Value Investing

Real Estate Case Study On The Sears Tower

Real Estate Case Study On The Sears Tower by Joseph L. Pagliari, Jr., Chicago Booth

Executive Summary

The Sears Tower is one of the most well-known skyscrapers in the world, having had a long reign as the tallest building in the world, and sharing a name with one of the world’s largest retailers. What is less widely known are the real estate decisions behind the Tower, namely the initial site selection by Sears, Roebuck & Company, its subsequent decision to build the world’s tallest tower, and their ultimate departure for the Chicago suburbs. Further, the Tower has gone through a series of refinancings and recapitalizations over six ownership structures in an effort to capitalize on its rapidly changing value. Over the past thirty years the Tower has been valued as high as $1.2 billion, and as low as $500 million, having faced shifting tenant demands, competition, real estate slumps, and the tragic terrorist events of September 11th, 2001.

The following timeline illustrates key milestones in the history of the Sears Tower:

Sears Tower

As one of fastest-growing retailers of the 20th century, Sears, Roebuck and Company had an impressive need for space and a desire to consolidate its vast operations under one roof. Several sites in Illinois were considered and Sears quickly settled on 233 South Wacker Drive for its convenience to major transportation nodes and widespread city support. Skidmore, Owings & Merrill were retained as architects and created a flexible, yet open design based on a “megamodule” system of structural tubes. Sears presence at the Tower, however, was short lived; in 1990, Sears moved to a new headquarters complex in Hoffman Estates, a suburb outside of Chicago.

Unable to find a buyer to purchase the Tower during the late 1980s, Sears instead leveraged the value of the Tower and borrowed $850 million in 1990, thereby injecting cash into its balance sheet. In 1994, Sears entered into a complex financial arrangement transferring effective control of the Tower to its creditors MetLife ($600 million first mortgage loan) and AEW ($250 million second mortgage loan). Between 1997 and 2003, TrizecHahn – which had acquired AEW’s interest – attempted to buy a controlling stake in the Tower but reversed course due to the economic downturn after September 11, 2001. Subsequently, Trizec sold its position to MetLife. After serving as the primary loan note holder for the past 13 years, MetLife now had full control of the Tower.

In 2004, MetLife sold the Tower to a small investor group led by Joseph Chetrit for $840 million. In a great twist of irony, Chetrit’s financing package ($600 million in first-mortgage financing and $225 million in mezzanine financing) looks eerily similar to the financing package supplied by MetLife and AEW nearly 15 years earlier. Fueling the purchase was a combination of historically low interest rates and an aggressive lending environment. Chetrit was able to secure an interest-only loan covering 93% of the purchase price of the Tower. As of the date of this writing, Chetrit is reportedly looking to refinance the Tower, using a combination of outside equity and a fixed-rate loan.

Despite the Tower’s turbulent history, an impressive rent roll, a desirable Chicago CBD location, a design well ahead of its time and a perceived premier status have made the Tower an attractive acquisition for investors since it was built. What does the future hold for the Tower? There are several key questions that must be considered in the context of the Chicago office market and national investment trends. They include: Will the Chetrit acquisition of the Tower prove financially viable? Will lenders remain as aggressive? Will the Tower be repositioned for another purpose or kept as primarily office space?

Overview of The Sears Tower

Background of Sears & Roebuck Co.

Sears, Roebuck & Company (“Sears”) was formed in 1893 as a mail-order watch company in Chicago, Illinois, and was the innovative idea of Richard Sears, a railway station agent from Minneapolis, Minnesota. Early on, Sears and his partner, Alvah C. Roebuck, recognized that there was a lucrative market to sell general merchandise using a mail-order business model. At this time, the United States was largely an agricultural economy. Rural farmers primarily bought their goods at the local general store and, since little competition existed in these locations, were often faced with intolerably high markups on the items they purchased. By purchasing goods in bulk to take advantage of volume discounts, Sears utilized the rail and postal systems to deliver goods to rural customers at prices well below those of the local general stores.

Sears’ mail order business took off. Sales reached $400,000 by 1893, and surpassed $750,000 by 1895. The company began producing a general merchandise catalog with over 500 pages offering items ranging from shoes, women’s garments and china to firearms, furniture and buggies. As Sears expanded, they leased various buildings throughout Chicago. By 1906, they constructed a 40-acre, $5 million2, 3 million square foot mail-order plant and office building on Chicago’s West Side. At that time, it was the largest commercial building in the world.

Sears Consolidates Chicago Operations

Sears’ continued success led to the expansion of its offices and retail stores nationwide as well as internationally. In December 1967, Sears, Roebuck & Co reached $1 billion of sales in a single month, a new record for Sears. By 1969, Sears earned $8.9 billion in annual sales up from $8.2 billion the year prior, thus breaking its own sales record for 15 consecutive years. That same year, the company’s management, under the direction of Chairman Gordon Metcalf and President Arthur Wood, decided to consolidate its Chicago office locations into one building. The company had an immediate need for approximately 3 million square feet of space and wanted to ensure it would have room to expand in the future.

Rumors circulated about where the new headquarters would be. Sears had previously moved its Allstate Insurance division to Northbrook, Illinois, a northern suburb of Chicago. Speculation came to an end in April 1969, when Sears named Cushman and Wakefield, Inc. as the developer of its new headquarters at 233 South Wacker Drive in Chicago’s West Loop, as shown in Exhibit 2. The site provided easy access to public transportation including suburban commuter trains and the city’s elevated trains, as well as several major expressways. Building the Tower in Chicago helped combat the downtown’s downtrodden image (partially caused by the loss of manufacturing companies), strengthened the city’s tax base, and stimulated additional office construction in the Loop.3 A disadvantage of this site was that the City of Chicago had to vacate Quincy Street between Franklin and Wacker Streets.

Sears Tower

See full PDF below.