June 28, 2006
Real estate is an extremely capital-intensive business. For managers of real estate investment trusts, or REITs, raising capital can be a nearly constant concern, since the law requires REITs to distribute the bulk of their income back to shareholders. One way to raise that capital is to sell a property that has appreciated in value since it was acquired, and REITs have been doing just that over the past several years in every property sector -- from United Dominion Realty Trust (NYSE: UDR ) in the apartment space to Kimco Realty (NYSE: KIM ) in retail.
Tuesday gave us a prime example of this approach, when office REIT SL Green Realty (NYSE: SLG ) announced that it had entered an agreement to sell a midtown New York office building for $97.5 million. SL Green had acquired the building back in 1997 as part of its initial public offering, and the company expects to recognize a gain of more than $60 million on the sale.
By selling a property in this manner, a REIT can redeploy the net proceeds into the acquisition of assets that it believes offer a greater return on investment. Through this method of recycling capital, a REIT can potentially grow its revenues and earnings without the dilution that an equity offering would cause.
SL Green considered this particular building a "non-core" investment. Although the company did not provide specific details, it intends to redeploy the capital into a higher-quality property leased to tenants with higher-quality credit profiles.
Timing can be key when recycling capital in this way. In most circumstances -- provided that the new investment will offer greater returns over the long haul -- the faster the capital can be redeployed, the better, since the period between selling an existing asset and investing the proceeds in a new property represents lost rental revenues for the REIT. Investors should keep an eye on how SL Green puts the proceeds to work upon the closing of this sale, which is scheduled for the third quarter.
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Fool contributor Sean P. Smith is a freelance analyst and writer living in St. Louis. He does not own shares of any company mentioned in this article.