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December 10, 2003 Stock rating: In-Line
Coverage view: Cautious Price: US$28.03
Preview
Asset re-positioning how to play it. EOP completes a major asset sale in the very near future. We see no FFO dilution or valuation implications, but EOP can buy time for the dividend. We are keeping the 7% yield in our Income Portfolio, but do not expect growth returns. The stock has lagged, rent it for now.
We write this to get in front of a major asset sale and offer a 2004 outlook Equity Office Properties has made clear its intent to complete a large sale, potentially into a JV structure before year-end. We sensitized our model and see no earnings dilution. Management comments on 2004 in December; market outlook and sensitivity test are inside. You can buy EOP for the 7% dividend yield, but we do not see growth Our conclusion is the dividend yield of 7% remains attractive and is unlikely to be cut even as the company shrinks through asset sales; JV management fees and accretive capital redeployment buy EOP time. EOP is in the Goldman Sachs Income Portfolio. Three observations from our market review: consider with 2004 guidance (1) Top market Boston will be a focus with a flurry of corporate mergers hitting real estate demand, but EOP is relatively well positioned with high occupancy and light lease rollover; (2) San Jose is showing some early positive signs; (3) EOP, like virtually all office REITs has a major 2005 roll issue given how many leases expire; a recovery before then is essential. Still see risk to the dividend, as coverage is tight, but not a liquidity issue EOPs dividend coverage will be stretched above 100%, but the company can effectively buy itself almost a year of dividend coverage with a large asset sale transaction. Stock likely to rise on announcement, but no real change to value We expect EOP shares to react positively initially to any announcement, but to give back those gains as investors realize: there isnt an earnings impact; the multiple shouldnt change meaningfully (we expect a modest downward movement) and NAV is largely unchanged.
Stock data
52-week range Yield S&P 500 $29.10-$23.47 7.2% 1,062
28 27
Carey Callaghan
Price performance
Absolute Rel to S&P 500
1M 0% -1%
3M 0% -4%
12M 7% -10%
Capitalization
Market cap Latest net debt/(cash) Free float Derivatives Shares outstanding $11,805 mn $11,985 mn C 425.1 mn
Forecasts/valuation
FFO P/FFO ROE EV/EBITDA Long-term EPS growth 2%
26
25
24
-0.10 -0.12 J F M A M J J A S O N D
FOR REG AC CERTIFICATION, SEE PAGE 32. FOR OTHER IMPORTANT DISCLOSURES, SEE PAGE 35, GO TO http://www.gs.com/research/hedge.html, OR CONTACT YOUR INVESTMENT REPRESENTATIVE.
Table of contents
1 Overview: Asset re-positioning how to play it 3 Overview of a potential transaction and implications 7 Source of upcoming funds: whats in the works? 10 How to think about uses 11 A strategic review of EOPs major markets 18 Devils advocate view: could the dividend still be cut? 21 Financials: more leverage to a recovery, but not much growth 25 Valuation: shares seem reasonably priced 32 Company strategy/profile: the giant 35 Disclosures
The prices in this report are based on the market close of December 9, 2003.
Year to Revenues December ($ mn) 2001 2,829 2002 3,221 2003E 3,059 2004E 3,073
interests in about a dozen trophystyle properties; without these, the picture of EOPs asset quality, occupancy opportunity and tenant quality is different. While shedding high occupancy properties potentially creates more leverage to an economic recovery exactly when one might want it most, a look at the multiples awarded to companies with similar assets to the new EOP suggests there could be some modest downside.
Even with a relatively attractive deal, the dividend issue persists. We think EOP can effectively buy time with a transaction.
A joint venture yielding $750 million in proceeds to the company would reduce debt-tocapitalization by 200bp and given a roughly FFO-neutral impact, the payout ratios would be about the same. But EOP would net about 10 months of dividend payments
effectively buying it more time to sustain the dividend at the current level while awaiting some clarity in end-market demand. We conclude that EOP will not cut its
dividend despite the likelihood that the payout ratio will top 100% for several years. We rate EOP shares In-Line within our Cautious coverage view on REITs. Clearly, EOP has some of the greatest leverage to an economic recovery with 125 million square feet of national office space, and with only 86% occupancy there could be significant upside if the recovery persists. However 30% of the companys income is earned in northern California markets, which may take longer to recover.
Financials: Even with accretive transaction, we do not see a lot of growth for EOP
The three key drivers to rental revenue for any REIT are square footage, occupancy and rental rate per square foot. We forecast only a very slight improvement in occupancy in 2004, when 10% of leases are rolling at flat-to-down 10% rental rates. Beyond 2004 we expect a more meaningful occupancy recovery, in 2005 and beyond. Even with an earnings neutral or accretive JV transaction, we do not see much growth for EOP. Our five-year FFO/share growth rate is 1.7%.
The bigger questions will be: what implication would a deal have for dividend coverage, what kind of portfolio EOP would be left with, and whether value has been created or lost. To begin with sizing the transaction, we think EOP is likely to sell 50% to 75% interests in up to $1 billion worth of property, netting the company at least $500 million and likely up to $750 million of proceeds (see Exhibit 2).
Exhibit 2: At least $500 million in cash likely headed EOPs way this month our assumption is highlighted in blue
SOURCES Sell 50% interest: Sell 65% interest: Sell 75% interest: Value of asset sale
sold @ an 8.0% cap rate: sold @ a 7.5% cap rate: sold @ a 7.0% cap rate: sold @ an 8.5% cap rate:
The obvious questions become what EOP will do with the cash and whether the deal will be dilutive to FFO; with incremental management fees in a JV and relatively high-cost debt coming due soon, we think the company can avoid FFO dilution. With $400 million of 7.4% debt having come due in November and an additional $400 million of 6.7% debt coming due in January, the spread implications are relatively modest assuming asset sales (into the JV) with about an 8% yield. We believe incremental fees from managing the JV assets will come close to bridging the difference (see Exhibit 3).
Exhibit 3: We think the company can most likely avoid dilution by paying down debt this assumes a JV deal brings incremental management fees, though timing could impact
Debt Dilution PLUS: Asset Paydown (1) Equals: ($m) Mgmt fees (2) 7.0% -7 10 7.0% -6 10 7.0% -3 12 7.0% 0 14 7.0% -4 12 Net Effect/ share $ 0.01 $ 0.01 $ 0.02 $ 0.03 $ 0.02
(1) Equals average of $400 m of debt rolling in November at 7.38% and $400 m rolling in January at 6.7% (2) Asset managemt fees assumed at 2% of the value of assets acquired by a JV
But putting aside for a moment the FFO impact of a large transaction like this, it is clear that dividend coverage, which is really one of the focal issues for EOPs share price right now, remains stretched even with a neutral or accretive deal (see Exhibit 4).
Exhibit 4: But dividend coverage remains an issue: will EOP just manage through?
Dividend/share FAD Payout ratio, without JV deal FAD Payout ratio, with JV deal $ 2003 2.00 $ 125% 122% 2004 2.00 $ 107% 104% 2005 2.00 $ 110% 108% 2006 2.00 $ 110% 110% 2007 2.00 $ 100% 100% 2008 2.00 96% 96%
So what does EOP do with the dividend? The sustained period of stretched payout ratios highlighted in Exhibit 4 suggests EOP would need to borrow in order to pay its distributions (debt-to-total cap would increase from 51% currently to 57% by 2008, interest coverage would remain stuck at 2.5X versus 2.8X in the late 1990s), effectively damaging the balance sheet. While EOP Chairman Sam Zell had been vocal about maintaining the dividend earlier in 2003, we have not heard any such confident reiteration in recent months. In fact, the EOP management team has been notably silent on the subject of dividend sustainability in conversations we have had with them on the subject. Conservatism usually dictates that a REIT cut its dividend if its payout ratio is above 100% for a prolonged period of time and despite Zells flamboyant personality we view his management philosophy in overseeing EOP as essentially a conservative one, given the company and its investor profile. We estimate the 2003-2008 payout of FAD to be 125% (2003), 108%, 110%, 110%, 100% and 96% (2008), while debt to total capitalization currently stands at a relatively high (but manageable) 50%. A joint venture yielding $750 million in proceeds to the company would reduce debt to cap by 100bp and given a roughly FFO-neutral impact, the payout ratios would be about the same. But EOP would net about 10
months of dividend payments effectively buying it more time to sustain the dividend at the current level while awaiting some clarity in end-market demand.
Importantly, if the high payout ratio in 2005 and beyond stems from upfront investments to fill the buildings (in the form of tenant improvement allowances and leasing commissions) we believe EOP will be far more likely to maintain the dividend at its current $2.00 level given that it will have visibility on higher cash flows from higher occupancy. The key will be to watch employment trends, especially in office-intensive service industries, as well as EOPs occupancy trends. Were EOP to characterize any JV proceeds as a dividend bridge to a better economy, as we believe the company may, we would again become concerned about dividend security by next fall in the absence of a marked pick-up in occupancy.
