Berkshire Realty Holdings, L.P. Business Information, Profile, and History

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History of Berkshire Realty Holdings, L.P.

Berkshire Realty Holdings, L.P. is a private real estate investment firm located in Boston, although it is not involved in the New England market. Rather, it acquires, develops, and operates multifamily apartment properties in select cities located in the states of Florida, Georgia, Maryland, New York, North Carolina, South Carolina, and Texas, as well as Washington, D.C. The company's portfolio includes some 80 properties and more than 26,000 apartment units.

Launch of Real Estate Business by the Krupp Brothers in 1969

Brothers Douglas and George Krupp formed a Boston real estate business in 1969 called Krupp Companies. Its activities grew beyond the buying and sell of real estate to include property and asset management services, mortgage banking, and healthcare facilities. Eventually, the businesses were placed under a holding company, The Berkshire Group. The Krupps launched dozens of real estate limited partnerships, including the Krupp Cash Plus I through IV series, which were offered to the public from 1985 to 1988. Because of changes in the tax laws in 1986, as well as a sagging real estate market, the partnerships struggled through the remainder of the decade. While investors fared poorly, the Krupps as general partners were collecting management fees and were doing much better.

In November 1990 the Krupps announced their intention to "roll up," or combine, the four Cash Plus partnerships into a publicly traded real estate investment firm (REIT), Berkshire Realty Company, which had been formed in April 1990. It was intended to own 30 properties located in 15 states, including 16 apartment buildings with nearly 4,400 apartments and 13 shopping centers with 2.5 million square feet of retail rental space. By converting the partnerships into a REIT investors would gain immediate liquidity.

REITs were a little-used investment structure originally established by Congress in 1960 as a way for small investors to become involved in real estate in a manner similar to mutual funds. REITs could be taken public and their shares traded just like stock. They also were subject to regulation by the Securities and Exchange Commission. Unlike stocks, however, REITs were required by law to pay out at least 95 percent of their taxable income to shareholders each year, a provision that severely limited the ability of REITs to raise funds internally. During the first 25 years of existence, REITs were allowed only to own real estate, a situation that hindered their growth. Third parties had to be contracted to manage the properties. Not until the Tax Reform Act of 1986 began to change the nature of real estate investment did REITs begin to gain widespread usage. Tax shelter schemes that had drained potential investments were shut down. Interest and depreciation deductions were greatly reduced so that taxpayers could not generate paper losses in order to lower their tax liabilities. The Act also permitted REITs to provide customary services for properties, in effect allowing the trusts to operate and manage the properties they owned. Despite these major changes in law, REITs were still not fully utilized. In the latter half of the 1980s the banks, insurance companies, pension funds, and foreign investors (in particular, the Japanese) provided the lion's share of real estate investment funds. That period also witnessed overbuilding and a glutted marketplace, leading to a shakeout in the marketplace. With real estate available at distressed prices in the early 1990s, REITs finally became an attractive mainstream investment option.

The terms of the Krupps' plan to combine the four Cash Plus partnerships and exchange investors' interests for shares of the Berkshire REIT caused an immediate adverse reaction from investors, and initiated one of the most contentious roll-ups the industry had witnessed in many years. Despite the attraction of gaining liquidity, many investors were upset by the investment philosophy espoused by Berkshire, which they felt was not consistent with the original Cash Plus prospectuses, which promised a low-risk approach that had eschewed borrowing and had attracted them to the investment in the first place. Moreover, the partnerships were intended as finite investments, set to be liquidated at specified dates; the REIT would have an infinite life. The Krupps maintained that the previous investment strategy had not worked and now planned to borrow money in order to take advantage of attractive properties that might become available. Investors were further angered by the high fees that the Krupps were in line to receive during every stage of the roll-up process. According to Barry Vinocur, writing in Barron's, "In most other roll-ups, sponsors have emphasized that consolidating partnerships would result in cost savings. But in Krupp's roll-up, instead of dropping, the fees going to the company would actually soar by roughly 40%." In addition, investors questioned the estimated value of the partnership's properties, alleging that the numbers were inflated. Also causing some concern were the provisions of the Krupp management contract, a four-year term that could only be terminated for "cause," as well as a clause that called for the REIT to pay the managers an amount equal to 18 months worth of management should the Krupps be removed at "any time" for "any reason." Such a removal was unlikely, however, because another provision required a supermajority of shareholders to vote out Berkshire's directors. Investors also feared that the Krupps had an incentive to sell off existing properties in order to earn an asset management fee for buying new properties.

Opposition of Major Investors to 1991 Roll-Up

It was many of the same investment firms that had sold the original investments who were the most vocal in their criticism of the roll-up, including PaineWebber, Smith Barney, Legg Mason, First of Michigan, A.G. Edwards, Royal Alliance Associates, and Kavanaugh Securities. All of them recommended that investors reject the proposal. As a result, the Krupps were forced to make changes, three times revising the terms, as well as extending the deadline for investors to vote on the roll-up. In the end, the proposal cut the transaction fees, and the Krupps agreed not to use more than 15 percent leverage and not to charge asset management fees when proceeds from the sale of an existing property were reinvested. One of the most important concessions was a change in the charter that mandated a review of Berkshire's portfolio at the end of 1998, at which point a liquidation plan had to be submitted to shareholders.

