Patterson Seeks Global Status

New York City—A group of Asian investors is considering selling a large-scale residential development on Manhattan's West Side to a U.S. REIT. The matchmaker: Salomon Smith Barney Holding Co.

A year ago, neither Salomon Brothers nor Smith Barney, then separate companies, might have won the deal. Salomon had a Hong Kong office but only a fair presence in the REIT market. Smith Barney was a proven leader among REIT underwriters but purely a domestic real estate player. The newly combined real estate group is expanding its reach in equity and debt on an international basis. It is counting on subsequent agreements made by parent company Travelers Group—including a merger with Citicorp and a global strategic alliance with The Nikko Securities Co.—to make it a real estate investment banking power worldwide.

"Our mission is going to be extracting the opportunities out of all this," said Mark Patterson, group head & managing director of Salomon Smith Barney's real estate and lodging group, which operates within the firm's investment banking division.

In addition to the global presence—Salomon also had offices in Japan and London—the $9 billion merger gave Smith Barney institutional strength to complement its leadership in retail distribution. Marriages of institutional and retail investment houses are a growing trend: The merger of Morgan Stanley Group and Dean Witter Discover & Co. is another example.

The Salomon merger also provided Smith Barney with a larger and more active fixed-income department, which operates separately from the real estate group. Salomon Smith Barney's commercial mortgage group is headed by managing director David Tibbals. "Prior to the merger, we weren't really on the radar screen," Patterson admitted.

Salomon Smith Barney's presence in the debt arena is still arguably not that large. But it will certainly be boosted when Travelers completes its $140 billion merger with Citicorp to form Citigroup Inc. In fact, Salomon Smith Barney is expected to bring to market a $1 billion CMBS offering with Citibank this year. It will be the investment bank's first issue of the year.

Unlike the Salomon-Smith Barney combination, Patterson said, Citicorp and Travelers probably will not merge their real estate departments after their union. "(With Salomon Smith Barney) there was a duplication of every single seat," he explained. "Citibank is going to be more of a cross-selling, more of an integration." Those cross-selling opportunities will not only be domestic, since Citicorp has offices in 100 cities around the globe.

Travelers' purchase of a sizable interest in Nikko expands the international presence still further. The joint venture, to be called Nikko Salomon Smith Barney Ltd., will provide investment banking services for corporate and institutional clients in Japan.

"Many other investment banks have tried to penetrate (retail investment) in this country," said Patterson. "I think it's good timing with all the turbulence."

So far, the merged capabilities have paid off, believes Steve Jorns, vice chairman of Meristar Hospitality Inc. "We think (Salomon Smith Barney) has really become a one-stop-shop type of investment bank," he observed. Jorns has firsthand experience: Smith Barney underwrote American General Hospitality's 1996 initial public offering and represented it again in its merger with Capstar Hotel Co. to create Meristar.

Certainly, Salomon Smith Barney's real estate group has an established presence with equity real estate clients, particularly the public variety. Since 1987, the firm has transacted TKTKT in equity offerings, making it the TKTKT player since 1997. It has shown a particular prowess with lodging transactions, maintaining a significant share of hospitality offerings.

"They weren't one of the early firms to get active in REIT underwriting, but they have achieved a reasonably respectable market share since," said Fred Carr, TITLE TK of The Penobscot Group.

Smith Barney started the engine in late 1993(CK), under the leadership of Tom Lavin, who had come from Credit Suisse First Boston to launch the effort. By third quarter 1994, Smith Barney had become the second most active REIT bank on the street. When Lavin left the firm in tk, longtime real estate banker Patterson assumed the driver's seat. He retained that role with the merger, during which Salomon head real estate banker Rick Singer resigned to start his own firm.

Known for its retail access, Salomon Smith Barney lead managed only $1.8 billion worth of common stock deals last year, placing it third among lead underwriters. Merrill Lynch remained the leader with $4.5 billion. But it outpaced the rest of the market, even longtime leader Merrill Lynch & Co., in total lead- and co-managed equity offerings, amassing $11.6 billion in common stock offerings, according to Securities Data Co.