Therefore, we are keeping EOP shares in the Goldman Sachs REIT Income Portfolio with a 7.2% dividend yield.
occupancy would be lower, given the presumably well-leased nature of the JV assets, and therefore leverage would increase. However, we think there could be modest downside risk to the multiple investors are willing to pay for EOP, which should also limit upside. Consider EOPs current multiple, 10X 2004E FFO, which is the sector average. We think this multiple reflects EOPs particular mix of assets, which one might think of as one-third Boston Property-style assets (protected markets, class-A properties in the CBD), one-third Trizec-style assets (national, mix of CBD and suburban) and one-third CarrAmerica-style assets (Californiaconcentrated). Boston Properties trades at 12X FFO, EOP at 10X, CarrAmerica at 10X and Trizec at 8X. If EOP sells its trophy assets that are worthy of a 12X multiple of
income, could there be a multiple adjustment to reflect a more Trizec/CarrAmerica type of portfolio?
EOP will maintain a 25% to 50% stake in these properties, and is likely to have additional income from the asset management fees, but we think there is some possibility that investor enthusiasm for a deal could be muted as a result of the change in portfolio quality. Occupancy would likely dip somewhat in the core portfolio. We would also add, however, that the leverage to a better economy is even greater in the remaining portfolio. In total, we do not see a real change in the value of EOPs portfolio and think any initial rally will give way and the stock will remain valued at about $27-28 per share (see Exhibit 5), all else being equal.
Exhibit 5: Following share price appreciation to reflect approval of a deal we think investors will make some modest multiple adjustment and bring shares back to the current $28 level
% Sq Ft Boston San Francisco San Jose Seattle New York Chicago Washington DC Los Angeles Atlanta Orange County Other Total/Avg CBD % NOI 9.8% 4.7% 0.4% 4.3% 7.3% 4.3% 2.8% 1.5% 1.8% 0.0% 7.5% 44.4% Type BXP BXP CRE BXP BXP BXP BXP BXP TRZ TRZ Multiple 12 12 10 12 12 12 12 12 8 8 10.8 1 1 0 1 1 1 0 0 0 0 1 SUBURBAN % Sq Ft % NOI 3.0% 4.5% 6.6% 3.8% 0.0% 3.6% 3.0% 4.3% 4.6% 4.9% 20.0% 58.3% 3.7% 7.2% 10.6% 3.1% 0.0% 2.5% 3.3% 3.9% 2.7% 4.1% 14.4% 55.5% Type TRZ CRE CRE CRE TRZ CRE TRZ TRZ TRZ TRZ Multiple 8 10 10 10 8 10 8 8 8 8 8.9 0 1 1 0 0 0 0 0 0 0 1 TOTAL EOP MULTIPLE 1 1 1 1 1 1 1 0 0 0 2 Actual '04 Multiple today
7.3% 4.3% 0.2% 4.1% 4.0% 5.3% 1.8% 1.5% 1.6% 0.0% 11.4% 41.5%
CBD Multiple: Assumptions: Current estimated CBD NOI, '04: % of total Average multiple: Current estimated sub NOI, '04: % of total Average multiple: Total NOI Current multiple Stock price
4.9
Suburban Multiple:
4.9
9.8
NEW CBD/SUBURBAN MIX AND VALUATION IMPLICATIONS: Sell $80 m of NOI ($1 billion deal, 8% cap rate) $ mm % of total Multiple CBD NOI 752.5 42% 10.8 4.5 Suburban NOI 1042.5 58% 8.9 5.1 Total 9.7 1795.0 Stock Price $ 27.11 upside/downside -2%
Achieve growth with value oriented acquisitions (i.e., properties with management opportunities and/or low occupancy levels acquired below replacement cost); Capitalize on EOPs operating leverage as the largest office landlord (i.e., concentrate in fewer markets); and Do more sizable joint venture transactions to take advantage of a financial structure than can boost returns while lowering risk.
The company re-hired Jeff Johnson as Chief Investment Officer and put the wheels in motion for a major asset re-positioning. In October, management commented that a large disposition of joint venture transaction was likely to close by year-end. Since that time there has been much market comment on the potential size of a transaction, with many sources pointing to up to $1 billion of asset sales, with proceeds to EOP depending on what interest the company might retain.
Exhibit 6: EOPs market presence at December 2002 EOP has exited at least three markets and substantially pared down exposure in others
4Q2002 Market Boston Chicago San Francisco Seattle San Jose Atlanta LA Orange County Washington DC New York Dallas Denver Portland Oakland Minneapolis Houston San Diego Sacramento Philadelphia New Orleans Stamford Austin Cleveland Indianapolis Orlando Phoenix San Antonio Charlotte Columbus Riverside, CA Fort Worth Salt Lake City % of Total 10.4% 8.9% 8.5% 8.0% 6.8% 6.2% 5.7% 5.0% 4.8% 4.0% 3.4% 3.3% 3.0% 2.4% 2.3% 2.2% 2.1% 2.1% 2.0% 1.9% 1.4% 1.1% 1.0% 0.8% 0.5% 0.5% 0.5% 0.5% 0.3% 0.2% 0.2% 0.1% 100%
Rank 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 TOTAL
Square ft 13,018.0 11,190.2 10,642.7 10,071.1 8,577.4 7,783.2 7,130.1 6,227.8 6,041.2 4,986.4 4,237.0 4,206.7 3,774.1 3,050.6 2,933.0 2,734.4 2,607.9 2,595.6 2,528.1 2,357.7 1,814.1 1,426.9 1,270.2 1,057.9 640.7 605.3 604.3 583.4 379.8 274.3 239.1 136.2 125,725
Grey highlighting represents market exit, blue highlighting represents decreased presence.
Market San Jose San Diego Charlotte Fort Worth San Francisco Minneapolis Oakland Los Angeles Los Angeles Salt Lake City Seattle Durham, NC Riverside, CA St Louis Seattle
Square ft. 194.0 362.8 583.4 239.1 496.1 929.7 60.3 92.4 94.4 136.2 114.5 181.7 308.4 339.2 408.4
Price ($mm) 106.8 67.0 Market exit Market exit 174.0 4.4 35.5 16.1 11.6 Market exit 13.5 20.0 Market exit 39.3 51.2 Market exit 56.2
However the company has used the structure in the past, in fact in a similar way. Moreover, some EOP executives have hinted that the planned deal for December might be modeled after a transaction with Lend Lease back in 1999. In 1999, EOP sold interests in seven assets for $535 million to an Australian-listed property trust managed by Lend Lease (now managed by The Principal Group of Des Moines, Iowa). The assets were also spread across the country, in Chicago, Indianapolis, Atlanta, Orlando, Dallas and Los Angeles. The properties had a mix of occupancy levels. Generally, 50-75% interests in the various buildings were sold. EOP used the proceeds immediately to pay down debt on its credit line, and subsequently for share repurchases and acquisitions.
Proceeds from the sale of asset interests to a joint venture: $500 million to $750 million, most likely, assuming 7-8% cap rates
Debt paydown option: $400m at 7.38% due in November $400m at 6.7% due in January = only MODEST DILUTION Acquisition option: Mgmt has indicated an expectation that interest rates, and cap rates, will go up in 2004; assuming the company wants to leverage scale in markets it is already in, cap rates will probably run in the 7% range; but timing factors would result in about 5c of dilution; what might be interesting is if EOP considered buying assets in a different property type, such as industrial- this could create POTENTIAL ACCRETION
Equity buyback option: Year to date EOP has repurchased about $700m of preferred and common equity; the company has called another $115 million of preferred series in December; not many preferred redemption opportunities remain; the return on buying back common stock at these levels is 10%- ACCRETIVE
More DILUTIVE
More ACCRETIVE
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mergers likely to pressure real estate demandbut EOP has positioned itself relatively well here with a healthy occupancy pickup this quarter and a relatively easier rent roll on re-leases in 2004.
2. Sister cities San Francisco and San Jose have begun behaving differently and this
surprises us. Fundamentals in San Francisco appear to be weakening (consistent with layoff news we have heard), while San Jose has begun to show signs of relative strength. While these are early days in this trend we think it bears watching: these markets are almost 25% of income for EOP (mostly acquired through the Spieker merger in 1999).
3. EOP could be in for some real trouble if markets do not pick up by 2005, because
that is the year rent rolls really get tough. Note this is also true for several other office REITs. This is because leases expiring in 2005 were likely signed between 1995 and 2000 and those rents are now above-market. Specifically, Boston and San Jose are large markets with rent roll-down risk in 2005 for EOP. We think this 05 Roll Risk across office companies has not yet been fully understood by the market and is a key driver behind our cautious stance on these companies.
