Duke Realty Corp.’s decision to sell a huge portfolio of suburban office buildings for $1.1 billion might make the Indianapolis real estate company a little more predictable and bland.

But that’s OK with investors, who have bid up the shares 13 percent since the Oct. 20 announcement of the deal—a span when the overall market, as measured by the S&P 500, was essentially flat.

“What we are looking for is a little more stability in earnings and cash flow to pay the dividends,” Duke CEO Denny Oklak said. “Unfortunately, in suburban office, when we get into some of these economic cycles, it’s almost like a roller-coaster ride.”
 

Oklak

The sale to New York-based Blackstone Group LP, the world’s largest private equity firm, infuses Duke with cash to reduce debt and ramp up its ownership in bulk industrial and medical office properties.

Suburban office has been a great business for Duke over the years. But company officials and analysts believe the growth potential may be greater in industrial and, especially, medical office.

Analysts have been blessing the deal, even though it will result in a short-term earnings hit. The 82 buildings—which represent all the company’s wholly owned suburban office properties in Atlanta, Chicago, Columbus, Dallas, Minneapolis, Orlando and Tampa—generated $63 million in net operating income in the first nine months of the year, about 15 percent of the company’s total.

“Dilution for a better balance sheet [is] a good trade,” Goldman Sachs analyst Sloan Bohlen said in an Oct. 30 report.

It helped that Duke sold the properties at an attractive price, even though the sputtering economy has slackened demand for office space. Blackstone was able to pay up in part because the properties carried just $30 million in debt, enabling the private equity behemoth to capitalize on historically low interest rates by lining up dirt-cheap financing.

“I think the pricing we are getting on this transaction is as good as we would get in any market,” Oklak said.

Duke in 2009 announced plans to reposition its portfolio, which at the time was 55 percent office, 36 percent industrial, 5 percent medical office and 4 percent retail. By 2013, it wanted to boost industrial to 60 percent and medical office to 15 percent while scaling back office to 25 percent.

It was well on its way toward meeting its targets even before the Blackstone deal. It expects to complete the sale in early December and close the year at 54 percent industrial, 32 percent office, 10 percent medical office and 4 percent retail.

The company over the same span has been retooling its geographic mix, with the goal of boosting its presence in the Southeast from 21 percent to 30 percent, and reducing its Midwest presence from 53 percent to 40 percent.

The Blackstone deal reduces the Midwest presence to about 43 percent, Duke officials say. However, they say the geographic mix is less important than the mix of product types.

Regardless, in his interview with IBJ, Oklak said nothing to suggest the continued retooling would lead Duke to scale back its presence in its hometown market of Indianapolis.

None of the properties Blackstone is acquiring is here, and Oklak said “we are extremely comfortable with the office business in Indianapolis.” Duke owns 2.7 million square feet of suburban office space in the Indianapolis area, including the Parkwood Crossing office park at 96th and Meridian streets, as well as 21 million square feet of bulk industrial space—the most of any market.

Two of the deals Duke touted on its third-quarter conference call were in its hometown. The company said locally based Interactive Intelligence Group signed a 66,000-square-foot new office lease. And Duke launched development of a 274,000-square-foot medical office building on the grounds of the new Wishard Memorial Hospital. Duke will own the $85 million project as a joint venture with the county-owned hospital.

Though Duke won the Wishard project through a formal bidding process, the medical-office development business typically is more relationship-driven than other sectors of real estate, said Jim Bremner, president of Duke’s health care division.

Duke, for instance, already is one of four preferred developers nationally for St. Louis-based Ascension Health, parent of St. Vincent Health in Indianapolis—putting it in a strong position to land future work for that hospital system.

Analysts say long-term health care trends also are alluring. Roughly 70 million people will be 65 or older by 2030. By 2020, health care spending is expected to account for 23 percent of GDP, up from 14 percent now, according to Baird Equity Research.

“As this segment of [Duke’s] development business gains traction, we believe the company will have a significant differentiating competitive advantage over peers,” Baird analyst David AuBuchon said in a report.•