08/08/2014 | By Sarah Borchersen-Keto
First Potomac Realty Trust (NYSE: FPO) is looking to become the leading owner of office real estate in the Washington, D.C. area, and the company is counting on a shift towards high-quality assets and operational improvements to reach that goal.
“It’s a bold goal, but I think it’s really something we can make a tremendous amount of progress against,” said Andrew Blocher, First Potomac’s CFO.
Blocher, recently named a CFO of the Year by Washington Business Journal, joined the company in 2012. Shortly thereafter he became involved in updating the company’s strategic and capital plan, resulting in the sale of the majority of First Potomac's industrial portfolio for about $260 million and a public offering of more than 7 million common shares. Proceeds from the sale and equity raise were used to pay down debt and purchase high-quality office properties, Blocher said.
Today, about 60 percent of the company’s rental income is generated from office properties, compared with 4 percent in 2009. Since that time, the company’s portfolio has also moved further away from the suburbs in favor of downtown Washington and the surrounding neighborhoods.
Challenges of Washington Market
Blocher acknowledges that the Washington market has faced challenges in recent years, including a government shutdown, budget sequestration and downsizing of many area law firms. Despite the difficulties, opportunities have been present.
“The tendency is always to paint everything with the same brush, when the reality is that the markets are nuanced. You need to peel back the layers to be able to figure out what it is that’s in demand,” he said.
First Potomac’s focus during the last several years has been on purchasing newer buildings that incorporate features including column-free space, “great window lines,” and proximity to transportation options and amenity-rich submarkets, Blocher said.
Paul Adornato, a managing director with BMO Capital Markets, noted that because of its focus on multi-tenant properties that are rich in amenities and close to public transportation, First Potomac’s portfolio is more resilient than the office market overall. “First Potomac is well-positioned to benefit as the overall regional economy recovers,” Adornato added.
The strategy appears to be paying off. Despite an operating environment in which tenant concession packages are high and rent growth is sluggish, the company has posted 10 consecutive quarters of positive net absorption, Blocher said. “This really talks to the quality of the space we have, and our aggressiveness in going after users for that space,” he added.
At the same time, First Potomac has made “dramatic” improvements on the operating side, including an increase in occupancy of more than 300 basis points in the course of the last year or so, Blocher said. Shares in First Potomac have gained almost 12 percent year to date, compared with a 16 percent return for the FTSE NAREIT All REITs Index and an approximately 5 percent return for the S&P 500.
Tough Acquisitions Market
When it comes to increasing the size of its portfolio, Blocher concedes that making acquisitions in the Washington market is challenging. Despite the difficult operating environment, assets are still trading at or above record pricing levels, according to Blocher.
Sovereign wealth funds are particularly active and are taking a longer-term view of the market, Blocher noted. Because First Potomac does not enjoy the same cost of capital as sovereign wealth funds, it seeks to take advantage of the company’s relationships with ownership teams and buy assets off-market.
“We’re a strong local operator. That certainly works to our benefit, and that’s the way we try to go about our business,” Blocher said. “Over time, we hope we can play a bigger role with respect to the fully marketed deals, but right now, we’re utilizing our relationships to pry something loose.”
Jon Petersen, an analyst at MLV & Co., noted that although fundamentals in Washington have been under pressure, cross-border investors view the market favorably on a long-term basis and are willing to pay a premium to own assets there. Petersen said he would not want to see First Potomac acquiring the type of assets sought by sovereign wealth funds, “because it would mean they overpaid.”
Adornato said the Washington market holds cachet for non-U.S. investors, while prices in the U.S. capital may appear more reasonable than what they would expect to pay in cities such as London or Tokyo.
Petersen said he expects the Washington market to start to recover within the next two to three years.
“We actually think the [Washington] office REITs are pretty good investments right now because they trade at pretty big discounts to their fair valuation,” he said.
Blocher, meanwhile, expressed confidence that interest in REITs that hold Washington-area assets, which have been “pretty out of favor for a while,” will revive. When it does, “the First Potomac that people see then will be drastically different from the First Potomac they saw last time they looked,” he predicted.