Tier 1 Markets: at 45% of income, these are the ones to watch San Francisco and San Jose: the needle than can move the dial
While Boston is EOPs single largest market at 14% of income, we think of the Bay Area and San Jose markets together and these two combined represent 23% of incomewhat happens here will move the numbers for EOP. The large presence here is a function of the 1999 acquisition of Spieker Properties. We thought the 3Q2003 trends in these
markets were interesting: for the first time in a while, the direction of business activity diverged. Occupancy in San Francisco fell 500bp from 2Q2003 while
occupancy increased 200bp in San Jose. Could the 50% move in the NASDAQ since
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March and positive newsflow from technology companies suggest a recovery is underway in tech-heavy San Jose? While it is clearly too early to call, we think the relationship between the two markets should be monitored. We are modeling a 10% rolldown on lease expirations in San Francisco in 2004, but San Jose is fortunate with a relatively easier roll over the next two years. Leases are expiring $30-$32 per sq foot versus $37 this year, so we think the company could get flat re-leases. See Exhibits 1014.
Exhibit 10: San Jose office rents bottoming out projections provided by REIS Exhibit 11: San Francisco office rent projections mirror San Jose
$58
55%
$47
45%
Net Effective Rent
30%
$37
20%
$38
5%
$27
-5%
-20%
$17 1990 1992 1994 1996 1998 2000 2002 2004 2006 Rent % Change
-30%
$18 1990 1992 1994 1996 1998 2000 2002 2004 2006 Rent % Change
-45%
Source: REIS.
Source: REIS.
Exhibit 12: San Jose vacancy has likely peaked projections provided by REIS.
5 25%
Exhibit 13: Similar story for San Fran, though the change is less dramatic
25%
20% 2 15%
20%
15%
10% -1 5%
-3
10%
5%
0%
-8 1990 1992 Completions 1994 1996 1998 2000 2002 2004 2006
0%
Completions
Absorptions
Vacancy Rate
Absorptions
Vacancy Rate
Source: REIS.
Source: REIS.
12
Vacancy Rate
Exhibit 14: San Francisco and San Jose lease rollover schedule and Goldman Sachs assumptions 2001-2008
2001A
SAN FRANCISCO Rentable Sq ft (000) (period end) Expiring Sq ft (000) Annualized rent ($ mm) Base Portfolio Rent/SF Rent Step % Rollover Rent/SF Rate on new and renewal leases % Change in new lease rates Rollover Renewal % Renewal space leased in period Vacant Space Leased in period Total Period Leasing (000 SF) Period End Occupancy Average Occupancy Unallocated Market Revenue Total Market Revenue ($mm) (EOP) Average Total Market Revenue ($mm) 86.8% 92.6% $ $ 10,618 774 43.5 43.29 $ 19% 56.18 $
2002A
10,643 961 34.2 44.57 $ 3% 35.58 $ $
2003E
10,932 1,206 42.6 42.47 $ 0% 35.30 $ 37.00 $
2004E
10,643 783 29.3 43.24 $ 0% 37.41 $ 33.67 $ -9% 85% 666 862 1,528 80.0% 76.1% 0.0 368.2 362.9
2005E
10,643 1,422 58.8 42.23 $ 0% 41.36 $ 34.34 $ 2% 85% 1,209 320 1,528 81.0% 80.5% 0.0 364.1 366.1
2006E
10,643 920 41.7 41.24 $ 0% 45.35 $ 34.39 $ 5% 85% 782 244 1,027 82.0% 81.5% 0.0 359.9 362.0
2007E
10,643 1,100 42.8 40.84 $ 0% 38.94 $ 34.44 $ 5% 85% 935 271 1,206 83.0% 82.5% 0.0 360.8 360.3
2008E
10,643 1,085 46.7 39.97 0% 43.03 34.49 5% 85% 923 269 1,192 84.0% 83.5% 0.0 357.3 359.0
398.8 398.8
357.7 363.5
SAN JOSE Rentable Sq ft (000) (period end) Expiring Sq ft (000) Annualized rent ($ mm) Base Portfolio Rent/SF Rent Step % Rollover Rent/SF Rate on new and renewal leases % Change in new lease rates Rollover Renewal % Renewal space leased in period Vacant Space Leased in period Total Period Leasing (000 SF) Period End Occupancy Average Occupancy Unallocated Market Revenue Total Market Revenue ($mm) (EOP) Average Total Market Revenue ($mm) 91.5% 45.8% $ 39.56 $ $
8,577 834 27.1 37.54 $ 0% 32.54 $ 33.30 $ -10% 85% 709 254 962 86.5% 85.6% 0.0 278.6 273.9
8,577 1,686 51.8 38.37 $ 0% 30.71 $ 33.97 $ 2% 85% 1,433 296 1,729 87.0% 86.8% 0.0 286.3 282.4
8,577 941 34.8 38.39 $ 0% 37.00 $ 35.66 $ 5% 85% 800 227 1,027 88.0% 87.5% 0.0 289.8 288.0
8,577 656 26.8 38.30 $ 0% 40.85 $ 37.45 $ 5% 85% 558 184 742 89.0% 88.5% 0.0 292.4 291.1
8,577 370 12.6 38.78 0% 34.11 39.32 5% 85% 314 141 456 90.0% 89.5% 0.0 299.4 295.9
313.9 313.9
149.9 306.0
technology companies now employ more workers than Boeing and the aerospace
13
industry, following a rapid decline in aerospace jobs in the last three years. This reinforces the notion that we can really think about the trends driving this market as similar to what is driving the tech-prevalent Bay Area and San Jose. See Exhibits 15-17.
Exhibit 15: Seattle still under rent pressure Exhibit 16: because vacancy has probably not quite peaked
25%
16% 11%
square feet (millions)
6 20%
6% 1%
$20
15%
2 10%
-4% -9%
5%
$14 1990 1992 1994 1996 1998 2000 2002 2004 2006 Rent % Change
-14%
0%
Completions
Absorptions
Vacancy Rate
Source: REIS.
Source: REIS.
Exhibit 17: Seattle lease rollover schedule and Goldman Sachs assumptions 2001-2008
2001A
SEATTLE Rentable Sq ft (000) (period end) Expiring Sq ft (000) Annualized rent ($ mm) Base Portfolio Rent/SF Rent Step % Rollover Rent/SF Rate on new and renewal leases % Change in new lease rates Rollover Renewal % Renewal space leased in period Vacant Space Leased in period Total Period Leasing (000 SF) Period End Occupancy Average Occupancy Unallocated Market Revenue Total Market Revenue ($mm) (EOP) Average Total Market Revenue ($mm) 92.8% 94.7% $ $ 10,380 689 17.0 28.06 $ 2% 24.63 $
2002A
10,071 1,399 33.3 28.40 $ 1% 23.81 $ $
2003E
9,954 2,091 58.1 27.29 $ 0% 27.80 $ 27.00 $
2004E
9,954 1,006 27.4 27.34 $ 0% 27.28 $ 27.00 $ 0% 85% 855 250 1,105 89.0% 88.4% 0.0 242.2 238.1
2005E
9,954 1,130 33.4 27.39 $ 0% 29.58 $ 27.54 $ 2% 85% 960 369 1,329 91.0% 90.0% 0.0 248.1 245.1
2006E
9,954 923 27.3 27.49 $ 0% 29.59 $ 28.92 $ 5% 85% 785 238 1,023 92.0% 91.5% 0.0 251.7 249.9
2007E
9,954 616 17.1 27.84 $ 0% 27.80 $ 30.36 $ 5% 85% 524 192 716 93.0% 92.5% 0.0 257.7 254.7
2008E
9,954 974 25.8 28.59 0% 26.55 31.88 5% 85% 828 246 1,073 94.0% 93.5% 0.0 267.5 262.6
270.3 270.3
263.8 261.4
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$26
feet in Boston and John Hancock has 1.5 million sq feet. Or the Banc of America purchase of Fleet Fleet has 1.4 million sq feet. While Banc of America does not have a real presence in Boston there will clearly be a need to squeeze efficiencies wherever possible. In addition, the rent roll becomes considerably more difficult in 2005. If 2004 is anything like 2003, during which tenants look to lock in current low rates on leases ahead of a pickup in the economy, we could see the impact of those deals soon. See Exhibits 18-20.
Exhibit 18: Boston market rents set for modest increase, but note the roll gets tough for EOP in 2005 Exhibit 19: Falling vacancy should support rent growth
25%
$39
square feet (millions)
20%
10%
$32
15% 0
10% -5 5%
$25
-5%
$18 1990 1992 1994 1996 1998 2000 2002 2004 2006
-20%
-10 1990 1992 1994 1996 1998 2000 2002 2004 2006 Completions Absorptions
0%
Vacancy Rate
Rent
% Change
Source: REIS.
Source: REIS.
