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Real Deal’s “The Closing” Interview of Scott Rechler

Scott Rechler: “The Smartest Guy in the Real Estate Boom”

Crains

By Theresa Agovino

Last week, RXR Realty Chairman Scott Rechler addressed a group of fellow real estate executives and joked that there were so many familiar faces he felt like it was his bar mitzvah. Chuckles followed his instructions to leave the gift envelopes in the corner.

Mr. Rechler certainly isn’t hurting for cash. In the past 12 months, RXR has invested more than $3.5 billion in Manhattan real estate, including buying or signing contracts to purchase 4 million square feet of space in four properties. Underpinning the spending spree is a $1 billion-plus fund whose dozen or so investors include the Safra family and Rothschild Realty.

“Over the next 24 months, we are going to be very active,” Mr. Rechler told Crain’s. “We are making a substantial bet on Manhattan.”

That’s a switch from four years ago. In January 2007, the then-chairman of Reckson Associates Realty Corp. sold his public company to SL Green Realty Corp. for $6 billion after deciding the market was too frothy. Sure enough, the average price of a Manhattan office tower tumbled 59% between 2007 and 2009.

Mr. Rechler may have shown an excellent sense of timing back then, but some real estate executives say RXR is shelling out too much for its recent purchases. They note that rents, while no longer falling, are largely flat. And just like in the boom, scores of buyers are chasing deals. The average price of a Class A office tower rose 73% last year.

“If you aren’t paying a premium, you aren’t getting the property,” said Richard Baxter, a vice chairman at Jones Lang LaSalle’s New York Capital Markets Group, who doesn’t believe that Mr. Rechler is overpaying.

The office market in Manhattan is indeed improving. In the first quarter, leasing activity soared 34% from the year-earlier period, to 7.6 million square feet, according to Cushman & Wakefield Inc. In midtown, net effective rents—what the tenant pays after accounting for perks like construction allowances—rose 24%, to $57.82 per square foot.

Conservative financing is a key part of 43-year-old Mr. Rechler’s investment strategy. RXR’s plan is to pay an average of 50% of a building’s price in cash and fund the rest with long-term loans. That should allow it to ride out any future drops in the market.

A hit list in hand

“Scott is very smart and leads a great team that understands New York,” said Andrew Silberstein, a managing director at Rothschild Realty, which put $150 million into the RXR fund. “They really understand how to create value with real estate and not just financial engineering.”

RXR entered Manhattan in August 2009. Mr. Rechler had quietly mined his contacts, built over a lifelong real estate career, and compiled a hit list of buildings with financial problems. His goal was to swoop in and snap up a bargain.

“I wanted to be the first call when anything was for sale,” he said.

RXR’s first Manhattan purchase was buying discounted debt on a 556,000-square-foot office condominium at 1166 Sixth Ave. that is leased to two gold-plated tenants. The firm is now under contract to buy 40% of the condo.

Growing bolder, RXR in June 2010 bought 49% of 340 Madison Ave. in a deal that values the property at $570 million, or $760 a square foot. Mr. Rechler knew the building faced a refinancing in 18 months, which would make it less attractive to other investors. He took the risk—and is now in the process of refinancing the property in a deal that will bring in an additional partner.

RXR won 1330 Sixth Ave.—a prize Mr. Rechler had been eyeing since 2009, when Harry Macklowe was forced to give it back to lenders—in a bidding war late last year. Still, the $400 million purchase price was nearly $100 million less than what Mr. Macklowe paid in 2006.

When RXR bought the building, rents were about $70 a square foot. Recently. a tenant signed a $100-a-square-foot lease, Mr. Rechler notes with pride.

He understands that not all rents will jump so quickly. RXR has a contract to pay $900 million, or about $400 a square foot, for the Starrett-Lehigh Building, the sprawling, 2.3 million-square-foot property in Chelsea.

Chelsea, of all places

Mr. Rechler, a midtown maven, says he’s drawn to the West Side neighborhood because it’s becoming a center for media and technology companies that are a vital part of New York’s economy. Google’s recent purchase of its Eighth Avenue home and the eventual construction of Hudson Yards will only add to the area’s allure.

The Starrett-Lehigh Building’s rents, currently around $40 a square foot, could jump to $70, he predicts. Of course, that could take a decade. “I have,” he said, “very patient money.”

Before SL Green bought it in 2006, the REIT formerly known as Reckson Associates had a strong presence in the city. After that sale, however, the company, now known as RXR Realty, pulled back from Manhattan and, instead, focused on New Jersey, Westchester and Long Island. But as executive vice president and managing director Bill Elder, 45, tells the story, the group has bounced back to Manhattan in a major way.

