It didn’t take David LaRue very long to make an impression on the Ratners, one of the founding families of Cleveland-based REIT Forest City Realty Trust.
When LaRue, an accountant hired to be a financial analyst, arrived at Forest City from Sherwin-Williams in April 1986, he was given responsibility for the redevelopment of Cleveland’s Tower City Center, a multi-building mixed-use project above the city's main rapid-transit hub. It was an endeavor that executive vice president of development Ron Ratner recalls as both “very complex and very difficult.” But LaRue aced the first test—and just about every other challenge that was thrown his way in those early years.
“David is by training an accountant, but no matter whether it was directly in his wheelhouse or something that we asked him to think about or he was just in the room and very quietly doing it, from the very beginning it was obvious he was someone who has tremendous runway in front of him,” Ratner says.
Quietly, over time, LaRue continued rolling down that runway, excelling in both operations and development and earning promotions along the way, eventually becoming president and COO of the Commercial Group.
“When I look back at careers in the company and people who progressed in our company and elsewhere, [what I see] is that they’re generally people who are doing the work before they get the promotion,” Ratner says. “You stop [and] say, ‘Wait a minute. He’s already doing that. It’s about time we already gave him a promotion and a raise, because he’s been doing the job without being asked.’ He’s always been there for us, and he’s always been doing the job before he was asked.”
Eventually, that earned LaRue the title of CEO, in 2011, and made him the first non–family-member CEO of Forest City, which was founded in the 1920s after the Ratowczer (later changed to Ratner) family emigrated to the U.S. from Poland. It was started by siblings Charles, Max (Ron’s father), Leonard, and Fannye Ratner.
Unfortunately, the newly minted leader was facing one of the roughest years in Forest City’s history six years ago. “He came on board just after our most difficult year,” Ratner says. “The recession was tough on nearly everyone in the industry. While we were a strong company, David clearly made some decisions that needed to be made. The company has really rallied behind him.”
After Forest City staggered through the recession, LaRue needed to make some changes. The firm encountered delays at the high-profile Atlantic Yards project and ran into a problem that many other land developers and apartment builders had as well—too much debt.
“We put in place a new structure coming out of the recession,” LaRue says. “We narrowed our focus on specific markets and products, sustainable capital structure, and operational excellence.”
At the time, Forest City found itself with a ratio of 13x debt to EBITDA. “When debt was plentiful and cheap, we used a lot of it to activate our structure,” LaRue says.
At the end of the third quarter of 2016, that ratio was 8.4x and the company wanted to hit the mid-7x range by the end of 2017. “We certainly looked at our company and said, while leverage has been a part of real estate for a long time, we need to take a different look at our balance sheet,” Ratner says. “We’ve done that and significantly reduced our reliance on debt.”
But getting there hasn’t been easy. Part of the process was picking what the company was good at and getting out of the businesses that no longer made sense.
Forest City took other steps to lessen its exposure as well. During the period from roughly 2008 to 2012, the company had three very large projects under construction simultaneously in its New York core market. Those deals, plus other projects, totaled more than $3 billion.
“We realized we took on too many large-scale single developments,” Ratner says. “We had three projects that were north of a billion in cost that were under construction. That was probably more risk than we needed to take on.”
Now, instead of focusing on a single large building on a particular site, Forest City is working on longer-term, multi-building developments, like The Yards in Washington, D.C.; Pier 70 in San Francisco; and its decade-and-a-half–long Stapleton project in Denver.
The Yards, a 42-acre development with apartments, dining options, office space, and specialty retailers along the Anacostia River waterfront in Washington, D.C., and Pier 70 in San Francisco cover 69 acres with a mix of office, street retail, and multifamily. These multi-building developments allow Forest City the flexibility to pull back if market conditions change.
“While over time some of these projects will be three to five million square feet in mixed-use opportunity, each building, as part of that project, is a smaller risk. Thus, we have less money riding on each individual project so that we can weather some of the ups and downs,” LaRue says.