15
Exhibit 20: Boston lease rollover schedule and Goldman Sachs assumptions 2001-2008
2001A
BOSTON Rentable Sq ft (000) (period end) Expiring Sq ft (000) Period rent ($ mm) Base Portfolio Rent/SF Rent Step % Rollover Rent/SF Rate on new and renewal leases % Change in new lease rates Rollover Renewal % Renewal space leased in period Vacant Space Leased in period Total Period Leasing (000 SF) Period End Occupancy Average Occupancy Unallocated Market Revenue Total Market Revenue ($mm) (EOP) Average Total Market Revenue ($mm) 97.2% 98.2% $ 13,019 1,314 46.7 36.85 $
2002A
13,018 1,199 46.0 38.67 $ $ $
2003E
12,931 1,213 44.5 38.49 $ 0% 36.68 $ 35.00 $
2004E
12,931 965 33.4 37.99 $ 0% 34.60 $ 31.50 $ -10% 85% 820 80 901 91.5% 91.2% 0.0 449.5 448.1
2005E
12,931 1,171 43.5 37.57 $ 0% 37.13 $ 32.13 $ 2% 85% 995 240 1,235 92.0% 91.8% 0.0 447.0 448.2
2006E
12,931 846 28.6 37.72 $ 0% 33.84 $ 33.74 $ 5% 85% 719 256 976 93.0% 92.5% 0.0 453.7 450.3
2007E
12,931 1,390 55.0 37.42 $ 0% 39.61 $ 35.42 $ 5% 85% 1,181 338 1,519 94.0% 93.5% 0.0 454.8 454.3
2008E
12,931 1,374 51.2 37.61 0% 37.26 37.19 5% 85% 1,168 335 1,503 95.0% 94.5% 0.0 462.0 458.4
466.6 466.6
460.1 460.0
Tier 2 Market: Healthy markets, if only EOP had more of them New York: great market but flipside is theres nowhere to go but down
New York is about equal to Seattle in importance to EOP at 7% of income. Occupancy in the New York City market is an eye-catching 98-99% every quarter but the result of this is that there is not much growth upside. EOP has had below-market rents expiring in New York City in 2003, so rent growth has materialized this will be a little tougher in 2004 when leases expire at $56 per square foot. We are assuming a 10% negative rent roll in this market.
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Washington, DC: Election year should keep this market strong in 2004
Washington DC at 6% of income should see growth next year as real estate demand could benefit from players in the presidential election process. The market lost 200 bp of occupancy in 3Q2003 (Washington, DC is one of only a few markets with new office supply pressure) but our sense is that the company is signing leases with reasonably good rent growth on expirations. Again this is a market with a 2005 rent roll issue, as expiring leases step up from $33/ft to $38/ft in that year.
Southern California: Apartments, industrial and retail steal all the sunshine
Los Angeles at 5% of income and Orange County at 4% give EOP exposure to southern California, which has been a hot market for apartment, industrial and retail REITs but relatively quiet for office. Los Angeles lost 250bp of occupancy in the quarter and rents came under pressure because of a much tougher roll than earlier in the year ($25/ft leases expired in the first half and $29/ft leases expired in 3Q2003). If EOP continues to sign leases comparable to rates in 3Q2003, this would imply a 9% rolldown in 2004, which is what we are modeling. Orange County picked up 120 bp of occupancy but also at a big negative spread, which we expect to persist.
Atlanta: Early signs of job growth but rent roll is really tough here
Atlanta (5% of income) rounds out Tier-2 markets. Occupancy and rents are stable now and early signs of job growth in this market give us hopebut EOP will need it with the roll faced in 2004. If the company continues to sign leases at $20/foot there will be a stunning 20% rolldown in 2004, which we are modeling.
Tier 3 Markets: Everything else and curiously, where the company is buying
The rest of EOPs markets represent 22% of income and include most of the suburban assets which have been hit much harder in this downturn (recall that central business district occupancy stands at 90% currently versus 84% for suburban assets). Interestingly, the company added to this bucket in 3Q2003 with the purchase of a 485k sq foot building in Denver (the US Bank Tower downtown, acquired for $165 per sq foot).
17
EOP isn't in the clear for 4-5 years, assuming TI/LC are about $20-25/foot leased
Sensitivity with JV sale (sell $1bn into JV, retain 25% stake & redeem debt) Dividend/share FAD Payout ratio $ 2.00 $ 122% 2.00 $ 104% 2.00 $ 108% 2.00 $ 110% 2.00 $ 100% 2.00 96%
While EOP Chairman Sam Zell had been vocal about maintaining the dividend earlier in the year, we have not heard any such confident reiterations in recent months. In fact the EOP management team has been notably silent on the subject of dividend sustainability in conversations we have had with them on the subject. Conservatism usually dictates that a REIT cut its dividend if its payout ratio is above 100% for a prolonged period, and despite Zells flamboyant personality we view his management philosophy in overseeing EOP as essentially a conservative one, given the company and its investor profile. The sustained period of stretched payout ratios suggests EOP would need to borrow in order to pay its distributions (debt to total cap would increase from 50% currently to 57% by 2008, interest coverage would remain stuck at 2.5X versus 2.8X in the late 1990s), effectively damaging the balance sheet. A joint venture yielding $750 million in proceeds to the company would reduce debt to cap by 200bp and given a roughly FFO neutral
18
impact the payout ratios would be about the same. But EOP would net about 10
months of dividend payments effectively buying it more time to sustain the dividend at the current level while awaiting some clarity in end-market demand.
Importantly, if the high payout ratio in 2005 and beyond stems from upfront investments to fill the buildings (in the form of tenant improvement allowances and leasing commissions), we believe EOP will be far more likely to maintain the dividend at its current $2.00 level given that it will have visibility on higher cash flows from higher occupancy. The key will be to watch employment trends, especially in officeintensive service industries, as well as EOPs occupancy trends. Were EOP to characterize the JV proceeds as a dividend bridge to a better economy, as we believe it may, we would again become concerned about dividend security by next fall in the absence of a marked pick-up in occupancy.
19
Exhibit 22: Dividend sensitivity: even with a 10-15% cut, yield would be attractive each scenario assumes our current forecast for capex/tenant improvements/commissions
Payout Ratios (FAD) 2004 Dividend: Yield: Dividend: Yield: Dividend: Yield: Dividend: Yield: $ 2.00 7.2% 1.90 6.8% 1.75 6.3% 1.50 5.4% 108% 2005 110% 2006 111% 2007 100% 2008 96%
102%
105%
104%
94%
90%
94%
96%
95%
86%
81%
81%
82%
91%
72%
68%
20
The three key drivers to rental revenue for any REIT are square footage, occupancy and rental rate per square foot. We forecast only a very slight improvement in occupancy in 2004, when 10% of leases are rolling at flat to down 10% rental rates. Beyond 2004 we expect a more meaningful occupancy recovery in 2005 and beyond. Even with an earnings neutral or accretive JV transaction, we see little growth for EOP. Our fvive-year FFO/share growth rate is 1.7%. One interesting moving piece that could potentially arise from an asset sale of this size would be the occupancy level of the remaining portfolio. Most of EOPs downtown office buildings tend to be very well leased; thus removing these properties from the consolidated total could lower the average occupancy modestly, and offer more leverage to an economic recovery (see Exhibit 23).
Exhibit 23: EOP has experienced a steep drop in occupancy and should see more gains that peers in 2004 represents weighted average occupancy for each
2001A EOP BXP TRZ CRE 93.6% 97.1% 90.7% 95.4% 2002A 90.2% 95.0% 90.0% 92.3% 2003E 87.1% 93.2% 86.2% 91.4% 03 Drop -3.1% -1.8% -3.8% -0.9% 2004E 87.3% 92.6% 86.3% 90.4% 04 Pickup 0.2% -0.6% 0.1% -1.0% 2005E 89.0% 92.9% 87.4% 91.2% 2006E 89.9% 93.5% 88.5% 92.1% 2007E 90.7% 94.0% 89.6% 93.2% 2008E 91.4% 94.5% 90.8% 94.0%
From a cost standpoint, EOP has launched a program called EOPlus, which management believes can save the company $75-100 million per year, half in expenses and half in capital costs. With G&A costs at less than 2% of revenue, EOP has proven scale advantages, though this number may not be directly comparable to prior years or peers since some costs were recently reclassified as operating. Please see Exhibits 24-26 for our full financial model.