Even with these changes to the offer, the vote on the roll-up continued to generate controversy and the deadline on the vote was pushed back four times. Some investors had requested the names and addresses of other investors in the Cash Plus partnerships, with the expressed purpose of making contact to discuss the roll-up vote. Not only did the general partners not send the lists as required by provisions in the 1934 Securities and Exchange Act, they asked for additional information from the requestors. A number of complaints were made to the SEC, which eventually leveled charges against the general partners. Investors did finally receive the lists, but according to the SEC suit it took an average of 13 weeks after the initial requests were made for the appropriate lists to be delivered. Even then, the investors who received the lists considered them to be unusable. They were some 5,000 pages long, the names printed in tiny black print set against a dark maroon page that not only caused eyestrain but prevented the list from being photocopied. The resulting SEC suit would linger for more than a year before the general partners agreed to cease and desist from future proxy violations. By this time, of course, the roll-up vote had been long since completed. In the end, in June 1991, investors in only two of the partnerships agreed to the proposal. Investors in the two partnerships that represented some 70 percent of the total assets, however, agreed to exchange their partnership units for shares in Berkshire Realty.

With access to the capital markets, Berkshire experienced a period of steady growth. Revenues improved from $39.6 million in 1992 to nearly $68.5 million in 1994, although net income fell from $7.3 million to $5.8 million in the same period. In 1995 Berkshire underwent some changes. It was restructured as an umbrella partnership real estate investment trust (UPREIT), and then it shifted its business strategy. Because Berkshire lacked the resources to effectively operate in all of its historical markets, management elected to exit the Midwest market and began selling off all of its properties in the region. The REIT now focused on Washington, D.C., and 12 other cities located in six target markets: the Carolinas, Georgia, Tennessee, Florida, and Texas. Although Berkshire would develop A properties, they were deemed too expensive to acquire. Purchases, therefore, were generally limited to B and C assets. Boston continued to be the headquarters of the REIT and where management strategy and corporate finance functions were conducted, but Atlanta also became an important hub for company operations. With most of Berkshire's development activities taking place in the Southeast, Atlanta housed the development group, as well as the property management company, because of its proximity to most of Berkshire's properties.

As a result of Berkshire's strategy, the REIT saw revenues improve to more than $70 million in 1995 while posting a $14.8 million net profit. In 1996 revenues almost reached $90 million, but Berkshire lost $14.3 million. At the end of the year, the REIT's assets included 35 apartment communities, totaling 12,435 units, and investments in six retail centers. Management now decided to sell off its retail portfolio and reinvest the proceeds in the development of apartment communities. In 1997 Berkshire lost an additional $8.4 million as it continued adjustments to its portfolio. By year's end it had investments in 68 properties located in the Mid-Atlantic states, the Southeast, Florida, and Texas: 18,773 apartment units in total.

Reaching a Crossroads in 1998

In 1998 Berkshire reached a crossroads, required by the terms of its roll-up agreement to evaluate its current state and determine whether the REIT should be sold, merged, or liqui- dated. Moreover, a general slump in REIT share prices put pressure on companies the size of Berkshire to join up with larger rivals in order to compete. Accordingly, in May 1998 a committee of outside directors engaged Lazard Freres & Co. and Lehman Brothers for assistance in exploring its strategic alternatives and preparing a plan to be considered by shareholders by the end of the year, as required by the roll-up provisions. There was no shortage of suitors for Berkshire, which boasted a market capitalization of nearly $450 million and owned real estate valued at $769 million. Finalists included Chicago's Equity Residential and the New Jersey private apartment developer Charles Kushner. Douglas Krupp also led a management buyout effort, which included Blackman Group Inc. and Goldman, Sachs & Company.

The sale of Berkshire now assumed overtones of the earlier roll-up flap. As reported by the Boston Globe in March 1999: "Just this week, as the bidding process seemed to be winding up, Krupp dropped one new item into the public record: His offer was contingent on Berkshire Realty showing that certain services provided to apartment tenants did violate REIT laws. A problem with Berkshire's legal status would have huge tax consequences and temper all bids for the company. The nature of those services that gave Krupp a late case of the willies? Berkshire had discounted rents to five tenants who ran aerobics classes for their neighbors. ... The company confirmed yesterday that the Internal Revenue Service had already determined that such an arrangement was acceptable. Even if there was a problem, the worst-case tax fine would have been about $25,000."

Krupp's first buyout offer of $11.05 a share, a $1.15 billion deal, was deemed by the committee of outside directors to be insufficient. After Equity Residential dropped out of the running it appeared that Kushner had won the bidding with an offer of $12.50 a share, but in the end Kushner balked and failed to present the required letter of credit or the financing commitments. Instead Berkshire was sold to the Krupp group at $12.25 per share, or $660 million in cash and the assumption of some $600 million in debt. Having taken Berkshire private, with the new entity becoming Berkshire Realty Holdings, L.P., Krupp's management team kept the company's finances and activities closely guarded.

Principal Competitors: Equity Residential; JPI; Lincoln Property.

Chronology

• Key Dates:
• 1969: Krupp Companies is formed.
• 1985: The first Krupp Cash Plus real estate partnership is launched.
• 1990: Berkshire Realty is formed as a REIT.
• 1991: Two Cash Plus partnerships are rolled up into Berkshire.
• 1998: As required by roll-up provisions, the directors consider strategic alternatives for Berkshire.
• 1999: Berkshire is taken private by its management group.