Value-Added Case Study

Waikiki Galleria
Honolulu, Hawaii


2222 Kalakaua Avenue, known as Waikiki Galleria is a sixteen-story, Class “A” reinforced concrete building containing approximately 160,284-rentable-square-feet. The building consists of a world-class retail complex on the ground and second floors leased in its entirety to DFS Group, L.P. and totaling 74,556-square-feet. The sixth through sixteenth floors consist of 85,728-square-feet of office space featuring ocean views from three sides of the building. Parking for 252 vehicles is provided on the third through fifth floors. Located in the intersection of Kalakaua and Royal Hawaiian Avenues, the property stands at the premier location in one of the world’s most dominant retail markets, in the heart of Hawaii’s tourist industry.

Waikiki Galleria

The seller, Nippon Shinpan, is a major Japanese credit card company that acquired the property in 1988 for approximately $66M. The seller was under pressure to liquidate quickly and quietly in order to return the capital to Japan. For these reasons, the property was not listed for sale or actively marketed. Parallel Capital’s Founders (“Parallel” or “Founders”) have a reputation as a consistent buyer of retail and office properties in the Hawaiian Islands which resulted in this acquisition opportunity through a small, off the grid Japanese brokerage contact with whom Parallel has maintained a multi-year relationship.

Creation of Value

Parallel was able to differentiate itself from the two other prospective buyers by placing a large, non-refundable deposit ($2.5M) in escrow that was subsequently released to the seller on September 1, 2001 (ten days prior to 9/11). This deposit was essentially set up as liquidated damages in the event of a failure to close.

Due to the compressed sales timeframe and the lack of solid brokerage representation for the seller, a price of $95M and an extremely attractive cap rate of over 9.5% were the terms negotiated in connection with the purchase agreement. This initial unleveraged 9.5% yield compared very favorably with historical cap rates of 6-7 percent for fee simple assets in Waikiki. The quality of the net operating income was excellent with over 82% of the NOI guaranteed by an investment grade tenant (LVMH Moet Hennessy) through 2016. The 9.5% cap rate alone represented a tremendous cap rate arbitrage opportunity, but there was additional upside to be realized by working the rent roll on the office component of the project.

During due diligence, Parallel discovered that the books and records provided by the seller mis-represented true net operating income in that they were prepared on a cash basis. The annual operating expenses being used to construct the net operating income (NOI) were dramatically overstated due to a double payment for real property taxes in the prior year. This served to understate the true annual NOI – lending further credence to the inadequate representation for the seller.

The largest challenge facing Parallel in closing the transaction was the financial sector’s melt down that surrounded the terrible events of 9/11 – which occurred exactly ten days after Parallel released $2.5M to the seller as a non-refundable deposit. The original closing date was scheduled to be 9/15, but the practical reality of getting the lender (Deutsche Bank) to fund in the days and weeks after 9/11 was nil. After arduous negotiation, the seller granted 30 days post the traumatic event to close the transaction or forfeit our deposit. By this time, word of our deal and the economic terms had leaked into the market and a number of competitors were lining up to pay a higher price.

Our Performance

The Parallel founders purchased the Waikiki Galleria in October 2001 for $95M and invested an additional $3,000,000 to re-position and finalize the significant lease with Duty Free Shops (LVMH).  The total investment of $98,000,000 was funded with $30,000,000 of equity and a $68,000,000 loan from Deutsche Bank. After a 27 month holding period, the property was sold, generating a whole dollar profit of $30.8M, an unleveraged IRR of 18% and a deal level leveraged IRR of over 44%.