By Adam Corelli
(First Published Globe and Mail, January 31, 1992)
TORONTO, Ont.: THERE WAS A time not so long ago when Toronto’s Reichmann brothers could afford to indulge their renowned penchant for privacy. Over several decades, they had amassed one of the great real estate fortunes of all time without a misstep, and so nobody asked too many questions about the precise composition of their empire.
But the savage property downturn in Canada, the United States and Britain has frayed even the Reichmanns’ cloak of invincibility. Their debts are believed to be enormous and only family insiders truly know whether the rents they are collecting are sufficient to cover interest costs.
Determined to maintain the confidence of the world’s financial markets, the Reichmanns have partly lifted the veil of secrecy that has shrouded Olympia & York Developments Ltd. for decades.
Their release of a host of detailed financial information on their worldwide real estate projects – while difficult to corroborate – tell an incredible story.O&Y executives say the company still has a net worth of more than $8.5 billion, despite the commercial real estate slump.
However, their figures also show the Reichmanns’ have been badly hurt by the recession: their net worth has fallen by more than $3 billion in the past three years.
Beyond the turmoil in their real estate holdings, 61-year-old Paul Reichmann and his brothers, Albert, 63, and Ralph, 59, have watched the value of their stock portfolio fall during the past 18 months to about $5-billion from $6.6-billion 18 months ago.
Significantly, the financial information provided by O&Y indicates that the Reichmanns have been conservative in terms of the level of debt they have accumulated against their vast portfolio of real estate. The decision to release these all-important debt-equity ratios no doubt has a lot to do with the fact they are not as bad as some of the speculation in bond markets would suggest.
According to John Zuccotti, the head of O&Y’s U.S. operations, the average debt-equity ratio on O&Y’s North American properties, as of Dec. 19, 1991, was 61.5 per cent. “I don’t want to leave the impression with you that these are easy times,” he said. “It would be ludicrous for anybody in the real estate business to say there are not challenges right now. But we are meeting our challenges.”
For U.S. properties, the average percentage of debt was 67.5 per cent. In Canada, the figure was just 60 per cent, although this was up substantially on a 50-per-cent ratio just two years ago.
O&Y executives say the ratio on Canadian real estate has worsened because of falling real estate values. Indeed, O&Y actually has slightly reduced the amount of outstanding debt on its Canadian real estate, although not enough to offset the decline in the value of commercial real estate.
In the United States, the Reichmanns appear to be moving aggressively to reduce debt. Last year, they put $325 million (U.S.) toward bringing their U.S. debt-equity ratio down about three percentage points.
In Britain, where the Reichmahns are building the giant Canary Wharf office development, debt levels will not exceed half of the project’s equity, company officials say.
THESE levels are considered surprisingly low given the sorry financial state of many other developers. “It is conservative by industry standards,” Toronto real estate analyst Harry Rannala said. “That is a ratio in North America of two to one – that’s pretty good.”
The debt-equity ratio is not a definitive vital sign, however. Cash flow is all-important for developers. Each individual Reichmann building carries debt and each building should produce a stream of cash (after expenses) sufficient to cover the cost of servicing these debts.
In contrast to its more forthcoming approach to debt levels, O&Y refuses to release specific numbers on cash flow.
“Our cash flow is more than sufficient to meet our existing obligations and we continue to meet all our obligations,” Mr. Zuccotti stated. “We never missed a payment. Out of our current cash flow we are trying to carry out the goal of reducing current leverage.”
When it comes to vacancy rates the numbers released by O&Y are better than most analysts’ estimates. O&Y has always focused on building quality real estate at prime locations to attract long-term stable tenants. That strategy seems to be paying off.
The average vacancy rate at Reichmann-owned buildings across North America, as of Dec. 19, 1991, was just 10.2 per cent, according to the company. (Not included in this figure is vacant but leased space.)
In Toronto, the average vacancy rate for office space is 16.5 per cent, while the average in the United States is 19 per cent.
