pension fund and one of the largest pension funds in the U.S.—in a transaction valued at $820 million. CalSTRS acquired a majority, 96-percent interest in the operating company, 14 apartment assets consisting of nearly 5,000 units, and a development pipeline of sites potentially totaling 16 million square feet located in key, high-growth, transit-oriented locations such as Tysons Corner, Va., Montgomery County, Md., Hoboken, N.J. and Brooklyn, N.Y. The fully operating existing apartment properties acquired by CalSTRS in the purchase price included 25 Broad Street in Manhattan, 462 units in Greenwich, Conn., and properties in Aventura, Fla. and Tysons Corner, Va.
The partnership with CalSTRS now provides LCOR with several market advantages, including a formidable balance sheet and a ready source of funding in a currently very competitive development market. “No question, that is the biggest advantage,” says DiLullo. “For a private developer, it takes a lot of money to prepare projects for the development stage. It may cost as much as $1 million in upfront costs to purchase and design the project… It is difficult to get the money arranged on the front end. To have a partner with the financial capability to pursue, fund, underwrite and close the deal tremendously expands the scope of the amount of projects we can pursue.”
Already, the new LCOR/CalSTRS venture has purchased 400 Army-Navy Drive in Arlington, Va. and closed on the purchase of a Montclair, N.J. development site that will see the construction of 259 units starting in the fall. Since the partnership, LCOR has also hired additional staff for its headquarters.
Land sites that were a part of the development pipeline acquired by CalSTRS included a 65- to 70-acre mixed-use parcel behind the Ferry Terminal in Hoboken, N.J. (zoning is being completed); a property in McLean, Va. that has been upzoned from 507 to 2,500 units; a 204-acre site in Clarksburg, Md. that is targeted for rezoning; and a 560-unit apartment project in White Plains, N.J., says DiLullo.
Other ground-up developments that are under construction currently include the 234-unit 250 North 10th Street in Brooklyn, N.Y. and 341-unit mid-rise Aurora in North Bethesda, Md. Since the signing of the partnership agreement, LCOR/CalSTRS has embarked on negotiations for the development of a 250-unit project in Philadelphia; a 120-unit project in Madison, N.J.; and a 230-unit project in Norwalk, Conn.
Not a bad situation for a regional company that was so uncertain of its fate in those days after the Lehman collapse. DiLullo attributes LCOR’s success and survival in part to a company philosophy stressing relationships, integrity and fairness. As he tells it, after the sale to CalSTRS was signed, the LCOR management took the headquarters staff for a celebration. “I told my people that I have not thought through why it happened this way, but this sale speaks volumes about relationships,” says DiLullo. “Relationships are so key to our company. We work hard to maintain relationships in everything we do… Don’t ever burn bridges. Maintain your relationships. You can be a tough negotiator, but you need to be transparent and fair.” As testament to the high regard with which the company is held, DiLullo says, most of the companies that LCOR works with will participate in “five more” subsequent transactions with LCOR. DiLullo says that if LCOR had not maintained its relationship with Lehman, “they may just have treated us like any other sponsor who wants its assets back… However, it made economic sense for Lehman not to take that approach because of their confidence in the company.”
LCOR’s operations philosophy is not surprising considering its company pedigree. LCOR has its origins in a legendary heavyweight of the multifamily development world—Lincoln Property Co. The former chairman of LCOR, Eric Eichler, who was Northeast regional partner at Lincoln, formed LinPro Co. in 1977 as a spin-off from Lincoln, explains DiLullo. DiLullo joined LinPro in 1981 as corporate comptroller. During the 1980s, LinPro expanded. However, after the real estate crash of the late-1980s, LinPro decided to move away from a single partnership structure to more of a corporate format, and Eichler and DiLullo co-founded LCOR, acquiring all of LinPro’s assets, explains DiLullo.
Finding it burdensome to have to raise debt and equity capital each time it started a project, LCOR eventually went to market seeking an investment partner that would provide it with a consistent stream of funding. In 1999, LCOR signed a partnership contract with Lehman Brothers, thus starting its 14-year relationship with the investment bank. DiLullo says it was fun to work with Lehman. “It was a very entertaining period. They were hard workers, very smart and very competent.” LCOR did not come into the relationship new to Lehman—in earlier years, it had the opportunity to work with Lehman in New York City on the redevelopment of Terminal Four at John F. Kennedy Airport and the World Trade Center retail concourse renovation project.