21
Exhibit 24: EOP income statement analysis $ millions, except per-share data
2003 Quarterly Statements
2000A
2,027.5 (752.0) 1,275.5 168.5 56.3 (88.7) 1,411.5 (421.2) 990.3 (535.4) 36.1 491.0 (2.7) 0.6% (43.3) (59.4) (6.8) 378.8 48.8 (2.6) 424.9 277.2 280.1 $1.37 $1.35 $1.53 $1.52
2001A
2,828.7 (986.4) 1,842.3 212.1 69.2 (109.7) 2,013.9 (566.6) 1,447.3 (741.9) 40.2 745.6 (8.8) 1.2% (57.0) (76.2) (8.7) 594.8 103.7 (134.7) 563.8 360.0 363.1 $1.65 $1.64 $1.57 $1.55
2002A
3,220.5 (1,138.4) 2,082.1 263.2 106.9 (137.5) 2,314.7 (684.2) 1,630.5 (815.0) 22.3 837.8 (9.4) 1.1% (62.6) (89.2) (7.2) 669.4 38.2 0.0 707.6 414.7 416.7 $1.61 $1.61 $1.71 $1.70
1Q03A
765.6 (284.9) 480.7 60.4 20.8 (13.5) 548.4 (174.3) 374.1 (207.0) 3.3 170.4 (1.0) 0.6% (15.5) (17.3) (2.5) 134.1 7.6 0.0 141.7 408.3 409.2 $0.33 $0.33 $0.35 $0.35
2Q03A
759.6 (288.4) 471.2 47.6 20.9 (17.7) 522.1 (176.1) 346.0 (208.7) 3.7 141.0 (1.6) 1.1% (15.4) (18.5) (1.9) 103.7 46.2 0.0 149.9 400.5 402.3 $0.26 $0.26 $0.37 $0.37
3Q03A
753.6 (291.0) 462.6 52.5 21.2 (13.5) 522.9 (178.9) 343.9 (208.1) 3.7 139.6 0.3 (0.2%) (10.5) (13.6) (1.8) 113.9 (3.8) 0.0 110.2 397.4 399.5 $0.29 $0.29 $0.28 $0.31 13.6
4Q03E
780.4 (330.1) 450.3 51.3 20.2 (13.8) 508.0 (180.4) 327.6 (207.7) 3.6 123.6 (1.2) 0.9% (10.5) (12.1) (1.8) 98.0 0.0 0.0 98.0 398.9 401.6 $0.25 $0.24 $0.25 $0.24
2003E
3,059.3 (1,194.4) 1,864.9 211.9 83.1 (58.5) 2,101.4 (709.6) 1,391.7 (831.5) 14.3 574.6 (3.4) 0.6% (51.9) (61.6) (8.0) 449.7 50.1 0.0 499.7 401.3 403.1 $1.12 $1.12 $1.25 $1.24
2004E
3,072.7 (1,197.6) 1,875.1 216.1 73.4 (59.7) 2,104.9 1.9% (737.8) 1,367.2 (835.9) 14.6 545.9 (3.3) 0.6% (42.0) (54.2) (8.0) 438.4 0.0 0.0 438.4 398.9 400.9 $1.10 $1.09 $1.10 $1.09
Addback Derivation of Funds From Operations (FFO) 1998A (1) 1999A (1) Net Income to common shareholders 316.8 382.1 Property Sales (Gains)/ Losses D & A (including JV D&A) Minority Interest/OP adjustment Non-recurring and/or Convert Addback Funds from Operations (FFO) Straight-line rent adjustment Capitalized Interest CAPEX, TIs, and Lease Commissions Other (incl. FAS 141/142 adjustment) Funds Available for Distribution (FAD) Common Shares & Units Outstanding (diluted) FFO/share (diluted) FAD/share Dividends/share Dividend growth (YOY) Payout Ratio (Dividend/FFO) Payout Ratio (Dividend/FAD) Payout Ratio (Dividend/Net Income) Profit and Return Metrics Margin Analysis: Property Operating (NOI) Margin EBITDA Margin (3) Pretax Income Margin Net-Continuing Operations Margin Net Margin Return on Equity Analysis: Pretax Margin Retention Rate to Common (4) Asset Turnover Leverage ROE (common) Current Yield on Cost (NOI/gross PP&E) Return on Invested Capital FFO Return on Equity (FFO/(Eq+MI+Acc. D&A) (12.4) 313.5 36.2 0.0 654.1 (59.7) 368.5 48.2 0.0 739.1 (65.4) (18.0) (352.6) 0.0 303.1 291.2 $2.54 $1.04 $1.58 14.5% 62.2% 151.8% 107.0%
2000A
424.9 (34.5) 459.4 59.4 0.0 909.1 (69.8) (14.8) (373.2) 0.0 451.4 319.0 $2.85 $1.42 $1.74 10.1% 61.1% 123.0% 114.7%
2001A
563.8 (81.7) 613.9 76.2 4.7 1,177.0 (69.1) (25.9) (437.7) 0.0 644.3 412.0 $2.86 $1.56 $1.90 9.2% 66.5% 121.5% 122.4%
2002A
707.6 (0.4) 708.1 89.2 0.0 1,504.5 (72.9) (21.4) (433.6) 0.0 976.6 469.1 $3.21 $2.08 $2.00 5.3% 62.4% 96.1% 117.8%
1Q03A
141.7 0.0 175.9 17.3 0.0 334.9 (13.0) (3.6) (94.6) 0.0 223.7 459.3 $0.73 $0.49 $0.50 0.0% 68.6% 102.7% 144.4%
2Q03A
149.9 (44.1) 185.9 18.5 0.0 310.2 (19.0) (1.2) (124.0) 0.0 166.0 452.0 $0.69 $0.37 $0.50 0.0% 72.9% 136.2% 134.2%
3Q03A
110.2 0.0 188.3 13.6 3.9 316.0 (19.9) (2.2) (134.8) 0.0 159.1 457.2 $0.69 $0.35 $0.50 0.0% 72.3% 143.7% 161.3%
4Q03E
98.0 0.0 190.4 12.1 3.9 304.4 (20.2) (2.2) (101.5) 0.0 180.5 457.2 $0.67 $0.39 $0.50 0.0% 75.1% 126.6% 204.9%
2003E
499.7 (44.1) 740.4 61.6 7.9 1,265.5 (72.0) (9.2) (455.0) 0.0 729.3 456.4 $2.77 $1.60 $2.00 0.0% 72.1% 125.2% 161.3%
2004E
438.4 0.0 779.8 54.2 15.7 1,288.1 (70.0) (8.9) (359.3) 0.0 849.9 456.5 $2.82 $1.86 $1.75 0.0% 62.0% 94.0% 160.0%
(15.1) (253.4) 0.0 385.6 284.0 $2.30 $1.36 $1.38 NA 59.9% 101.6% 111.1%
2000A
62.9% 66.8% 24.2% 18.7% 21.0%
2001A
65.1% 68.7% 26.4% 21.0% 19.9%
2002A
64.7% 68.6% 26.0% 20.8% 22.0%
1Q03A
62.8% 68.9% 22.3% 17.5% 18.5%
2Q03A
62.0% 66.0% 18.6% 13.7% 19.7%
3Q03A
61.4% 66.6% 18.5% 15.1% 14.6%
4Q03E
57.7% 62.5% 15.8% 12.6% 12.6%
2003E
61.0% 66.0% 18.8% 14.7% 16.3%
2004E
61.0% 66.1% 17.8% 14.3% 14.3%
22
1998A
94.5%
1999A
45,189 94.5% 0.0
2000A
82,215 94.5% 0.0
2001A
119,562 93.6% 2,478.3 9,517 8% 14,711
2002A
125,725 90.2% $ 23.33 3,236.9 15,381 12% 20,620
2003E
2004E
124,887 124,598 87.1% 87.3% $ 22.28 $ 22.53 3,177.9 3,283.5 16,271 13% 13,787 11,945 10% 14,373
(1,335.3) (1,378.0) (1,384.1) 10.89 $ 11.00 $ 11.10 1.0% 0.9% 1,901.6 561.5 (196.9) 2,675.5 72.9 305.4 3,053.7 3,220.5 (1,138.4) 1,915.3 433.6 21.03 1,800.0 470.0 (180.0) 2,785.8 72.0 210.0 3,067.8 (1,198.0) 1,587.9 455.0 33.00 1,899.4 485.6 (180.8) 2,797.9 70.0 218.0 3,085.9 (1,203.3) 1,594.6 359.3 25.00
83.1
73.4
23
Exhibit 26: EOP statement of cash flows and balance sheets $ millions, except per-share data
1998A (1) 1999A (1)
Cash from Operations Net Income Preferred Dividends & Minority Interest Extr Items, Disc Ops & Gains on prop sales Depreciation & Amt. Deferred Taxes & Other Change in Working Capital Total Cash from Operations Uses Maintenance Capex Other Capex Development Expenditures Acquisitions Divestitures Net Dist/(Inv) in JVs Incr. In Deferred Leasing Costs & Other Total Uses of Cash Preferred Dividends (including OP) Common Dividends Free Cash Flow Equity Issuance/(Repurchase) Preferred Issuance/(Redemption) Debt Issuance/(Repayment) Other Financing (ex-LOC) Financing Activities Cash Available/(Line of Credit Draw) Line of Credit Use/(Repayment) Change in Cash & Mktable Sec. Balance Sheet Cash and cash equivalents Accounts Receivable Prepaid Expenses Other current assets Total Current Assets Deferred charges, gross Accumulated amortization Joint venture - rental properties Joint venture - construction in process Deferred rent & other assets Operating Assets: Land Buildings & Improvements Accumulated depreciation Total Operating Real Estate Construction in process Land Held for Development Total Property Assets Total Assets Accrued interest and dividend payable Accounts payable Prepaid rents and other Other liabilities Short Term Debt Total Current Liabilities: Total Long Term debt Other Long Term Liability Total Liabilities Minority Interest (including OP interest) Preferred stock Common stock Total Shareholders' Equity Total Liabilities, MI, and Sh. Equity ROIC Analysis Return on Capital (Graham & Dodd) Interest coverage Ratio (1) Fixed charge coverage Ratio (2) Effective leverage (3) Net Debt / EBITDA
