Shopping center REITs play both sides of the rebounding investment market to boost portfolio quality.
After spending several quarters focusing on survival, retail real estate investment trusts (REITs) are taking advantage of a rejuvenated investment climate to polish their portfolios.
Landlords last year began acquiring high-quality grocery-anchored and power center assets and remain on the hunt. At the same time, the companies have ramped up efforts to prune lower-quality real estate, or so-called “B” properties, and well-performing assets that no longer fit their strategy.
REITs spent $3.6 billion to acquire shopping centers in 2010, which was more than triple the amount they shelled out in 2009, according to Real Capital Analytics. The New York-based firm tracks sales $5 million and above.
Retail REITs reaped only $953 million from dispositions in 2010, however, which was about $300 million less than the year before.
Hyde Park, N.Y.-based Kimco Realty Corp., which owns interests in 951 shopping centers in 44 states, Canada, Mexico, Puerto Rico and South America, wants to spend more than $250 million annually over the next few years on acquisitions.
At the same time, Kimco has targeted roughly 150 properties for disposal. Like other REITs, it's recycling proceeds to fund acquisitions.
In the fourth quarter of 2010, for example, the company acquired four retail centers totaling 982,000 sq. ft. for $151 million, and it sold eight assets totaling 536,000 sq. ft. for $35.2 million.
The efforts follow Kimco's decision last year to focus on 25 core markets in the U.S. and marks something of a philosophical departure, says Kimco CEO David Henry.
Company executives always have believed that they could run any type of property better than others, so Kimco hasn't been a disciplined seller, he admits.
No better time than the present to exert discipline, it appears, considering that escalating prices for the best retail centers in major markets are pushing investors down market.
“From where we sit there's an awful lot of money chasing deals. There's good demand for B properties,” says Henry. “It's no fun coming in 23rd out of 30 bidders for an asset, so buyers are being a little more flexible.”
Gearing up for growth
The ambitious buying and selling programs follow a wave of capital raising that the REITs conducted over the last few years to strengthen their balance sheets.
The offerings allowed the companies to reduce their debt, but they diluted shareholders, says Keven Lindemann, director of the real estate group for SNL Financial, a Charlottesville, Va.-based research organization.
Shopping center REITs raised $4.6 billion in equity in 2009 and 2010, reports the National Association of Real Estate Investment Trusts (NAREIT). So far this year, the companies have raised $585 million.
On average, shopping center REITs generated a total return of nearly 31% in 2010 compared with a negative 1.6% total return in 2009, says NAREIT.
But shopping center landlords saw a key REIT earnings determinant, funds from operations (FFO) per share, decline 8% in 2010 from 2009, points out Lindemann. Now investors want to see growth.
“If earnings growth is declining, stock prices aren't going to keep rising indefinitely,” Lindemann says. “Everyone is on the hunt for growth opportunities.”
The REITs, however, are confronting an increasing number of competitors that view shopping centers as safe bets. That's because properties are producing attractive cash flow in an environment where yields are tough to find, experts say, and they provide a hedge against inflation.
What's more, debt remains historically cheap. The 10-year Treasury yield was roughly 3.4% in late April.
Meanwhile, retail construction is at a 20-year low while retail sales are picking up, says Hessam Nadji, managing director of research and advisory services at Marcus & Millichap Real Estate Investment Services based in Encino, Calif.
Retail sales grew 0.4% in March over February, marking the ninth consecutive monthly increase, according to the U.S. Department of Commerce.
“Retail is the dark horse in the recovery race among different product types,” emphasizes Nadji. “Everyone had written it off as the absolute worst sector, but the retailers that survived are looking to expand and new concepts are popping up.”
Still, it's questionable whether consumers can sustain increased spending as food and oil prices rise. Ultimately that could retard retailer earnings and the ability to pay higher rents.
In late April, for example, the average price of gasoline had climbed to $3.86 a gallon nationally, $1 more than a year earlier, according to the American Automobile Association (AAA). In fact, retail spending in March only increased by 0.1% when excluding fuel.
“Consumer spending is still pretty anemic,” observes Dylan Taylor, CEO of the USA group for Seattle-based Colliers International. “So a lot of this acquisition activity is being driven by capital and the fact that we're supply-constrained.”
Despite the rocky recovery, competition for assets continues to build. Shopping center sales in the first quarter totaled $1.5 billion this year, according to Real Capital Analytics. That was about $100 million more than the first quarter of 2010.
But the average capitalization rate — the initial return to an investor based on the annual net operating income and purchase price of an asset — dropped to 7.5% from 8.3% over the same period. That has made REIT executives more cautious.
Oak Brook, Ill.-based Inland Real Estate Corp., which owns 142 grocery-anchored and power centers primarily in the Midwest, last year formed a joint venture with Dutch pension fund PGGM to invest $270 million in retail centers. So far, the joint venture entity has paid $65 million for three properties totaling 253,000 sq. ft. in Chicago and Minneapolis.