The situation shouldn’t get too much worse in the near term unless major tenants run into their own difficulties. In the United States, just 5 per cent of leases expire during 1992, while in Canada the number is less than 2 per cent.
“If I didn’t lease another square foot in the next 18 months I wouldn’t have a vacancy rate in the United States that exceeds 15 per cent,” Mr. Zuccotti said.
Yet as decent as all these numbers are for O&Y, they may not be good enough. O&Y is racing to adjust to the changing outlook of international bankers, which is dramatically affecting the ability to finance real estate developments.
What a difference a decade makes. In the 1980s, bankers and builders used optimistic projections of future rental income and future real estate values to justify more and more development. They lost sight of demand. They ignored current yields and cash flow – how much rent a building earns today as opposed to predictions of future earnings.
Bankers fell over themselves jumping on the bandwagon. In the 1970s, $300-billion was lent to property developers in the United States. In the 1980s, the amount soared. More than $600-billion was lent to developers between 1986 and 1988 alone.
As a result, 12.5 billion square feet of office space was built in the United States during the 1980s, an amount equal to a skyscraper more than 1,600 kilometres high. It turned out to be about 15 per cent more space than was needed. That set the scene for the brutal shakeout now flattening the industry.
THE same scenario unfolded in London, the home of O&Y’s Canary Wharf project. London has 20 million square feet of vacant office space today, roughly five times the level of two years ago. The vacancy rate is more than 20 per cent. “We’re coming into a decade where credit is more expensive. There’s lots of people looking for money but few people able to lend it, ” an O&Y executive said.
Moreover, the troubles in real estate go beyond vacancy rates and demand. A rapid drop in inflation, as is currently occurring, has changed the way real estate values are determined. A building erected in inflationary times will cost more in straight dollar terms to replace a few years later after prices have jumped. As well, office rents also rise during inflationary times.
But no longer. With inflation falling and banks tightening up, it is becoming more difficult for developers like the Reichmanns to refinance individual buildings.”
The banks have really stepped back from encouraging more construction,” Mr. Rannala said.
It is all very frustrating for the Reichmanns. O&Y was one of the first developers to recognize the importance of reducing debt and to do something about it.
But as a major landlord, it can’t escape the bind. Today, the Reichmanns own more office space in New York City than anyone else, in excess of 24 million square feet. In Toronto, the Reichmanns own the crown jewels of the city’s real estate, including about one-sixth of the downtown’s prime office space. And Canary Wharf, when completed, will be the largest office development in Europe.
Indeed, O&Y has decided its future lies in focusing on its real estate roots. During the 1980s, the company attempted to diversify, spreading its investments equally among real estate and stock investments.
TODAY, the brothers are sitting on a portfolio of stocks with a current trading value of about $5-billion (Canadian). There is debt outstanding on these stocks, although O&Y will not say how much.
The Reichmanns are not pleased with the performance of their public companies. “It is very clear they have been pushing the resource companies to perform better, ” said an O&Y executive who didn’t want his name used.
O&Y’s goal is to get its exposure to non-real estate holdings down to 25 per cent. To reach this objective – which O&Y says it is closing in on – the company is selling publicly traded assets and using the proceeds to reduce real estate debt.
According to figures released by the company, corporate assets totaling $3-billion have been sold during the past 24 months. Not included in this tally is Home Oil Co. Ltd. or Interprovincial Pipe Line Ltd., the two remaining pieces of GW Utilities Ltd., both of which are on the block.
O&Y executives say that once these are sold off, the Reichmanns will have accomplished their corporate restructuring goals.
Non-real estate assets will have dropped to between 25 and 30 per cent of O&Y’s portfolio, while the debt exposure on real estate will be down to 50 per cent.
O&Y insiders say the Reichmanns’ plan to shake up Gulf Canada Resources Ltd. and Abitibi-Price Inc., which they intend to retain. Over the course of the decade, they hope to reduce and then eliminate debt within the public companies and then take some of them private.That, in turn, would allow the company once again to indulge its penchant for privacy.