When LaRue took over, Forest City operated in low-barrier-to-entry cities like its home base of Cleveland, as well as the coastal hubs. But over the years, it tightened its focus, amassing strength in markets such as Boston, San Francisco, and Washington, D.C.
Forest City also had a large stake in land development, hotels, strip centers, the Brooklyn Nets basketball team and its home at Barclay’s Center, and military housing. Now, none of those lines of business can be found on Forest City's balance sheet (other than the Stapleton development and a small portfolio of strip centers in the New York City market).
“We've focused our business,” LaRue says. “We’re going to focus on our apartment and office portfolios.”
The company had long been a player in the development business, but with the exception of Stapleton, it’s no longer buying and developing dirt outside of its core urban locations. “Land is a very capital-intensive business,” LaRue says.
It’s a risky business, as well.
Forest City also holds a portfolio of 47 federally assisted housing projects, which it developed in the ’70s and ’80s as the general partner. Those are now for sale. The firm, too, was a big player in the military’s housing privatization program that began in 1996.
“We’ve exited the military housing business, which was a significant component of our activity and a great business,” Ratner says. “We had gotten to the stable management phase and we thought that was something where we weren’t really adding value.”
Finally, in the third quarter of 2016, Forest City announced that it was weighing options that would allow it to divest its retail business, though it plans to continue to develop amenity retail as part of its mixed-use developments.
“The mall portfolio didn’t really have a clear role in a company that’s focusing on their core expertise, which is mixed-use placemaking development that often entails partnering with local government to regentrify an area,” says Sheila McGrath, senior managing director covering equity REITs and real estate operating companies at Evercore ISI, an investment banking advisory firm.
The REIT Decision
When a number of private apartment companies, including firms like Camden Property Trust and Equity Residential, rushed into the REIT space in the early ’90s, Forest City, which was public at the time, chose to stay on the sidelines and remain a C corporation.
“We didn’t see a particular benefit to changing our format,” Ratner says. “We were already public and already had access to the public market. We also had the benefit of the discipline it takes to be a public company. At the time, we said, ‘At the right time, we’ll look at it.’ ”
In 2016, after a year of preparation, that moment arrived. “In January 2016, we did everything we needed to become a REIT,” LaRue says. “We had always been tax efficient; we were a tax-efficient C corp.”
But after the company sold off major assets, the REIT structure made more sense than it ever had in Forest City’s history. “Forest City was operating in a very tax-efficient manner by using net operating loss [NOL] carry-forwards that reduced the company’s tax obligations,” LaRue says. “As we began to transform the company and sell assets and lines of business, gains from those sales began to 'use up' those NOLs. Given that our NOLs were likely to 'burn off,' it made sense to reconsider the REIT form, which management and the board had looked at in the past.”
The REIT conversion also opens Forest City to a new class of investors, both institutional and individual.
With Forest City one of the last remaining non-REIT real estate firms, it was difficult for investors to compare the company with REITs. “Another important reason was to [create] comparability to our peers. Operating in the REIT format would open up opportunity for exposure to a wider audience of investors. Many investors who choose to invest in real estate only invest in REITs, and most of the major industry indexes only include REITs,” LaRue says.
Of course, that inevitable, welcomed comparison with REITs puts more pressure on the management team to compete and allocate capital to pay a dividend, even though Forest City’s emphasis on urban placemaking makes it fairly unique. But LaRue isn’t concerned.
“All good management teams put pressure on themselves,” he says. “I’ve met very few non-A types in management.”
In addition to the REIT conversion, at the end of 2016, Forest City announced it was changing its dual class of stock, which meant the family had one series of stock and investors had another, by converting its Class B common into shares of Class A stock.
“We often see dual class structures at companies where the founder or their families want to retain control despite going public,” says Britton Costa, director of Healthcare & REITs at Fitch Ratings, which revised the company’s outlook to positive from stable in October 2015. “Dual class structures can influence corporate governance and valuation and relative access to capital. Collapsing the structure at Forest City was a longstanding request of certain shareholders.”
