Here's Your Chance To Buy The Largest REIT IPO In History

Tim Begany's picture

Wednesday, December 3, 2014 - 1:30pm

by Tim Begany

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.

Importantly, the firm is established in locations that usually outperform the surrounding REIT market, thanks to robust local economies that lead to higher rents. In the areas of New York City where Paramount operates, for example, rental fees for office space average out to just over $86 per square foot. That's a 16% premium to the $74 a square foot typically charged in New York City markets. The firm enjoys an even greater advantage in Washington, D.C., where, at nearly $64 a square foot, rental fees in its markets are 44% higher.

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.

Tim Begany does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.