(calcs include JV adjustment beginning in 2000)
2000A
424.9 109.6 (27.1) 435.5 (54.5) 18.9 907.3
2001A
563.8 142.0 (82.2) 587.4 91.5 (60.9) 1,241.6
2002A
707.6 159.0 (17.9) 687.9 (63.9) (81.7) 1,390.9
2003E
499.7 121.5 (50.1) 713.3 (83.1) (102.4) 1,099.0
2004E
438.2 104.2 0.0 741.4 (73.4) (106.6) 1,103.8
(207.1) (46.3) 0.0 (1,930.2) 10.2 4.1 (62.4) (2,231.7) (29.6) (389.0) (1,891.1) 59.4 400.5 1,333.4 (64.0) 1,729.3 (161.8) (161.8)
(297.5) (55.1) 0.0 (122.4) 452.7 13.4 (58.2) (67.1) (43.8) (454.5) 155.2 (48.7) 0.0 (83.7) (87.6) (220.0) (64.7) (64.7)
(293.7) (79.4) 0.0 (1,229.4) 352.4 (54.1) (7.5) (1,311.8) (43.5) (578.9) (1,026.9) (41.5) (0.9) 1,173.1 (53.0) 1,077.8 50.9 50.9
(360.1) (77.6) 0.0 (1,181.7) 361.4 (117.9) 27.8 (1,348.2) (58.6) (837.7) (1,002.8) 70.6 (106.3) 1,021.9 24.5 1,010.7 7.9 7.9
(328.9) (104.7) 0.0 (53.1) 377.2 1.6 193.1 85.2 (62.8) (935.1) 478.3 (263.6) 5.8 (251.1) 27.9 (480.9) (2.7) (2.7)
(344.6) (138.0) 0.0 (87.4) 399.0 108.0 0.0 (63.1) (53.8) (680.3) 301.7 (348.6) (250.0) 259.5 (8.0) (347.1) (45.4) 45.4 47.3
(359.3) 0.0 0.0 0.0 0.0 10.0 0.0 (349.3) (42.0) (909.1) (196.6) 0.0 0.0 60.0 0.0 60.0 (136.6) 136.6 0.0
2000A
53.3 101.8 353.3 39.8 548.2 294.7 (61.7) 1,164.6 0.0 207.1
2001A
61.1 120.4 252.4 196.3 630.2 380.0 (114.8) 1,321.1 0.0 269.8
2002A
58.5 77.6 273.7 29.2 439.0 466.7 (164.5) 1,087.8 0.0 331.9
2003E
105.8 85.5 291.2 49.7 532.2 583.7 (215.0) 979.8 0.0 403.2
2004E
105.8 71.6 286.6 45.1 509.0 631.8 (218.6) 969.8 0.0 473.2
1,343.3 12,006.3 (352.3) 12,997.4 268.4 65.8 13,331.6 14,261.3 5.1 348.0 0.0 1.1 1,216.0 1,570.2 4,809.4 93.0 6,472.6 737.7 615.0 6,436.0 7,051.0 14,261.3
1,278.3 11,569.1 (630.4) 12,217.0 229.2 125.9 12,572.2 14,046.1 5.4 318.0 0.0 0.0 453.0 776.4 5,398.9 161.2 6,336.5 883.5 615.0 6,211.1 6,826.1 14,046.1 5.5% 2.7x 2.5x 49.0% 4.9x
1,931.5 15,529.0 (978.1) 16,482.5 70.4 88.4 16,641.3 18,794.3 3.7 497.8 0.0 0.0 51.0 552.5 8,752.0 200.2 9,504.7 1,218.4 613.9 7,457.3 8,071.2 18,794.3 5.7% 2.5x 2.3x 52.3% 6.5x
2,820.1 21,579.6 (1,494.3) 22,905.4 165.0 251.7 23,322.1 25,808.4 6.1 570.7 0.0 0.0 244.3 821.1 11,744.3 330.3 12,895.7 1,604.4 863.4 10,444.9 11,308.4 25,808.4 6.1% 2.6x 2.4x 50.8% 6.0x
2,878.1 21,747.8 (2,077.6) 22,548.3 284.7 252.9 23,085.9 25,246.8 5.7 560.1 0.0 0.0 205.7 771.5 11,565.5 392.0 12,729.0 1,432.4 876.1 10,209.4 11,085.5 25,246.8 5.9% 2.7x 2.6x 49.7% 5.2x
2,884.1 22,085.6 (2,726.5) 22,243.2 61.3 253.9 22,558.5 24,842.4 227.5 578.9 0.0 0.0 513.7 1,320.0 11,483.0 457.1 13,260.1 170.3 626.1 10,786.0 11,412.0 24,842.4 5.2% 2.5x 2.3x 49.6% 5.9x
2,884.1 22,444.9 (3,467.9) 21,861.1 61.3 253.9 22,176.3 24,541.6 227.5 584.1 0.0 0.0 650.3 1,461.8 11,543.0 363.1 13,367.9 121.7 626.1 10,425.9 11,052.0 24,541.6 5.3% 2.5x 2.4x 49.7% 5.9x
Interest Rate Analysis Interest Expense Capitalized Interest Weighted Average Interest Rate Balance Sheet Statistics Days Receivable (period end) Days Payables (period end) Net Debt (period end) Debt to Cap (period end)
(345.0) (15.1)
24
35 33 31 29 27 25 23 21 19
Beacon merger
Spieker acquisition
Cornerstone merger
IPO, $21
17 15 1997
1998
1999
2000
2001
2002
2003
2004
25
Exhibit 28: EOPs shares have underperformed those of its peers in the last three, six and 12 months
Performance & Trading
GS Rating/ View Current Share Price 12/09/2003 Absolute and Relative Price Change (k) 6 months 12 months Abs. Rel. Abs. Rel. Avg. daily vol (6 m) (000)
Company
Ticker
52 Week L-H
Office Properties
Alexandria Real Estate Arden Realty, Inc. Brandywine Realty Trust Brookfield Properties Corp. Boston Properties Mack-Cali Corporation CarrAmerica Realty Equity Office Properties Great Lakes REIT Glenborough Realty Trust Highwoods Properties HRPT Properties Trust Kilroy Properties Maguire Properties Mission West Properties Corporate Office Properties Prime Group Realty Parkway Properties Prentiss Properties Reckson Associates SL Green Realty Trizec Properties, Inc. Weighted Average/Total Average ARE ARI BDN BPO BXP CLI CRE EOP GL GLB HIW HRP KRC MPG MSW OFC PGE PKY PP RA SLG TRZ NC NC NC IL/C IL/C IL/C U/C IL/C NC NC NC NC NC NC NC NC NC NC NC U/C U/C IL/C $56.65 29.45 27.35 28.02 46.95 40.20 30.15 28.03 15.72 19.51 25.01 9.98 31.55 23.35 12.70 21.38 6.04 42.85 32.10 23.90 38.18 14.86 20.1% 5.8 8.2 17.8 6.4 7.6 5.1 0.1 0.2 1.5 5.6 9.1 10.3 NM 5.8 11.1 -11.9 -5.0 4.4 2.2 4.0 16.8 6.3% 6.0 13.4 % (0.9) 1.5 11.1 (0.3) 0.9 (1.6) (6.6) (6.5) (5.2) (1.1) 2.4 3.6 NM (0.9) 4.4 (18.6) (11.8) (2.3) (4.6) (2.7) 10.1 (0.4)% (0.7) 27.0 % 11.0 12.7 26.4 8.6 14.2 5.4 2.9 (0.3) 0.4 15.6 4.0 16.6 NM 12.0 29.7 0.5 4.4 10.4 13.5 9.4 26.9 11.3 % 12.0 13.8 % (2.2) (0.5) 13.2 (4.6) 1.0 (7.8) (10.2) (13.5) (12.8) 2.4 (9.2) 3.4 NM (1.2) 16.5 (12.7) (8.8) (2.8) 0.3 (3.8) 13.7 (1.9)% (1.2) 39.2 % 31.9 26.0 60.6 27.0 33.0 19.3 7.5 (5.0) 11.3 16.5 20.6 36.7 NM 26.9 55.0 16.9 18.6 16.0 13.4 21.9 50.1 25.3 % 25.9 12.8 % 5.5 (0.4) 34.3 0.6 6.7 (7.0) (18.9) (31.4) (15.0) (9.9) (5.8) 10.4 NM 0.6 28.6 (9.4) (7.7) (10.4) (13.0) (4.4) 23.7 (1.1)% (0.5) 34.0 % 32.5 24.5 52.8 27.5 33.1 20.2 11.8 (4.9) 9.7 13.4 20.3 38.4 NM 29.5 52.1 31.9 21.7 13.5 12.8 21.0 54.2 25.8 % 26.2 7.7 % 6.2 (1.8) 26.4 1.2 6.8 (6.2) (14.5) (31.3) (16.7) (12.9) (6.1) 12.0 NM 3.2 25.8 5.6 (4.6) (12.8) (13.5) (5.3) 27.9 (0.6)% (0.1) $40 21 19 17 35 27 23 23 13 15 20 8 21 19 9 13 5 33 25 18 29 8 $57 30 27 28 47 41 32 29 17 21 26 10 32 24 14 21 7 46 33 24 39 15 90 222 161 114 296 219 217 1,158 54 103 281 482 110 315 43 99 68 36 177 369 159 285
Exhibit 29: Historically, EOP has outperformed its office peers office REIT index is our calculation of a market cap weighted index of office REITs
120
110
100
90
80
EOP's recent share price performance has lagged, even versus a market cap weighted office index in which EOP is very influential
70
60
50
1997 1998 1999 2000 2001 2002 2003
26
Exhibit 30: Historical multiple analysis shows EOP trading in line with historical average
20.0x 18.0x 16.0x 14.0x 12.0x 10.0x 8.0x 6.0x 4.0x 2.0x 0.0x Average NTM P/E: 10.2x Average LTM P/E: 10.3x
1998
1999
2000
2001
2002
NTM P/ E
LTM P/ E
Ave LTM
Ave NTM
Source: Factset.
