I Love L.A.--but Not This Real Estate IPO

Six suburbs in search of a city. That was the joke about downtown Los Angeles back when I was born there and City Hall overlooked everything. Today, suburbs keep consuming the desert, but no one can miss downtown L.A.'s stand of high rises, most of all the 73-floor Library Tower. For this, Angelenos have no one to credit more than Robert Maguire III -- dreamer, developer, manager, and owner of downtown L.A.'s trophy buildings. Now, at 68, Maguire has become a seller.

If all goes as planned in a flurry of deals set for June, Maguire will bundle his equity in four downtown towers, plus several outlying properties and development interests, put them into a real estate investment trust, and sell a 67% stake to public investors for $669 million. His timing looks good. Although the market for initial public offerings has been comatose, REITs are kicking: Standard & Poor's (MHP ) REIT Composite Index outpaced stocks -- while showing positive returns -- in each of the past three years. In 2003, REITs are at it again. One reason is the nice dividends they pay. Maguire Properties, as this REIT is known, would be no exception. It's expected to yield 8.25% a year (table).

Tempting? Yes, and Maguire has done an impressive job of keeping vacancies in his buildings relatively low amid these troubled times. For example, Arthur Andersen, now kaput, recently vacated 160,000 square feet in Library Tower. Maguire swiftly re-leased it to US Bancorp's US Bank unit, which will soon put its name atop the building.

Just the same, even if you love L.A., or simply believe as I do that its best days lie ahead, it's hard to read the fine print in this IPO and not come away with a creepy feeling. It's one of those deals that seems to offer something sweet to everybody -- except, perhaps, the buyers.

Maguire and his executives are keeping quiet ahead of the deal. But to see why it bugs me, all you need do is follow the cash. Maguire Properties aims to sell at least 33.4 million shares. It estimates they will bring $20 each. That would raise nearly $669 million. The cost of the IPO, including fees to the underwriters led by Citigroup (C ) and Credit Suisse First Boston (CSR ), would lop $60 million right off the top, leaving $609 million. The benefit to the bankers doesn't end there, though. Citigroup stands to take an additional $104 million in repayment of two loans it made to Maguire; CSFB would get $85 million for preferred stock it holds in Library Tower.

That leaves $420 million, $313 million of which would go into refinancing three big towers. Of the remaining $107 million, nearly $38 million would flow circuitously but ultimately to pay off debt on another Maguire property. But get this: It's not even one of those buildings set to go into the public REIT. The rationale? The loan on this "excluded" property is collateralized by buildings that are part of the REIT. Most of the final $69 million is drained off by assorted fees and refinancings of other buildings. Just $6.8 million would be left toward working capital.

Where does all of this leave Maguire? Much better off. Now, he and his partners own the properties outright. But debt is so heavy that the operations' net worth comes to negative $150 million. Once the IPO is done, Maguire will be freed of guarantees on $947 million in debt as the REIT instead takes on the burden of these obligations. Yet by keeping 31% of the REIT's equity and acting as co-CEO, he will remain very much in control.

As for public investors in the REIT, they figure to experience the deal quite differently. Each share they buy at $20 will suddenly represent net worth of just $5.76. Hey, did you hear the latest one about downtown Los Angeles: four tall buildings in search of some suckers?

By Robert Barker

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