Founded in 1920, Forest City Enterprises Inc. is starting a new chapter in its history with a recent restructuring from a publicly traded company to a public REIT with $10 billion in assets. Forest City Realty Trust Inc. (NYSE: FCEA and FCEB) made its debut on January 1. NREI recently spoke with Forest City Realty Trust President and CEO David J. LaRue about what motivated the change and what lies ahead for the REIT.
NREI: The new REIT status went into effect Jan. 1, correct?
David LaRue: Yes, effective on Jan. 1, 2016. The REIT statutes required us to be operating as a REIT for a full calendar year, which gave us the deadline of 12-31-15 to complete all of the work that we needed to do so that we would be in compliance for the full tax year 2016.
NREI: Forest City has a long history, including operating as a public company since 1960. What motivated that structure change in the first place?
David LaRue: Like all companies coming out of such a financial strain during the recession in 2008 through 2010, Forest City started to look at best ways to improve its operations. The conversion to a REIT was a destination where we were heading based on strategies that we articulated and started executing on starting in 2012. We had come out with strategic goals of focusing our business on core products and core markets. We said we needed to have a sustainable capital structure that translated into reducing our leverage and increasing the cash flow from the business. We said we needed to have a foundation built on operational excellence. Those are the pillars that were driving our business, and the pillars always have to sit on a foundation.
NREI: When did this idea of transitioning to a REIT first come up?
David LaRue: It goes back literally to the early 1990s period, when a lot of private companies were doing the UPREIT conversions based on a different financial bind that they found themselves in during that early 1990s real estate depression based on the change in tax laws and the savings & loan crisis. So when that (REIT) market became more and more established, and more companies continued to move into that operating structure, our investors frequently asked why wouldn’t, and when would Forest City consider converting into a REIT.
From a tax standpoint, we were tax efficient. We weren’t paying substantial taxes because of our depreciation and interest expense. Our taxable income was very much managed, and we could continue to grow the business and execute on the strategies we had at that time. So it was a question from investors, and as Chuck Ratner used to tell investors when he was CEO, when it’s the right time for Forest City to do this, based upon value and based upon the market, we would do it. That just happened to be as a result of the new strategy and where we saw ourselves heading to be competitive and wanting our shareholders to realize maximum value. Since most of [our] competitors were in that space, all of those things combined to say this was the right time for us to do that.
NREI: In hindsight, 2015 was a pretty tough year on Wall Street for REITs. Do you think the timing could have been better, or doesn’t that matter given the restructuring you had to do to put things in place for the conversion?
David LaRue: I don’t think businesses in general try to time markets. If you look at the years leading up to 2015, you can go back to the low point of REITs back in 2009. From 2009 mid-way through 2015 the REIT index out-performed most of the indexes. Strategically looking forward, we believe the REIT structure, the REIT industry, the REIT index based upon delivering value to shareholders, will be a good thing for us over the long term.
NREI: So summarize for me, what do you think the advantages are for operating as a REIT versus the public company format?
David LaRue: Right now, there are 224 REITs in the REIT Index and 198 REITs traded on the NYSE. We were one of a handful, maybe five companies, operating as C-corps in that real estate world. So I think as you look at investors and analysts, Forest City Realty Trust as a REIT is a business they understand. They know we have to distribute and pay a dividend based on taxable income. That is a benefit to shareholders. So we have common structure that is familiar. There are requirements to operate. A certain percent of your income and your assets must be qualified assets. So what it does is allow us to continue to have the market believe that we are remaining focused in our core businesses, which are in those qualified real estate businesses.
Paying a dividend is something that almost every public company wants to do. What we had to do since 2008 is direct our capital to our other needs—deleveraging being one, activating our development pipeline was another one and investing in our real estate portfolio was a third—to make sure that our properties and communities that we have in different markets are serving our residents and our customers appropriately. So I think what this does is that, once we are in an index and once we are operating in a standard format for real estate companies, it attracts investors to our name and gives us that common ground for the public to evaluate us. It also gives us more of a benchmark that we have to be on top of our game and remain competitive.
NREI: How will the new REIT status impact operations and strategy going forward?
David LaRue: The key piece of the REIT conversion will make us even more focused on our real estate business. A REIT is allowed to have assets and non-qualified income. For example, we have a very successful project with the redevelopment of the Stapleton Airport in Denver. But as we sell land to builders in Denver, that has to be put in a taxable REIT subsidiary.
We announced recently that we had made an agreement to sell our military housing business. It is a fee business versus a real estate business where we manage housing for the military. It is very good income, because we make a great profit on it, but it’s just not qualified for REIT purposes. So that had us shift our focus to selling that business and maximizing value out of that and reinvesting back into our other deals. So, strategically, I think that focus is going to be somewhat heightened to make sure it is in the qualified areas where we do invest or own.
From an operations standpoint, there are new compliance rules, more from an accounting and tax standpoint, that we have to focus on that we didn’t focus on before. A C-corporation, regardless of what business it is in, doesn’t have limits on what it can invest in or where it can invest money, where a REIT has to generate a majority of its income from real estate rent and qualified income sources and real estate related income. We now have to be able to track where all of that is; make sure it is going into the right bucket; and make sure it is not exceeding limits.
Being in this REIT environment we now are going to be held under a brighter spotlight because of the costs that are out there in the real estate world, and we are going to have to continue to compete and operate at standardized measurements and benchmarks. That is going to have us continue to focus on the operations.
NREI: How does this change make Forest City more competitive or better positioned to grow in the future?
David LaRue: I think we will attract a larger share of investment dollars into the real estate space than we had in the past because of our status. We will attract income investors due to the fact that we will pay a dividend where we had not been paying a dividend since 2008. It will allow us to remain efficient in that regard and distribute to our shareholders the income that we generate from our properties. As we move forward, and as we continue to execute the strategies that we have outlined to the public, I think that will be recognized and appropriately reflected in our overall value in stock price. We believe we are undervalued, which you probably hear from every CEO, but I think this conversion helps us to close a substantial part of that gap—not just by the fact of the conversion, but by the fact that we are now going to be in a place where dollars first get allocated from investors to invest in real estate companies.