Among the highlights of 2014 was the blockbuster $25 billion initial public offering for Alibaba Group Holding Ltd (Nasdaq: BABA), which may rank as the biggest deal ever for some time to come.
Hiding in Alibaba's shadow is another historic IPO that occurred exactly two months later. The $2.6 billion offering for Paramount Group, Inc. (NYSE: PGRE) is the biggest deal in the history of real estate investment trusts, or REITs.
Prior to Paramount's debut, Douglas Emmett, Inc. (NYSE: DEI) set the record in 2006 by raising $1.6 billion.
While Paramount Group -- and other REITs -- won't deliver the meteoric growth rates of tech stocks like Alibaba, they do represent a chance to own hard, stable assets that fare well in a range of economic climates.
Paramount's IPO has performed moderately well since it went public, but investors are coming to term with the fact that it offers a tepid 2.1% dividend yield.
That figure lags the 3.1% yield for the MSCI U.S. REIT index, a broad indicator of the domestic real estate sector. (Paramount's yield is roughly in line with two other major office REITs: Boston Properties, Inc. (NYSE: BXP) and Empire State Realty Trust, Inc. (NYSE: ESRT).)
The good news: Paramount is positioned for solid dividend growth. The company owns a world-class property portfolio, focused on affluent U.S. gateway cities with strong demand for high-quality office space. As of September 30, Paramount owned 12 top-tier office buildings and towers in midtown Manhattan, San Francisco and Washington, D.C. with a combined 10.4 million rentable square feet. Overall, 92% of this is rented to 260 tenants in a variety of industries including financial services, retail and food service.
In pure dollar terms, Paramount's most prolific property is Paramount Plaza on Broadway in New York City. The 48-story skyscraper, which holds two Broadway theaters and many floors of office space, currently generates annualized rental income of $151.3 million, or about 26% of the firm's $576 million total.
The key virtue of this business model is rent hikes. The Rosen Consulting Group, a leading real estate economics consulting firm, believes rent for midtown Manhattan offices could jump more than 5% annually through 2018. In San Francisco and Washington, D.C., office rent could grow about 4%, and 2% a year, respectively, during the next few years, according to the consulting firm.
Such increases are baked in: Paramount increases rent 2%-to-3% per year and typically requires long-term commitments lasting well over a decade. Existing contracts currently have an average of nearly eight years left on them.
I especially like the company's conservative balance sheet management. At $8.7 billion, assets already substantially outweigh total liabilities of $3.4 billion. Still, the bulk of the IPO proceeds -- about $2.2 billion -- will be applied to Paramount's $2.9 billion in outstanding loans. Thus, the firm will have relatively little debt for a REIT and be better able to weather downturns in the real estate market.
According to management, leverage will still be used in coming years, which makes sense since it's a normal part of REIT operations. However, Paramount's more conservative use of debt should free up extra cash for future capital investment, acquisitions and dividends.
The stock offers a couple other key advantages. It's liquid, which is an especially desirable trait in turbulent times, as it creates calming trading patterns. And because it's a relatively large company, Paramount is likely to be included in various REIT indexes, which means that REIT-focused funds will need to own more shares to track their benchmark.
Risks To Consider: With only 12 properties in just three cities, Paramount's holdings are concentrated. Unfavorable developments in any of these markets could substantially hinder the company's performance.
Action To Take --> If you're a conservative investor seeking REIT exposure, consider owning shares of the Paramount Group. With its high-quality portfolio, conservative approach to debt, liquidity and decent yield, the stock should be a relatively safe long-term income play that also has good capital appreciation potential.
Paramount's assets are truly irreplaceable, which makes the stock a perfect candidate to be a "Forever Stock" -- a company so great that you can buy shares and virtually own them forever. My colleague Dave Forest, the chief strategist behind Forever Stocks, just gave a presentation at St. Edward's University revealing the unique qualities that make a business worth holding for life. To watch the video of his latest groundbreaking research, click here.