Today, LCOR describes itself as an investment, management and development company with a portfolio of residential, commercial and public-private properties in core urban locations. LCOR’s focus is on ground-up core developments in high barriers-to-entry markets, says DiLullo. As a regional player, it develops properties on the East Coast north of Virginia or Washington, D.C. through Connecticut. LCOR also seeks to acquire properties, owning real estate assets in Georgia and Florida in addition to the East Coast. LCOR’s ownership portfolio today totals about 8,500 multifamily units and 8 million square feet of commercial space. (A handful of properties were not included in the CalSTRS purchase because LCOR is a minority partner in those deals.)
No doubt, LCOR’s focus on core investments at the safest end of the risk-adjusted returns spectrum suits the pension fund very well. When CalSTRS bought LCOR, “they bought into our business plan,” says DiLullo. “They want us to implement our business plan in the markets in which we operate.”
LCOR also touts its development experience. LCOR’s 30-plus years’ presence in the marketplace brings deep, established relationships with market players, not to mention development experience. “Cap rates on core acquisitions are sub-4 percent. If the project yields a 12 to 13 percent return, that’s a nice spread for development risk if you take the development risk with a company with a 40-year reputation of being on time and under budget,” says DiLullo.
For maximum effectiveness as a developer, LCOR does not venture freely outside its areas of expertise, either geographically or in terms of product types. Seniors and student housing are not the same businesses as apartment rental housing, notes DiLullo. The company also does not develop hotels or townhouses. And geographically, although the joint venture with CalSTRS allows LCOR to operate anywhere east of the Mississippi River, it will continue to focus on its historical markets of expertise. If the company does expand, it will hire locally, says DiLullo. “We believe this is a market-driven business. To go to markets in which you do not eat, live and sleep is risky. We do not deviate much outside our markets. We can drive by a site and know if it would be successful because we know that market.”
Another hallmark of LCOR as a developer may be its careful aversion to risk, or unnecessary risk. Very much fitting into that philosophy is CalSTRS’ 50 percent maximum leverage requirement. “We minimize downside risk, although there may be less profits going forward,” says DiLullo. “Real estate is a high risk business. To the extent we can mitigate that with strenuous underwriting, we will do so.” Perhaps because of its experience, the company has learned to, as Thomas J. O’Brien, LCOR’s executive vice president and COO, describes it, take time to seek to identify and understand downside risks. That approach may differ from that of the aggressive developers of today. “If you see only the upside, you miss a lot,” says O’Brien. In a way, that requires some courage, adds DiLullo. “We will walk away from possible deals if the environment is not conducive,” he says. “We are not afraid to walk away.”
LCOR’s philosophy of integrity and fairness is not limited to its clients and partners. The same approach also applies in LCOR’s treatment of its employees, DiLullo suggests. LCOR has offices in Berwyn, Pa., New York and Bethesda, Md. Each of the three offices are autonomous and fully staffed in finding and executing projects, says DiLullo. LCOR’s staff of 400 employees consists of onsite property staff and a core staff of about 75 located in company’s three locations. The tenure of the five partners that form the top management of the company adds to over 100 years, says DiLullo. “That says a lot. There is not a lot of turnover at the company. We treat people fairly… Third parties see all that,” says DiLullo.
While CalSTRS has 96 percent control of the company, LCOR’s top executives retain a 4 percent interest. Typically, both LCOR’s executives and CalSTRS will have equity invested in the venture, with CalSTRS acting as the limited partner. On the committee that makes the decisions as to whether to invest capital in projects, CalSTRS carries two votes, and the LCOR executives one. If CalSTRS declines to invest in a project, it may at its discretion permit LCOR/CalSTRS to pursue that project with another party as limited partner. “The benefit to CalSTRS is that they get the first approval. They have a captive developer and real estate services provider.”
The partnership with CalSTRS has also enabled LCOR to feed its asset and property management businesses. Managing 100 percent of properties that it owns, LCOR had assumed contracts to about 900 multifamily units owned by CalSTRS in the region following its acquisition by the pension fund. CalSTRS’ long-term hold strategy fits very well with the desire of LCOR’s management businesses, notes DiLullo. Going forward, LCOR’s partners would like the company to evolve towards even more of a full-service company real estate company. In particular, the company would like to expand its asset and property management businesses. “Historically, we depended on real estate development to fill [the management business]. But we would like to asset-manage for others, either by buying companies or working with banks,” says DiLullo.
The fact is, real estate management businesses furnish a steady stream of income and could boost LCOR’s resilience into the future when and if the development cycle winds down. “We came to work on Sept. 15 with a bankrupt partner not knowing our future. This was followed by record profits and CalSTRS as a new partner—and an $800 million balance sheet,” says DiLullo. “In a strange way, the Lehman bankruptcy was one of the best things that happened to us.” But perhaps the argument could be made that the quality of LCOR had something to do its good fortunes, too.