But some shareholders still aren’t satisfied. In late January, shareholder Land and Buildings, whose activism prompted sales of Cleveland-based REIT Associated Estates and San Francisco-based BRE Properties, sent a letter to the REIT’s shareholders saying it believes Forest City “has more than 40% upside to NAV given its enviable collection of high-quality real estate and significant embedded upside due to grossly inferior margins.
“At the root of the company’s abject underperformance is a tangled web of nepotism and self-dealing, which constitutes a true failure in public company corporate governance,” the Land and Buildings letter read.
Land and Buildings called “a special meeting of the shareholders immediately following the dissolution of the B share class.”
Forest City responded a day later in a release saying that Land and Buildings had purchased less than 1% of Forest City’s existing Class A common stock and that it "made no attempt to engage with management on this issue prior to the submission of their candidates and requested priority and approval rights over other shareholders.
“We are surprised that after working with our shareholders and announcing our governance enhancements, which were well received by shareholders, and prior to learning who Forest City’s new independent director nominees will be, Land and Buildings would choose this counterproductive path,” Forest City said in the release.
A Big Impact
While Land and Buildings has been critical of Forest City, the transition has met with good reviews from others. “Few companies underwent change like Forest City on the left side and right side of the balance sheets,” Fitch Ratings' Costa says. “They’ve improved the quality of their portfolio.”
The change to a REIT structure and the disposition of business units was also part of a structural change inside the corporate organization, which, like many real estate companies, is substantially smaller than it was a decade ago. The company had been organized in strategic units around its various businesses. Now, Forest City is organized into development and organizational units.
Despite the changes, the core of what Forest City does remains intact. Essentially, the company hangs its hat on creating great places that transform neighborhoods and attract people. And whether you're a C corp. or a REIT, great places lead to profits. Examples include Stapleton, the old Denver airport that turned into a home for 25,000 people, and Metrotech, a blighted area in Brooklyn that became home to a mixed-use office campus of 11 buildings, totaling 3.7 million square feet of office space.
“That [urban placemaking] has been their special sauce,” Costa says. “They have invested the time and capital and have experience working with local politicians. That’s their strength.”
Evercore ISI's McGrath agrees. “If you look at the company over a long period, one of their strengths is expertise across property types and placemaking, mixed-use development settings,” McGrath says.
She points to The Yards in D.C. as one success story. “These buildings, in an amenity-rich environment with retail and a park along the river, are leasing up much quicker than the market average,” McGrath says.
William Rich, senior vice president, multifamily practice director at real estate research firm Delta Associates, agrees. “The projects located at The Yards are proximate to amenities, including a grocery store, restaurants, convenience retail, and a riverfront park,” he says. “Many of the units also have views of the Anacostia River. As a result, rents tend to be higher at The Yards than at other communities in the Capitol Riverfront and Southwest Waterfront.”
But the pipeline will slow down for the REIT. LaRue says the company came into 2016 with 15 projects under construction. At the end of the third quarter, Forest City had 10 projects under construction, including nine residential deals. But there are more big projects in the works, including Pier 70 in San Francisco and Hudson Exchange, a multifamily project in Jersey City, N.J., with multiple potential future phases.
That’s not the only investment opportunity available to the company, however. “The reinvestment in our existing buildings is a priority,” LaRue says. “We have put $20 million in our own buildings.”
Whether it’s new development or renovation, the goal is the same. “We’re making sure we’re doing everything we can to capture [maximum] rents,” LaRue says. “Our operating team is focused on that.”
Regardless of what the future brings, Ratner is comfortable that Forest City made the right choice when it decided to elevate LaRue. “I think David has done some extraordinary things as CEO,” Ratner says. “He’s helped us transform the company in a lot of ways, and we’re really poised for more growth.”