Equity Office Properties has a simple solution to cope with its earnings slump — cut overhead to the bone and lavish new rewards on brokers who fill up those empty offices.

Clearly, EOP has to do something to goose revenue. In its fourth-quarter 2002 report, the Chicago-based REIT predicted that funds from operations (FFO) will dip by as much as 12.7% this year, falling from $3.21 per share in 2002 to between $2.80 and $3.00 per share in 2003. The company also predicts net operating income (NOI) will decline by 3%.

EOP is in the process of reducing the number of its regional offices from 169 to 48, which is expected to generate between $75 million and $100 million in annual savings beginning in 2004. The aggressive cost-cutting move, which also will eliminate 420 jobs, is part of the company's plan to focus on operating efficiencies rather than acquisitions. The office consolidations are expected to save the company $10 million this year.

“We're taking a much broader look at our operating expenses in general,” says Marsha Williams, chief financial officer at EOP, the nation's largest real estate investment trust. Williams says she also is optimistic that a more generous compensation package for brokers, who generate 97% of the company's new leases, will help the company close more deals this year.

The commission structure for securing lease renewals is now identical to that of new leases. Typically, broker commissions for renewals were 50% of what they were for new leases. Additionally, the company is paying brokers within 48 hours of a closed deal, and is sponsoring dinners where the highest-performing brokers are given rewards.

“It really makes sense to focus on the channel that's bringing you your customers,” says Williams. “We're really trying to reach out to brokers to help them fill some of our buildings.”

Declining Fundamentals

The company's fourth-quarter 2002 numbers show why the company is taking action. Rental rates across EOP's portfolio declined by 15.5%, from $30.76 per sq. ft. at the end of 2001 to $25.99 per sq. ft. at the end of 2002. Occupancy rates over the same time period fell from 91.8% to 88.6%.

In its fourth-quarter report, the company predicted that occupancy rates at the end of 2003 will range between 86.5% and 89.5%. Williams says she is cautiously optimistic that occupancies will be at the higher end of that range, which would represent a slight increase from 2002 levels. “We've seen an uptick in leasing velocity in December and January. We're hopeful that will be a trend,” she says.

In its fourth-quarter results, the company reported a 43% increase in net operating income (NOI), but that was largely because in 2001 the company had taken a $124.2 million charge for securities-related expenses. Backing out the charge, fourth-quarter NOI actually decreased 29%, from $242.1 million, or 55 cents per share, to $171.6 million, or 42 cents per share.

Another anomaly in EOP's results was the whopping $152 million in lease termination fees it collected in 2002. Such collections are expected to drop to between $25 million and $30 million this year. The projected decline is another reason the company lowered its income projection for 2003, Williams says. Also, there's another cost to the lease terminations: 6.1 million sq. ft. of empty space the company is now trying to fill.

Equity Office Properties Trust

Market cap: $9.77 billion

Stock price: $24.15 as of Feb. 21

52-week high: $31.36 on April 12, 2002

4Q 2001 4Q 2002
Revenues $885.6 million $884.5 million
Rental Rates $30.76 per sq. ft. $25.99 per sq. ft.
Lease Terminations $24.4 million $44.7 million