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When H&R Real Estate Investment Trust announced plans last month to buy a new green office tower in the United States, both the New York location and the $415.5-million (U.S.) price tag struck observers as a little unusual for the Toronto-based company.

Until now, H&R owned no real estate in the Big Apple, in spite of its North American portfolio of office, industrial and retail properties with a net book value of $5-billion. Once the deal closes later this year, Two Gotham Centre in Long Island City will become H&R's biggest office holding in the U.S. by a long shot.

But from a corporate strategy perspective, the deal is consistent with H&R's approach since it was set up in 1996: to lease new – or relatively new – buildings to creditworthy tenants (often a single big tenant) for long periods of time, and match the leases with long-term, fixed-rate financing.

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"The Gotham is a prime example of what we strive for," says H&R president and chief executive officer Tom Hofstedter, who describes the 22-storey office tower as a "trophy asset" for its location, design and generous floor plate.

Mr. Hofstedter said he had not been looking to buy in the New York area. "New York was too expensive and, as an international city, it never really got hurt a lot [by the recession]"

But when he saw the listing, he decided to bid because of the attractive rate of return on Two Gotham, and because of relatively easy access to capital in Canada compared with the U.S.

With 661,000 square feet of office space and 9,000 square feet of ground-floor retail space, the recently completed office tower has been fully leased to the City of New York for 20 years, with rent escalations scheduled at about 8 per cent every five years.

The rate of return is estimated to be 5.8 per cent for the building in year one, and H&R has negotiated a 10-year term mortgage for $250-million at 4.25 per cent, with the balance funded from the REIT's existing operating lines. New York City's AA credit rating means a REIT can get better rates and longer terms for mortgages.

The purchase "is unique among H&R's U.S. acquisitions of the past in that it is a large property in a primary market," says Alex Avery, an analyst who covers the company and other REITS in Canada for CIBC World Markets. "But the profile of the asset is very consistent with the strategy H&R has executed for a very long time."

Earlier this year, for example, H&R purchased an office-retail building in downtown Toronto for $344.8-million. According to the company, the Atrium on Bay, with 915,278 square feet of office space and 135,929 square feet of retail space, is expected to yield a one-year capitalization rate of 6.5 per cent.

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In addition, H&R is nearing completion of the Bow, a 58-storey, two-million-square-foot office tower in Calgary that will be the tallest building in Western Canada and the new head office for natural gas producer Encana Corp.

H&R's purchase of Two Gotham signals Canadian REITs' growing interest in buying quality commercial properties in the U.S. This year, six out of 18 property purchases reported by RioCan Real Estate Investment Trust are in the U.S., while H&R has added six more to its portfolio south of the border.

"These enterprises are finding it difficult to grow their businesses within the context of a Canadian market that has fairly concentrated ownership of institutional-calibre real estate," says Neil Downey, managing director of global equity research for RBC Dominion Securities Inc.

Two Gotham is the first building in a two-block development of about 3.5 million square feet of office, retail, parking and residential space by New York developer Tishman Speyer, the owners of Rockefeller Centre, in partnership with Square Mile Capital LLC and the Modell family. The developers of Two Gotham hope that it will earn LEED silver certification for using the latest environmental technology to reduce office operating costs.

Mr. Hofstedter does not foresee many more opportunities like Two Gotham – those that meet his company's preferred combination of long-term leases, quality tenants and long-term financing.

But buying the property has opened some doors.

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"The fact that we have managed to acquire this asset is going to put us on the radar screen and get us opportunities that we would otherwise never have," he says. "Now we are on all the brokers' lists." When it comes to other assets that fit H&R's criteria, "I think we will get a shot at all of them."

Special to The Globe and Mail

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