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2005: Another Good Year for Falcon

2005 was another excellent year for Falcon Real Estate. As in 2004, we set a number of new records. We advised our clients on, and then closed, the largest dollar volume of property purchases in Falcon's 14-year history. Similarly, we advised on the largest dollar volume of property sales since the company was formed. And, at the same time, we obtained the greatest dollar volume of mortgages compared to any previous year in the past. In addition, we again had an extremely active year in leasing space in the various properties that we manage for our clients. And finally, the market valuation of Falcon’s asset management portfolio at the end of 2005 was $1.86 billion, an increase of 22% for the year, and a record high.

I. Purchases

During 2005 we purchased nine properties with a dollar value of over $513 million. This was the largest dollar volume of purchases in Falcon's 14-year history. As in 2004, properties were purchased in seven different states in every section of the United States. The following is a list of the nine properties purchased by Falcon in 2005:

Property Rentable
Square Feet
Purchase Price
1. Novo Nordisk Buildings, Princeton, NJ 225,700 $71,250,000
2. Eagle-Picher Building, Phoenix, AZ 103,667 15,000,000
3. Hartford Insurance, San Antonio, TX 100,000 18,500,000
4. Carlyle Club Apartments, Plantation, FL 165,290 28,750,000
5. Highland Landmark, Downers Grove, IL 276,461 67,000,000
6. Boca Palms Apartments, Boca Raton, FL 673,400 80,000,000
7. Park Crest I (Land), Tysons Corners, VA -- 169,000,000
8. Crystal Cove Apartments, Chandler, AZ 172,380 21,700,000
9. IDT Building, Burbank, CA 155,042 42,500,000
Total 1,871,940 $513,700,000

The risk parameters involved in these purchases varied widely. Some of the properties, such as Novo Nordisk and Highland Landmark are leased to credit quality companies on long-term leases, thereby mitigating much of the risk. On the other hand, there was credit risk in the Eagle-Picher purchase; there was lease renewal risk in the Hartford Insurance property; there was development risk in Park Crest, and there was condominium conversion risk in Carlyle Club, Boca Palms and Crystal Cove. The wide array of risk that was assumed in these purchases is an indication of the varying investment objectives and risk tolerance levels of Falcon's clients. It should also be noted that six of the nine purchases were syndicated transactions (or “club deals”) in which Falcon acted as the general partner bringing together a number of investors who provided capital for the transaction.

II. Sales

With the very strong real estate market that the United States has experienced in recent years, many of the properties that we have purchased for our clients in the past had reached a point where it became appropriate to realize the properties' appreciation through sale. Accordingly, the active sales program that began in 2004 continued in 2005 with four properties, totaling over $150 million being sold. This was a significantly larger dollar volume of sales than had occurred in any previous year. In addition to the four properties that were sold in 2005, four other properties have been actively marketed and their sales are scheduled to close early in 2006. The following are the details of the 2005 sales:

Property Square Feet Sales Price
1. Ralph's Supermarket, West Hollywood, CA 47,000 $22,700,000
2. One Montgomery, San Francisco, CA 75,880 36,500,000
3. Waterfront Place, Seattle, WA 176,412 42,000,000
4. Phillips Electric, Parsippany, NJ 200,000 50,250,000
Total 499,292 $151,450,000

It is interesting to note that each of these four properties provided excellent internal rates of return to the investors:

Property Years Held IRR
1. Ralph's Supermarket, West Hollywood, CA 9 14.6%
2. One Montgomery, San Francisco, CA 4 24.5%
3. Waterfront Place, Seattle, WA 10 27.9%
4. Phillips Electric, Parsippany, NJ 4 13.8%

In addition to selling the four individual properties, Falcon also supervised the sale of 180 condominium units at the Aventi project in Aventura, Florida. This was Falcon’s first condominium conversion project, and with the very rapid sell-out of the individual units at prices above our initial projections, the investment results were extraordinarily good for the equity investors. The IRR in this case far exceeded original expectations. In the first quarter of 2006 Falcon will be engaged in the sale of individual condominium units in three other conversion projects and one development project.

III. Financings

The amount of new mortgage financings negotiated by Falcon Real Estate in 2005 considerably exceeded the total amount of mortgage financings in any previous year. This was partly due to the dollar amount of new properties purchased during the year, but it was also due to the fact that a number of those purchases were condominium conversion projects. In these kinds of projects, the mortgage lender will finance up to at least 80% of the total cost of the project, including renovation and conversion costs. As a result, the amount of the financing may exceed the purchase price of the property. These condo conversion mortgages are shorter-term, floating rate loans that are repaid as the individual condominium units are sold.
 

Mortgage Financings on New Purchases $416,175,000
Mortgage Refinancings 146,000,000
Total    $ 562,175,000

IV. Leasing

During 2005 our asset management staff was again very active in concluding lease negotiations with new and existing tenants for the properties on which we provide asset management. We signed 42 new leases during the year in both office and retail properties covering just over 340,500 square feet of space. These leases will produce approximately $105 million of rental income for our clients during their term. In addition, negotiations have been concluded on several additional major leases, with final execution expected in the near future.

Over 85% of the square footage that was leased in 2005 was in the office sector, with the remaining 15% being in retail. However, because of the fact that retail leases generally cover a longer period of time, and in high quality retail properties the rent per square foot is often higher, the retail properties produced 30% of the projected rental income and the office properties produced 70%.

The following is a breakdown of the leasing activity between renewing tenants and new tenants:

  Square feet Percent Total Dollar Value (millions) Percent
Renewals 175,943 51.7% $29.5 28.0%
New Tenants 164,598 48.3 75.8 72.0
Total    340,541   $105.3  

Although approximately 50% of the leases executed in 2005 were with new tenants, those leases produced 72% of projected dollar value of the rental income to be earned over the life of the leases. These leasing results were heavily influenced by the continuation of the repositioning program at 2 Rodeo Drive in Beverly Hills, California, and by the re-leasing of the former Time-Warner Building in Alexandria, Virginia. The Time-Warner Building was purchased with the understanding that the entire building would have to be re-leased during 2005. The fact that both of these programs were carried out very successfully during the year resulted in an exceptionally large number of long-term leases to new tenants.

V. Asset Management

Falcon’s asset management activity has had an unbroken record of growth since the company was formed in 1991. At the end of 2005 we now provide asset management for 47 properties, or more than 7.3 million square feet. This is an increase of 1.1 million square feet, or 18%, over the prior year. The growth came about not only from purchased properties, but Falcon was also appointed asset manager of an important retail property during the year. The market valuation of Falcon’s asset management portfolio at the end of 2005 was $1.86 billion, an increase of 22% for the year.

Outlook:

As we enter 2006 we remain optimistic about the basic fundamentals of the U.S. real estate market. As the economy continues to improve, we forecast both rising occupancy levels and higher rental rates in most of the geographic markets around the country. Our main concern at this time focuses on pricing, since we believe that many parts of the real estate market have become over-priced as a result of the tremendous amount of capital that is seeking to invest in U.S. real estate. We are therefore recommending to our clients that a more cautious approach be followed when investing in U.S. real estate during 2006. We have seen signs recently that many investors are taking a more conservative approach to the bids that they submit on properties being offered for sale in the market. We hope that this trend continues.

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January 2006