Salomon Smith Barney ranked second in lead- and co-managed deals for the year through Aug. 6, with $2.8 billion, according to Securities Data. It followed Prudential Securities, while Merrill Lynch came in third. Merrill Lynch, as usual, headed the lead managed business. According to Smith Barney's own figures, it had lead managed $722 million and co-managed $1.98 billion in transactions as of that date.

"This year hasn't been big for anybody," pointed out Patterson. "(The REITs) haven't wanted to issue equity. The prices have been so depressed."

Among the few IPOs that have launched this year was Smith Barney's issuance of a $125 million offering for Correctional Properties Trust. The REIT opened trading $3 above its $20 offering price. "One of the big prison operators wanted to find a financing source to develop new prisons around the world," said Patterson. "They had five or six in various stages of completion, and now they are using the capital to go around the world." Patterson said Salomon Smith Barney was selected for the transaction because of its experience with structuring sale-leasebacks in the lodging industry.

The firm also completed the largest follow-on offering of the year—$264 million for Brandywine Realty Trust—and it filed for an offering of Loeb Realty Trust, an office and industrial REIT. "That's one of the many IPOs out there," said Patterson.

Last month, the group represented American Industrial Properties in selling a strategic interest to Developers Diversified Realty Corp. The initial stage of the multi-phase deal, totaling 20 percent of the company, calls for DDR to sell 950,000 shares of newly issued stock to DDR at $15.50 per share or $14.7 million and for DDR to accept 1.2 million shares, valued at $19.5 million, in exchange for contributing five buildings(ONE OF THESE SHOULD BE AMERICAN INDUSTRIAL). The sale of another 5.2 million shares, another $81 million investment, is subject to shareholder approval. The second part of the transaction would boost DDR's total ownership to 40 percent on a fully diluted basis. DDR also gets four board seats, with Scott Wolstein assuming the position of chairman.

Salomon Smith Barney managing director Jeff Horowitz said DDR wanted to take advantage of the light industrial market, which is less competitive but still has decent returns. American Industrial, which specializes in light industrial, was looking for a capital partner. "It is a way for them to raise the profile of the company with a very well-thought-of investor—Developers Diversified Realty Corp. and Scott Wolstein in particular," Horowitz explained. "It was a way to grow and take advantage of the opportunities in the sector. Capital is hard to come by in equity."

Within the REIT market, Salomon Smith Barney prides itself on product innovation. Last fall, it brought to market the first REIT unit investment trust for $250 million. This spring, it completed another for $285 million. UITs combine common stock of a variety of REITs, usually in-house analysts' best picks based on a certain theme. The offering provides diversity for investors, while REITs are able to issue stock quickly and quietly—names of REITs are not known prior to pricing. The concept has attracted attention among investment banks: Prudential Securities has also become active in that area.

Salomon Smith Barney also claims to have transacted the first rapidly offered common stock issue, an overnight or two-day offering using its 11,000-broker retail network. Others have created similar arrangements and might argue they were the first to offer these quick capital raisings, but Smith Barney certainly was an early provider of the vehicle.

Although some have claimed there is little use for the vehicle, Carr credited it with giving the industry block trading capacity. "They, along with Lehman and PaineWebber in offering (these vehicles, have improved liquidity of REITs substantially," he said.

So far, Salomon Smith Barney has transacted 15 of these deals. "There is little to no price deterioration and the retail market is less likely to knock down a price before the offering," explained Patterson.

But with stock prices taking such a beating, the group, like others, has had to emphasize other capital-providing instruments for REITs. One alternative has been convertible preferred offerings, and it has transacted a number this year. According to Securities Data, it was lead- and co-manager on $1.4 billion in transactions and a lead manager in $600 million of convertible preferred deals as of Aug. 6.

