Insignia: The Making Of A Superlandlord
In 1988, 27-year-old Andrew L. Farkas saw his budding business--syndication of real estate limited partnerships--crash and burn. His investors, including friends and family, took big financial hits, and Farkas came close to personal bankruptcy. Fast-forward 10 years. Farkas now heads up Insignia Financial Group Inc., a rapidly growing, highly acquisitive real estate services firm with a market capitalization of $700 million. After just eight years in business, Insignia is the largest manager of apartment housing in the U.S., has real estate holdings of $250 million, is a leading firm in commercial brokerage, and is among the top 10 residential brokers. Now, it is expanding overseas.
Farkas' success is, to some degree, an outgrowth of his earlier failure. By launching--and then trying to salvage--real estate limited partnerships, Farkas hit upon a novel way to capitalize on ailing partnerships. By buying a controlling interest in a limited partnership (LP), Farkas, as general partner, could assign the management contract to his property-management company.
This laid the foundation for his current strategy. Farkas is now set on becoming the leader in a fast-consolidating real estate services industry. "Insignia is very, very aggressive," says Michael L. Evans, national director of E&Y Kenneth Leventhal Real Estate Group. "Farkas only started his business in the late 1980s, and he has now become the 800-pound gorilla."
Farkas faces formidable challenges. He is competing with well-established players, including Los Angeles' CB Commercial and Chicago's LaSalle Partners Inc. While competing for clients and choice acquisitions, Farkas must manage the staggering growth of his company. He must also contend with some unhappy limited partners who allege that, in connection with a series of tender offers that Insignia began making to LPs in late 1994, the firm, as the LP's general partner, is shirking its fiduciary duty--a claim Insignia vigorously denies.
WHO'S WHO. Farkas' tenure in the industry can't compare with James J. Didion's 36 years at CB Commercial, where Didion is now chairman. CB Commercial is also pursuing a goal to become a one-stop shop for real estate services. But Farkas brings a wealth of connections to the table. His grandfather founded the now defunct Alexander's department store chain, and he grew up in the same New York apartment building as vulture investor Leon Black. Now, Black's company, Apollo Real Estate, owns a large slice of Insignia and invests in many of the firm's deals. Farkas and William Lauder, of the cosmetics empire, are part of a group of friends that are a Who's Who of moguls-in-the-making. The circle includes Strauss Zelnick, president of media giant Bertelsmann's U.S. operations; Michael Lynton, Penguin Group chief executive officer; and Seagram heir Matthew Bronfman.
Farkas describes his firm as "the quintessential public real estate opportunity fund." Part of its strategy is to invest alongside the institutional owners it provides management services for. Once it finds properties it thinks its clients would like, Insignia goes to clients with the deal, asking to co-invest by injecting 10% to 35% of the equity and to manage and lease the entire property. Insignia gets a brokerage fee, too. Farkas says the firm has "tens of millions" co-invested in assets with gross valuations of about $1 billion.
Farkas' vision is of a real estate supermarket serving residential and corporate customers around the U.S. He sees synergies between, say, his mortgage banking business and his single-family-home brokerage arm, which could work when tenants depart to buy their own houses. His desire to buy strong firms in consolidating industries led to purchasing single-family residential brokerage firm Realty One in Cleveland last year. It is the first step in Farkas' plans to create a national independent network of residential brokers.
POWERHOUSE. The deal that put Insignia on the map in the commercial real estate brokerage industry came in mid-1996, when it bought Edward S. Gordon Co. (ESG), a New York powerhouse. "Insignia hadn't really been a competitor until it acquired ESG," says Didion. "We see Insignia as a rising entity. If Farkas can integrate it all, he'll have a formidable operation." Insignia has also bought brokerage firms in Chicago, Washington, and other big cities. He is taking the Insignia/ESG name nationwide, which could diminish the value of regional brands he has acquired. (Insignia/ESG is a real estate consultant for The McGraw-Hill Companies, BUSINESS WEEK's parent.)
Insignia is also advancing in its international push, although CB Commercial beat it out for London's REI Ltd., which operates in 28 countries. Insignia, however, beat out its rival for Richard Ellis Group, a leading real estate services and investment firm in Britain.
Farkas plans to merge the firm's partnership interests into a publicly traded real estate investment trust. Insignia Properties Trust (IPT), now a private REIT, is awaiting regulatory approval to go public. It will be a "paper-clipped" REIT, which trades separately but has the same management and board of directors as Insignia, which will initially own about 66% of IPT.
Insignia says that the main purpose of the REIT is to separate its real estate services and ownership businesses. Also, IPT will be able to access public markets to help fund growth. The move may bring shareholders added value. In 1997, Insignia's stock rose only 2.2%. But so far this year, the stock, at 24 7/16, is up 6%.
IPT will be an unusual REIT. "It has a built-in growth vehicle--the consumption of all those LPs," says Ron Sachs, a research analyst at Janus, a major holder of Insignia stock. "Insignia has been able to make incredibly attractive acquisitions because they know what the properties are worth."
CONFLICTS. Such statements make some limited partners boil. Insignia has been hit with a string of lawsuits since it began making discounted tender offers in late 1994. Some lawsuits alleged that Insignia's offers were inadequate and constituted unjust enrichment. Unhappy limited partners say that Insignia, since it gets fees from properties, has a disincentive to liquidate partnerships. Insignia gets $30 million to $40 million in revenue a year from 5% of gross rents it earns as manager of its 250,000 units, about half of which are owned in LPs.
Insignia lays out the conflict for limited partners. A recent offer states: "The General Partner has conflicts of interest...including the fact that a sale or liquidation of the...Partnership's assets would result in a decrease or elimination of fees paid to the General Partner," and that increased ownership by the Purchaser "...may result in a conflict for the GP in attempting to reconcile the interests of the Purchaser...with the interests of the other Limited Partners."
Insignia makes offers below what it believes is liquidation value. Says Farkas: "If we think liquidation value is $1, we offer 65 cents, and we tell the limited partners that." It's a great arbitrage for Insignia, because "that 65 cents is actually worth $1.30 because of the way REITs are valued in the market today--at a premium."
Farkas, usually animated, grows even more so when questioned about the lawsuits from limited partners. "If we hadn't come along to save these partnerships, the vast majority of them would be in bankruptcy or gone," he says, adding that lawsuits are inevitable with tender offers. "We've filed 50 tender offers. Every single case has been dismissed or settled for a nominal sum." That's not accurate. In one suit, settled in 1995, Insignia paid tendering limited partners an additional $6 million.
Farkas is well on the way to building his empire. But as competition for acquisitions heats up--and real estate values rise--growth will come at a higher price. Farkas has proved that he can do deals in a bull market. The real test will come when the bull slows down.