The plan itself was simple. With an average apartment age of 14 years, AEC wanted to grow younger. “The way we were going to grow younger was to sell older, low-margin assets and buy properties in faster-growing markets,” Friedman says. “That would help us in reducing our exposure in the Midwest.”
Buy Time
Associated Estates is poised to acquire new assets—in the right locations.
Jeffrey I. Friedman, chairman, president, and CEO of Cleveland-based Associated Estates Realty Corp. (AEC), is extremely proud of his company’s Midwestern heritage—as well as its performance in the markets it calls home, especially over the past couple of years. But he also knows he needs to branch out. Right now, 57 percent of AEC’s net operating income (NOI) comes from the Midwest, but Friedman wants to bring it closer to 50 percent.
Friedman thought he hit that magic number last year when AEC found a buyer for a five-property portfolio in Columbus, Ohio. But the firm found that it couldn’t use the proceeds to buy a replacement unless it overpaid. So AEC held the properties and avoided tax charges.
In the future, Friedman may just focus on buying before selling. “Today, we’re closer to the bottom than the top,” he says. “We want buyers closer to the bottom.”
But Friedman acknowledges that he may have to go back to Wall Street for more equity before making additional buys. The company had a 4.5 million stock offering in January that generated $54.7 million to help provide the dry powder for buys.
“It will take them a long time to grow, but going to the equity markets was smart,” says Andrew J. McCulloch, an analyst for Green Street Advisors, a Newport Beach, Calif.-based REIT consulting and research firm.
“Their leverage doesn’t give them a lot of wiggle room to get aggressive on expansion,” he continues. “You do it little by little. You do a little, you grow investor confidence and strengthen your balance sheet, that discount to asset value evident in your share price shrinks, and you issue more equity.”
Right now, Friedman says “no markets are off the table,” though he’d like to focus on metros and regions where AEC can obtain critical mass, such as the Mid-Atlantic or Southeast. He also prefers metros where higher education is a major economic driver.
Like most other firms in the apartment industry, the company would like to find distressed assets (or even distressed companies) to acquire. Unfortunately, there doesn’t seem to be a lot on the market in AEC’s high-end Class B and B-plus suburban apartment niche.
Friedman says that since he bought his son Jason’s construction platform last year, there’s also the opportunity to buy land and start new construction. Additionally, Friedman is considering other options, including buying some of the distressed older deals that are hitting the market. “If there was an opportunity to take someone else’s problem away, we may buy that on the cheap, turn it around, and then be able to sell it to someone who does want to own [for the long term],” he says.
So Friedman evaluated the return on equity and margins at his 128 properties (31,333 units), 74 of which AEC owned, 10 of which were owned with a JV partner, and 44 of which were managed. AEC kept the ones with the highest return on equity and margins and sold the ones trailing in those metrics. “The portfolio has been transformed in terms of selling older, non-core assets or assets where we only had one or two assets in a particular market and exiting from the affordable housing business,” says Lou Fatica, AEC’s CFO.
In 2005, the market encouraged Friedman to sell even more. “There were buyers leaving the coasts who saw higher yields in the Midwest,” he says. “From 2005 to 2008, the survival plan was to sell properties at high prices and low cap rates.”
From 2005 to 2009, Associated Estates sold 31 properties, totaling nearly 7,000 units, for $375 million. It spent $210 million paying down debt; $42 million buying common stock at $10.76 a share (it also repurchased $8 million in preferred stock at an average of $19.42); and $232 million to buy six properties, totaling more than 2,100 units. Now, the company only has one asset remaining from its original portfolio—a 143-unit townhome property in Cleveland. During that period (2005 to 2009), the company purchased two properties in Atlanta (1,011 units), one property in South Florida (316 units), two properties in Richmond, Va. (536 units), and one property in Norfolk, Va. (268 units). Now, Associated Estates owns four properties in the Atlanta area, four in Florida, and three in Virginia and Maryland, each. “They transitioned into a higher-quality portfolio,” McCulloch says. “I think they cleaned up their portfolio and simplified their story, such as exiting the affordable segment.”
And they sold at the right time. Friedman says he knew that 2005 prices couldn’t be sustained, and that’s when he started selling (though he did buy about 25 percent of his portfolio in that time frame). “We didn’t overpay for assets when it was easy to overpay for assets in 2006 and 2007,” Fatica says.
AEC also kept the right assets near economic engines in the Midwest. In Columbus, Ohio, it has assets near Ohio State University as well as the corporate headquarters for science and technology firm Battelle and apparel manufacturer Limited Brands. In Cleveland, its properties are near the Cleveland Clinic, National City (now PNC), Progressive, and KeyBank.