The Commercial Observer: RXR Realty bowed out of the Manhattan real estate market about two years ago. What prompted the return?

Mr. Elder: As you probably know, the company was sold in 2006–actually at the beginning of 2007–to SL Green. As part of the sale, all the city assets were basically integrated into SL Green, and then many of the suburban assets, Scott Reckler and his partners retained. SL Green did actually buy some of the suburban portfolio as well, but Scott retained holdings in New Jersey, Long Island, Westchester and Connecticut.

And the feeling at the time was that the market had reached a peak and it was time to hunker down and wait for the cycle to return, which, looking back on it, was perfect timing for that strategy to be implemented.

When do you re-emerge in the market?

So RXR came back into the city in a meaningful way in 2009, and the company started buying mostly in the capital stack–junior and senior mezzanine pieces throughout various buildings in the city. And then in the middle of 2010, and then late 2010, we executed on two property transactions: one being 340 Madison Avenue and the other being 1330 Avenue of the Americas.

Speaking of capital stacks, tell me about 1 Park Avenue. If I understand correctly, earlier this month, RXR just got paid off for its investment in a mezzanine piece.

That was an investment that we made in the middle of 2009. The thought at the time was, we were going to purchase one of the senior mezzanine pieces at a substantial discount–which we did–with the viewpoint that we would own the asset at some point in time.

Again, to my point earlier about New York in recovery mode, we never thought that anybody would recapitalize the asset–which Vornado just did, or that we’d be paid off at par value. So that’s one of those investments that we probably made in excess of a 10 multiple on our original investment in one year’s time.

What was attractive about 340 Madison Avenue?

With 340, we loved the in-place rent stream. We loved the asset from a physical standpoint: the facade, the lobby, the elevators and the physical plan. It was a great asset, and if you recall at that point, that was kind of the inflection point of the new market, where buildings were still trading in the $350-to-$400-a-foot range. We liked that asset for the yield that it had, and the relatively safe, long-term cash flow and the ability to harvest the little bit of vacancy that was there at the time.

So we liked it all the way around, from a physical standpoint and the investment profile.

And what attracted you to 1330 Avenue of the Americas?

At 1330 Avenue of the Americas, we viewed that as just one of the greatest buildings in New York: Central Park views, a really first-class trophy infrastructure, new lobby, new elevator cabs and a great tenant roster. And, in fact, it had the beginning of the building blocks to really take advantage of the improving market.

With 340 Madison Avenue, it sounds like there are plenty of opportunities to add value.

Definitely. Just through the transactions we’ll do in some of the vacant space. There’s just two floors–the 22nd floor and part of the 10th floor. Other than that, the building is in very, very good shape. And the 22nd floor is the top of the building.

Previous to SL Green purchasing the company, how active was RXR in Manhattan?

At the time we were called Rex & Associates, a publicly traded real estate investment trust. We owned about 24 million feet throughout the tristate area. In the city we owned just about 5 million feet; so very, very active. We owned several trophy-quality assets, many of which are in the same neighborhood as 1330. We owned 1350 Sixth Avenue; 810 Seventh Avenue; 1185 Sixth Avenue; 919 Third Avenue.

So we were very involved in the New York City market and also the tristate markets. I think we were viewed as one of the top landlords locally and certainly from a national REIT standpoint.

Now that you’re resurfacing in Manhattan, what will that mean with regard to your focus on Long Island, which traditionally has been a large part of your business?

I think it’s actually good news for the Long Island market. The focus on the city is really driven. … It doesn’t mean we aren’t focused on the other markets as well. We’re still focused on New Jersey, Long Island, Westchester and Connecticut. I think we just look at New York City as a really good place at this point in time to spend a disproportionate amount of our time and our energy and our focus, just given the fundamentals of what New York is right now.

I think our view on the New York City market is that every cycle you go through, the city continues to kind of push past the prior peaks of the prior market, which I think it’s on the way to doing right now. I think all the fundamentals are in place for the early stages of a booming recovery.

What is your forecast for 2011 and 2012 in terms of leasing and investment sales?

I think it’s safe to say that the properties for sale right now–just from an on-the-market perspective–are pretty anemic right now. There is deal flow and there is new product coming to the market, but it’s not as vibrant as what we would hope for. So what that means is that we spend a large percentage of our time–both mine and Scott and our investment teams–kind of mining relationships that we have throughout the city and elsewhere, uncovering hidden opportunities through partnerships or investment in the capital stacks or outright asset purchases.