By Allen Kenney

Will Eglin, CEO of Lexington Realty Trust (NYSE: LXP), admits that real estate "empire builders" are known for acquiring vast expanses of land and city blocks of skyscraper buildings. It's an ideal based on growing, not shrinking.

But what if selling is wiser than buying? That's the dilemma he and the rest of Lexington's management faced in early 2007.

"By the time we got to the first quarter of 2007, we realized that the right macroeconomic trade to be making was to be a seller of assets," Eglin says. "Rather than be frustrated on the investment side, we wanted to capitalize on the opportunity."

That strategic decision stood in stark contrast to the period from which Lexington was emerging, a four-year stretch in which the company aggressively sought to expand its holdings. Eglin had a tough sell to make to shareholders last year, as Lexington began shedding its portfolio. By the end of 2007, the company had liquidated approximately 20 percent of its real estate assets.

Spacelabs office park in Issaquah, Washington.

"A public company that's selling assets and shrinking? Not many people understand that strategy," Eglin says. Second-guessing has done nothing to change Eglin's analysis of 2007, though, which he says requires "the courage of your convictions." It's one of the most important lessons he has learned throughout his career in real estate, he says.

Leases Netting Cash

Founded in 1973, Lexington is headquartered in the heart of New York, and the company converted to a real estate investment trust and joined the New York Stock Exchange in 1993. Throughout its history, Lexington has focused on investing in single-tenant, net-lease properties, maintaining a $4 billion global property portfolio.

Lexington stands out in the net-lease sub-sector because of its concentration on office and industrial real estate. The vast majority of net-lease competitors specialize in retail and specialty properties. The decision to refocus on office and industrial properties was made last year to enhance Lexington's brand, according to Eglin. "We felt that would help in terms of the market having a clearer sense of what our identity and strategy is," he says.

Domestically, Lexington sites can be found just as easily in top-tier cities such as San Francisco as they can in smaller markets such as Suwanee, Ga. Tenants include major corporations as well as small independent companies.

The net-lease strategy has served Lexington well since its inception 35 years ago, says Eglin, who took over as chief executive in 2003 after serving as chief operating officer for 10 years. "There are lots of attributes in net-lease real estate that create very stable and predictable cash flow," he says. He describes Lexington's business model as a strategy much like "a hybrid of corporate bonds and real estate," thanks to the steady cash stream. The company also focuses on signing longer-term leases in the range of 10 to 15 years. As a result, Lexington gains consistent performance over the long haul.

Wackenhut office complex in Palm Beach Gardens, Florida.

"It's a little bit more of a defensive strategy for investing in real estate than buying traditional multi-tenant real estate," Eglin says. "But it's very safe and steady, and, primarily, it's a great generator of cash flow."

One of the major benefits of the net-lease structure is that Lexington's tenants are responsible for all costs when it comes to the day-to-day operations at each property, according to Eglin. "The cash flow that we collect is net of expenses, so if expenses go up, our returns don't erode," he says.

Credit Carding

When evaluating potential property acquisitions, Lexington's objective is pretty clear cut, and it's centered on tenants.

"Ideally, what you want is for the company to survive for the whole lease term and then renew its lease," Eglin says. "The best tenant to have in the building is the one that was in there from the very first day."

As a result, the net-lease strategy brings its own set of unique operating conditions. For example, Eglin says extensive analyses of potential tenants' credit worthiness are paramount to Lexington's success.

"We don't just rely on rating agencies," he says. "We do our own credit analysis, because often AA-rated companies can see their ratings change, and often it's too late."

Additionally, while many commercial real estate operators have little interest in their tenants' line of work, Eglin says his team at Lexington makes it a point to familiarize themselves with tenants' operations. Doing so helps Lexington's key decision-makers understand a property's true value to the tenant, according to Eglin.

"You want to make sure that you own a piece of real estate that is important to them as a profit center," says Eglin, referring to potential tenants.

Similarly, one of the major benefits of Lexington's reliance on long-term leases is that they reflect the tenant's view of the site's importance to its overall strategy.

Eglin contends that Lexington benefits because the length of a longer-term lease is actually less likely to match up with a tenant's actual needs. As a result, whether the business occupying the space needs the property for a shorter or longer time period than specified in its lease agreement, Eglin says Lexington stands to gain. If the tenant wants to move out, it must buy its way out of its lease. Or, the company could try to find another tenant to engage in a sublet agreement, in which case Lexington remains free from the burden of filling the space. Alternatively, if a company is thriving and wants to stay in the site past the term of its lease, Lexington has exclusive rights to negotiate a new agreement, rather than facing a public competition for the tenant's business.

Lexington's strategy has paid off in the form of a historic retention rate above 85 percent. The company also has never had an occupancy rate below 95 percent.

Back to Work

Going forward, Eglin indicates that joint ventures will play a major role in shaping Lexington's future. One of the major reasons Lexington's management opted to go public in the early 1990s was to improve its access to different sources of capital. Since then, besides on-balance-sheet capital brought in through public markets, the company has tapped private sources through joint ventures.

"That gives you a lot of flexibility that you don't have as a private company," Eglin says.

Lexington has undertaken a total of six joint ventures throughout its history, including its most recent partnership with Inland Real Estate Corporation (NYSE: IRC) intended to focus on Lexington's "specialty" sites, which include assets as disparate as automotive dealerships, call centers and a golf course. (Editor's note: Click here to read more on Inland Real Estate Corp.)

Eglin also plans for Lexington to resume its acquisitive posture. He notes that the company was able to prune its lower-quality assets during last year's sell-off.
"We were not trying to sell our best assets. We were trying to sell assets in what we thought of as the bottom part of our portfolio," he says. "We wanted to take advantage not only of an opportunity to get good prices for assets, but to reduce our exposure to slow growth markets and trade out of some credit exposure in our tenant base that we were worried about."

Now, however, Eglin says he's looking forward to "getting back into the business of capitalizing on good growth opportunities," of which he expects many in the near future. He notes that Lexington is flush with cash and has full access to a $200 million credit line.

"We're heading into a time when there are going to be good opportunities to grow our portfolio," Eglin says. "There's no rush to take cash out of the bank, but we're starting to see enough interesting opportunities to put our capital to work."