Company
Ticker
02A
2003
FAD/Share (c) 03E 04E
02A
Office Properties
Alexandria Real Estate Arden Realty, Inc. Brandywine Realty Trust Brookfield Properties Corp. Boston Properties Mack-Cali Corporation CarrAmerica Realty Equity Office Properties Great Lakes REIT Glenborough Realty Trust Highwoods Properties HRPT Properties Trust Kilroy Properties Maguire Properties Mission West Properties Corporate Office Properties Prime Group Realty Parkway Properties Prentiss Properties Reckson Associates SL Green Realty Trizec Properties, Inc. Weighted Average/Total Average ARE ARI BDN BPO BXP CLI CRE EOP GL GLB HIW HRP KRC MPG MSW OFC PGE PKY PP RA SLG TRZ NC NC NC IL/C IL/C IL/C U/C IL/C NC NC NC NC NC NC NC NC NC NC NC U/C U/C IL/C $56.65 29.45 27.35 28.02 46.95 40.20 30.15 28.03 15.72 19.51 25.01 9.98 31.55 23.35 12.70 21.38 6.04 42.85 32.10 23.90 38.18 14.86 $3.93 2.75 2.69 1.87 4.09 3.93 3.31 3.21 2.14 2.45 3.44 1.29 3.09 NA 1.13 1.39 1.06 4.64 3.36 2.36 3.32 2.05 $4.23 2.65 2.69 2.16 4.04 3.79 3.29 2.76 1.76 2.25 2.60 1.26 3.39 1.46 1.11 1.56 1.73 4.43 3.08 2.09 3.44 1.85 $4.55 2.58 2.66 2.38 4.00 3.73 3.10 2.82 1.42 2.10 2.61 1.30 2.74 2.15 1.04 1.69 0.96 4.42 3.10 2.15 3.55 1.72 13.4x 11.1 10.2 13.0 11.6 10.6 9.2 10.2 8.9 8.7 9.6 7.9 9.3 16.0 11.4 13.7 3.5 9.7 10.4 11.4 11.1 8.0 10.8x 10.4 12.4x 11.4 10.3 11.8 11.7 10.8 9.7 9.9 11.1 9.3 9.6 7.7 11.5 10.9 12.3 12.7 6.3 9.7 10.3 11.1 10.8 8.6 10.6x 10.5 180 80 (30) 120 110 20 (90) (70) NA (250) (100) (290) 90 30 170 210 (430) (90) (150) 50 20 (200) 7.7 % (3.7) (0.2) 15.5 (1.2) (3.6) (0.6) (14.0) (17.8) (8.2) (24.3) (2.3) 9.8 NM (1.8) 11.9 63.2 (4.6) (8.2) (11.4) 3.6 (9.8) (4.2)% 0.0 7.6 % (2.7) (1.1) 10.2 (1.0) (1.6) (5.8) 2.2 (17.8) (6.8) 0.3 3.2 (19.2) 47.1 (6.8) 8.6 (44.5) (0.2) 0.7 2.9 3.2 (7.0) 1.6 % (1.3)
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Dividends
GS Rating/ View Current Share Price 12/09/2003 Div/ Share (Ann.) Dividend CAGR 03-08E
Payout Ratios
04E FFO Payout Ratio (d) 04E FAD Payout Ratio (e)
Company
Ticker
Dividend Yield
Office Properties
Alexandria Real Estate Arden Realty, Inc. Brandywine Realty Trust Brookfield Properties Corp. Boston Properties Mack-Cali Corporation CarrAmerica Realty Equity Office Properties Great Lakes REIT Glenborough Realty Trust Highwoods Properties HRPT Properties Trust Kilroy Properties Maguire Properties Mission West Properties Corporate Office Properties Prime Group Realty Parkway Properties Prentiss Properties Reckson Associates SL Green Realty Trizec Properties, Inc. Weighted Average/Total Average ARE ARI BDN BPO BXP CLI CRE EOP GL GLB HIW HRP KRC MPG MSW OFC PGE PKY PP RA SLG TRZ NC NC NC IL/C IL/C IL/C U/C IL/C NC NC NC NC NC NC NC NC NC NC NC U/C U/C IL/C $56.65 29.45 27.35 28.02 46.95 40.20 30.15 28.03 15.72 19.51 25.01 9.98 31.55 23.35 12.70 21.38 6.04 42.85 32.10 23.90 38.18 14.86 $2.24 2.02 1.76 0.60 2.52 2.52 2.00 2.00 1.62 1.40 1.70 0.80 1.98 1.67 0.96 0.94 0.00 2.60 2.24 1.70 2.00 0.80 4.0 % 6.9 6.4 2.1 5.4 6.3 6.6 7.1 10.3 7.2 6.8 8.0 6.3 7.2 7.6 4.4 0.0 6.1 7.0 7.1 5.2 5.4 6.1 % 6.1 49 % 78 66 25 % 63 68 65 71 114 67 65 62 72 78 93 56 0 59 72 79 56 47 63 % 64
27 % 79 82 97 107
131 74.2 82 87 % 85
Margins-2003E
Pretax Income Margin Net Cont. Ops Margin
Company
Ticker
ROE 04E
ROIC 04E
CYC 04E
NAV
NOI Margin
EBITDA Margin
Net Margin
Office Properties
Alexandria Real Estate Arden Realty, Inc. Brandywine Realty Trust Brookfield Properties Corp. Boston Properties Mack-Cali Corporation CarrAmerica Realty Equity Office Properties Great Lakes REIT Glenborough Realty Trust Highwoods Properties HRPT Properties Trust Kilroy Properties Maguire Properties Mission West Properties Corporate Office Properties Prime Group Realty Parkway Properties Prentiss Properties Reckson Associates SL Green Realty Trizec Properties, Inc. Weighted Average/Total Average ARE ARI BDN BPO BXP CLI CRE EOP GL GLB HIW HRP KRC MPG MSW OFC PGE PKY PP RA SLG TRZ NC NC NC IL/C IL/C IL/C U/C IL/C NC NC NC NC NC NC NC NC NC NC NC U/C U/C IL/C $56.65 29.45 27.35 28.02 46.95 40.20 30.15 28.03 15.72 19.51 25.01 9.98 31.55 23.35 12.70 21.38 6.04 42.85 32.10 23.90 38.18 14.86
$21 38 32 28 21
31 23 25 6 35
22 32 12
9 21 24 27 22
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Implied Price Matrix FCF Terminal Growth Rate WACC $ 28.67 8.0% 8.5% 9.0% 9.5% E51 0.8% 27 23 21 18 1.3% 30 26 23 20 1.8% 33 29 25 22 Matrix Avg 2.3% 37 32 28 24 $26
2003E WACC Analysis Total Debt Total Preferred Total Equity WACC Valuation Assumptions: WACC (or r)= Perp. UFCF growth rate (or g)= 1/(r-g)=
Source: Goldman Sachs Research.