Inland earns between 2% and 5% in fees from PGGM to lease and manage the properties, which beefs up the REIT's return. That may enable Inland to pursue higher-priced developments that could enhance the quality of its portfolio even if a property generates a lower yield, suggests Inland CEO Mark Zalatoris.
Some prices are starting to move beyond what he's willing to pay, however. “Pricing has become more aggressive due to access to capital at very attractive finance rates,” Zalatoris says. “That's something we have to deal with, and we'll pass on bidding if we think it doesn't make sense.”
The compression of cap rates, however, also indicates that values for quality shopping centers have moved off the bottom.
Jacksonville, Fla.-based Regency Centers Corp., which owns roughly 400 grocery-anchored centers in 29 states, in late 2009 was negotiating to purchase a well-anchored 198,000 sq. ft. shopping center in a desirable Charlotte, N.C. submarket, says Barry Argalas, a senior vice president at Regency. The price reflected a cap rate of 8.9%.
Regency and a joint venture partner closed on the center in March 2010, but not before investment committee members agonized over the price.
Comparable sales were virtually nonexistent, and the committee worried that the yield would drop below 8.9% if rents fell, says Argalas, who heads up the REIT's national acquisition and disposition team.
In December, a mere nine months later, Regency bought Willow Festival, a similarly well-anchored center in a desirable Chicago submarket. The company paid a cap rate of 6.5% for the 405,527 sq. ft. property, but the investment committee had a much easier time evaluating the deal.
“Although the yield was 250 basis points lower, we had much more certainty and confidence forecasting net operating income,” says Argalas, who is planning to spend $150 million to $200 million for acquisitions this year and reap roughly the same amount via dispositions.
“We felt like there was stability in the shop rents that we had experienced post-recession.”
Joe Gose is a Kansas City-based writer.
SEEKING GROWTH OPPORTUNITIES
Several large shopping center REITs have experienced a healthy uptick in share price, although earnings growth among the group is mixed.
|Company||Share Price April 25 close||Change from one year ago||2009-2010 Change in FFO/Share|
|Kimco Realty Corp.||$18.89||18.73%||37.8%|
|Federal Realty Investment Trust||$85.95||9.35%||10.50%|
|Regency Centers Corp.||$45.50||12.00%||64.60%|
|Developers Diversified Realty||$14.34||11.94%||N/M*|
|Weingarten Realty Investors||$26.04||10.30%||-27.9%|
|Equity One Inc.||$19.50||-1.42%||-41.50%|
|Inland Real Estate Corp.||$9.71||2.21%||-31%|
*not meaningful; negative FFO per share in 2009 and 2010
Source: SNL Financial
Mall REITs Test Investor Appetite for B Assets
Like their grocery-anchored and power center brethren, mall real estate investment trusts (REITs) are hoping to exploit the current real estate investment binge. But rather than looking to buy properties, many consider the current climate an ideal time to cull lower-quality assets from their holdings.
Three mall REITs have put some 40 properties on the market over the last few months. Australia's Westfield Group and Chicago-based General Growth Properties are contributing 36 malls to the sales bin, while Indianapolis-based Simon Property Group is aiming to unload four properties.
Such a high number of malls for sale is rare for the shopping center industry, says Richard Moore, an analyst with RBC Capital Markets.
“There's never a regional mall for sale. They just don't hit the market,” he says. “But the REITs are saying, ‘Money is chasing real estate and there are buyers out there for these non-core assets.’”
Whether the assets will attract serious interest is uncertain. Observers largely classify the properties in the “B” category, and investment interest in such assets has yet to fully blossom.
In particular, mall REITs hunting for acquisition opportunities want properties that will enhance the profitability and productivity of their portfolios.
Glimcher Realty Trust wants to increase annual sales at its malls to $400 per sq. ft., up from $371 per sq. ft. at the end of 2010. One way the company can do that is to add well-performing assets to its stable of 23 malls in 14 states.
In November, Glimcher Realty and Blackstone Real Estate Advisors paid $245 million for the 1.1 million sq. ft. Pearlridge Center in Hawaii.
CEO Michael Glimcher, however, expresses skepticism that any of the malls for sale will fill that goal — at least at the current asking prices. Broadly speaking, he likens the marketing of the assets to a homeowner listing a $450,000 home for $600,000.
“We've looked at some properties that are on the market, and at a certain price are we interested? Sure,” he says. “But at the price where we'd be interested, are the sellers willing to sell? Maybe not.”
Still, Glimcher will definitely keep his eye on the activity the malls generate. “This is helpful to us because we're always looking at the bottom of our portfolio and want to bring it up,” he says. “The interesting thing will be who is the buyer that's willing to go after a B asset?”