For example, Salomon Smith Barney completed a $200 million sole-managed deal for Crescent Real Estate Equities Co. overnight. "It was one of the highest premiums ever achieved on a REIT convertible preferred," said Patterson. The firm also transacted a $150 million offering for Excel Realty Trust.

"It's been a nice product for REITs to get a piece of equity in their capital structure with a premium attached to it—effectively above what they are currently trading," said Patterson.

Early last year, the real estate group brought in TITLE TK John Herbert to create an asset sales division. Herbert had been a partner in a firm sponsored by Blackrock Capital Finance L.P. that bought moderately distressed retail properties and had a background in selling properties, including stints with Morgan Stanley and a company called Victor Capital.

"(Smith Barney) thought (asset sales) was a good complement to (its) existing business, and it gave us a more well-rounded view of the real estate market and enabled us to get closer to the private side of business, which is still dominant," explained Herbert. "We knew (asset sales) was coming back," added Patterson.

The firm has been involved in some of the key deals of late. Announced and completed transactions for 1998 totaled $9.7 billion through the first week of August and included representation of Boston Properties Inc. in the purchase of Embarcadero Center for more than $500 million; Travelers Group in its sale of the Hotel del Coronado for $320 million, or $500,000 per room—the second-highest price paid last year; Prudential Insurance Co. of America and entities controlled by David Rockefeller in the sale of the Park Hyatt Embarcadero and the Park Hyatt, both in San Francisco; and Layton-Belling Associates and AEW Capital Management L.P. in the sale of 500 million square feet of office and industrial in Southern California for more than $600 million.

"They wanted to assess the most efficient way of capitalizing their investment, and they had set out on a dual path of pursuing an IPO or selling the entire company, and we assisted them on evaluating both transactions," said Herbert of the Layton-Belling/AEW deal. "It was a better execution to actually sell the company, so we sold all of the properties."

In the sale of Embarcadero Center, Salomon Smith Barney helped Boston Properties iron out a deal that involved Prudential and David Rockefeller taking shares in the REIT as compensation. "They helped us analytically and in structuring a deal with the Rockefellers—that side of the deal that involved preferred units," said Boston Properties president & CEO Ed Linde.

The firm has also been engaged to sell Safeco's 700 million-square-foot office and retail portfolio. In addition, it is representing majority owner TIAA/CREF in the recapitalization of the Mall of America.

Among the group's pending transactions is the residential deal for the consortium of Asian investors in New York City. The consortium, which includes Donald Trump, is seeking to sell Riverside South, two high-rise apartment buildings currently under construction. Herbert would not discuss any pending deals for the property, but it has been reported the potential buyer is a U.S. REIT.

Patterson confirmed that the initial contact for this deal was made during an Asian real estate conference held by the firm. Drawing on Salomon's Hong Kong office, the meeting brought together about 200 Asian companies and 100 global real estate investors.

The merger-and-acquisition business, led by managing director Joe Gallo, is also competing for and winning some of the top M&A deals today. In July, the group represented a joint venture of Crescent and Reckson Associates Realty Corp. in its acquisition of Tower Realty Trust, a 5 million-square-foot office REIT that owned property in New York City, Orlando and Phoenix. The $734 million deal provided Crescent and Reckson with a platform through which to take part in New York City consolidation.

"They wanted a New York City presence and a way to get into the New York City market—much like Vornado did with Mendik," said Patterson. "We had brought the idea to Reckson originally, and we knew Tower was having difficulty. They had the partner in mind." The deal was one of the first REIT-to-REIT acquisitions in the office sector.

Earlier this year, Salomon Smith Barney helped set up the first paper-clip hote REIT, joining American General Hospitality with Capstar Hotel Co., a C-corp. represented by Lehman Brothers and Goldman, Sachs & Co. The result was REIT Meristar Hospitality and operating company Meristar Hotels & Resorts Inc.