g = our estimate
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1.92
1.77
1.63
1.50
Implied Price Matrix Dividend Terminal Growth Rate $ WACC 28.67 8.0% 8.5% 9.0% 9.5% C26 -0.4% -10.3% 3.9% 0.8% 31 29 27 25 1.3% 31 29 27 25 1.8% 31 29 27 25 Matrix Avg 0.2% 3.8% 4.8% 2.3% 31 29 27 25 $28
Valuation Assumptions g = Retention Rate X Return on Equity Retention Rate (=1-FAD Payout Ratio) ROE WACC= ("k")= r(e) * equity % + (1-t) * r(d) * debt %
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Exhibit 36: Net asset value analysis $ millions, except per-share data
2003 Annual Net Operating Income Inc Acq & Dev Straight Line Rent Adjustment Adjusted Net Operating Income Capitalization Rate Share of NOI, Subsidiaries Cap. Rate Non-rental Income Cap. Rate Real Estate Asset Value Construction in Process/Land Held for Development Cash Net of Balance Sheet (receivables, payables) Other Assets Asset Value 1,865 (72) 1,793 9.20% 145 7.50% 212 12.50% 23,122 315 106 (380) 772 23,935 1,865 (72) 1,793 9.70% 145 8.00% 212 12.50% 21,997 315 106 (380) 772 22,810 (12,816) (751) 9,243 456 $ 20.25 8.2% 1,865 (72) 1,793 10.20% 145 8.50% 212 12.50% 20,984 315 106 (380) 772 21,797 (12,816) (751) 8,230 456 $ 18.03 2004 Annual 1,875 (70) 1,805 9.20% 152 7.50% 216 12.50% 23,381 315 106 (408) 886 24,281 (13,012) (626) 10,642 457 $ 23.31 1,875 (70) 1,805 9.70% 152 8.00% 216 12.50% 22,243 315 106 (408) 886 23,142 (13,012) (626) 9,504 457 $ 20.82 8.3% 1,875 (70) 1,805 10.20% 152 8.50% 216 12.50% 21,219 315 106 (408) 886 22,118 (13,012) (626) 8,480 457 $ 18.57 2005 Annual 1,874 (70) 1,804 9.20% 152 7.50% 223 12.50% 23,412 315 106 (406) 984 24,411 (13,200) (626) 10,586 457 $ 23.19 1,874 (70) 1,804 9.70% 152 8.00% 223 12.50% 22,275 315 106 (406) 984 23,274 (13,200) (626) 9,448 457 $ 20.70 8.3% 1,874 (70) 1,804 10.20% 152 8.50% 223 12.50% 21,252 315 106 (406) 984 22,251 (13,200) (626) 8,425 457 $ 18.45
Less: Debt Outstanding (incl. share of unconsolidated (12,816) Less: Preferred Outstanding Net Asset Value Shares Outstanding NAV Per Share Implied Cap Rate (751) 10,369 456 $ 22.72
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EOP owns and manages approximately 125 million square feet of office space, 60% in the suburbs and the balance located in central business districts (see Exhibit 36). Properties located in the ten largest markets generate about 80% of net operating income, including San Francisco and San Jose (23% combined ), Boston (14%), Seattle (7%), and New York (7%). EOPs portfolio was 86.3% occupied at the end of 3Q2003. The federal government, under the auspices of the General Services Administration (GSA), is EOPs largest tenant, accounting for 1.8% of total annualized rental income, followed by PriceWaterhouseCoopers (1.5%), Washington Mutual Bank (1.4%), and Ogilvy and Mather (1.0%). 10% of EOPs existing leases expire during 2004, followed by 11% in 2004 and 2005.
Exhibit 37: Map of operations
Reg AC certification
I, Carey Callaghan, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report.
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Disclosures
33
34
Distribution of ratings/investment banking relationships Goldman Sachs Research global coverage universe
70% 60%
53%
Percentage of companies covered by the Goldman Sachs Group, Inc, within the specified category
50% 40%
67%
Percentage of companies within each category for which The Goldman Sachs Group, Inc. has provided investment banking services within the previous 12 months
As of 10/1/03 Goldman Sachs Global Investment Research had investment ratings on 1,654 equity securities.
OP/Buy
IL/Hold
U/Sell
Goldman Sachs uses three ratings - Outperform, In-Line, and Underperform - reflecting expected stock price performance relative to each analyst's coverage group, on an unweighted basis with regard to market capitalization and with a 12-month time horizon. Each analyst also assigns a coverage view - Attractive, Neutral, or Cautious - representing the analyst's investment outlook on the coverage group. NASD/NYSE rules require a member to disclose the percentage of its rated securities to which the member would assign a buy, hold, or sell rating if such a system were used. Although relative ratings do not correlate to buy, hold, and sell ratings across all rated securities, for purposes of the NASD/NYSE rules, Goldman Sachs has determined the indicated percentages by assigning buy ratings to securities rated Outperform, hold ratings to securities rated In-Line, and sell ratings to securities rated Underperform, without regard to the coverage views of analysts.
As of October 1, 2003
1,250
1,000
Stock Price
22
Jul 3 RL RL
Oct 31 MP
Nov 4 IL A S
750
N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J 2000 2001 2002 2003 Source: Goldman Sachs Research for ratings and price targets; Reuters for daily closing prices, as of 10/01/03.
Rating Price target Price target removal S&P 500; pricing by FactSet
Covered by David J. Kostin Not covered by current analyst New rating system as of 11/4/02
The price targets shown should be considered in the context of all prior published Goldman Sachs research, which may or may not have included price targets, as well as developments relating to the company, its industry and financial markets.
Index Price
35
Company-specific disclosures
The Goldman Sachs Group Inc. beneficially owned 1% or more of a class of equity securities of the following companies as of the end of the month immediately preceding the publication date of this report. If the publication date is less than ten calendar days after month end, The Goldman Sachs Group, Inc. beneficially owned 1% or more of a class of equity securities of the companies as of the end of the second most recent month: Reckson Associates. The Goldman Sachs Group, Inc. and/or its affiliates have received during the past 12 months compensation for investment banking services from the following companies, their parents, or their wholly owned or majority-owned subsidiaries: CarrAmerica Realty Corporation, Boston Properties, Inc., Equity Office Properties Trust, SL Green Realty Corp, and Brookfield Properties Corp. The Goldman Sachs Group, Inc. and/or its affiliates expect to receive or intend to seek compensation for investment banking services in the next 3 months from these companies, their parents, or wholly owned or majority-owned subsidiaries: CarrAmerica Realty Corporation, Trizec Properties Inc., Boston Properties, Inc., Reckson Associates, Equity Office Properties Trust, Mack Cali Realty Corporation, SL Green Realty Corp, and Brookfield Properties Corp. The Goldman Sachs Group, Inc. and/or its affiliates have managed or co-managed a public offering of the following companies' securities in the past 12 months: Boston Properties, Inc. The Goldman Sachs Group, Inc. is a specialist in the securities (including derivative securities) of the following: Boston Properties, Inc. and Reckson Associates.
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37
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Other definitions
Coverage view. The coverage view represents each analyst or analyst team's investment outlook on his/her/their coverage group(s). The coverage view will consist of one of the following designations: Attractive (A). The investment outlook over the following 12 months is favorable relative to the coverage group's historical fundamentals and/or valuation. Neutral (N). The investment outlook over the following 12 months is neutral relative to the coverage group's historical fundamentals and/or valuation. Cautious (C). The investment outlook over the following 12 months is unfavorable relative to the coverage group's historical fundamentals and/or valuation. CIL = Current Investment List. We expect stocks on this list to provide an absolute total return of approximately 15%20% over the next 12 months. We only assign this designation to stocks rated Outperform. We require a 12-month price target for stocks with this designation. Each stock on the CIL will automatically come off the list after 90 days unless renewed by the covering analyst and the relevant Regional Investment Review Committee.
Other ratings/identifiers
NR = Not Rated. The investment rating and target price, if any, have been suspended temporarily. Such suspension is in compliance with applicable regulation(s) and/or Goldman Sachs policies in circumstances when Goldman Sachs is acting in an advisory capacity in a merger or strategic transaction involving this company and in certain other circumstances. CS = Coverage Suspended. Goldman Sachs has suspended coverage of this company. NC = Not Covered. Goldman Sachs does not cover this company. RS = Rating Suspended. Goldman Sachs Research has suspended the investment rating and price target, if any, for this stock, because there is not a sufficient fundamental basis for determining an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon. NA = Not Available or Not Applicable. The information is not available for display or is not applicable. NM = Not Meaningful. The information is not meaningful and is therefore excluded.
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