Jorns, vice chairman of both entities, said Salomon Smith Barney brought to the table a great deal of M&A experience; he cited its having represented Meditrust in its merger with LaQuinta hotels as an example. "Joe Gallo and the firm's leadership role in our deal really facilitated a very productive and smooth M&A transaction," he said.

Other deals have included representing Intercontinental Hotels in its $3 billion sale to Bass Plc. and RFS in its merger with Equity Inns. Last year , it represented the partnership of Crescent and Vornado Realty Trust in the much discussed acquisition of cold storage company Americold Corp.

While the Salomon merger gave Smith Barney greater debt expertise, there is a perception on Wall Street that the combined entity is missing a hot market for loan origination and CMBS offerings. One leading CMBS player finds it surprising, given the financial strength of Salomon Smith Barney, its parent company and other affiliates. Indeed, while Salomon Smith Barney has been the leading underwriter of public mortgage-backed debt this year, it has yet to issue a commercial deal this year. The rumored $1 billion offering with Citibank, however, should put it back on the charts.

Tibbals said the firm offers the full range of mortgage products, and it has been averaging about $2 billion in annual originations. But, he said, it is less active in the primary market than the secondary market in terms of taking positions and trading product. He added that it has made quite a number of interim loans that have not been securitized yet. "We do a lot of business our competitors are not aware of," said Tibbals.

The firm does plan to become more active in the conduit area. Salomon, Tibbals said, had not made a major commitment to what had been viewed as a labor-intensive and lower-margin business. Instead, he said, it ran a lean group that focused on higher-margin transactions. With the Smith Barney and Citicorp mergers, there will be a greater emphasis on these smaller loans. Smith Barney had transacted some conduit business, and the Citicorp merger will put pressure on the firm to become more full-service. (Citicorp has completed $1.2 billion in lead and co-managed CMBS transactions this year.)

While Smith Barney gained greater debt skills with the Salomon merger, Tibbals believes Smith Barney's own track record should positively influence the company's debt effort. "I think it's been a major plus (that) Salomon Smith Barney has a very strong position in real estate markets, particularly REITs," said Tibbals. "We were very pleased to see the merger go through."

The combination gave Salomon Smith Barney plenty of professionals to help it expand. It has 50 professionals on the general real estate investment banking side, but its total real estate effort totals 100 people, including equity, debt, research and secured and unsecured lending. And Patterson believes in giving professionals a diversity of transactions. "No one here is a product specialist or a property specialist," he said.



Quotes:

"Our mission is going to be exacting the opportunities out of all this," said Mark Patterson, group head & managing director of Salomon Smith Barney's real estate and lodging group, which operates within the firm's investment banking division.



"We thought (asset sales) was a good complement to our existing business, and it gave us a more well-rounded view of the real estate market and enabled us to get closer to the private side of business, which is still dominant," said managing director John Herbert. (new scan)



"I think it's been a major plus (that) Salomon Smith Barney has a very strong position in real estate markets, particularly REITs," said managing director David Tibbals, who heads the commercial mortgage group. "We were very pleased to see the merger go through."





BOX (INSIDE)



Real Estate & Lodging Group Activity Year-to-Date





Common Equity Offerings:

Lead Managed $722M

Co-managed $1.98B

Noteworthy Deals: $125M IPO for Correctional Properties Trust and $264 million follow-on offering for Brandywine Realty Trust



Convertible Preferred:

Lead Managed $600M

Co-managed $750B

Noteworthy Deals: $200M for Crescent Real Estate Equities Co. and $150M for Excel Realty Trust



Asset Sales:

$9.7B in announced and completed transactions

Noteworthy Deals: Represented Boston Properties Inc. in acquisition of Embarcadero Center for $500M and sold Hotel del Coronado for Travelers Group for $320M



M&A:

$11.2B in announced and completed transactions

Noteworthy Deals: Represented Crescent Real Estate Equities Co. and Reckson Associates Realty Corp. to buy Tower Realty Trust in $734M deal and helped structure the first paper-clip hotel REIT in merger of American General Hospitality and Capstar Hotel Corp.