Mergers and acquisitions continue to idle in the shopping center industry, due in part to edgy interest rates and capital-squeezed markets. But according to some insiders, a rebound may be on the horizon. James A. Schoff has been hearing the "e-word" (for issuing equities, not a new Internet phrase) at some companies whose stocks have revived this year.

"The bloom has come off of tech stocks. Investors are looking for security and cash flow, so stock prices have risen gradually," says Schoff, chief investment officer and vice chairman of Developers Diversified Realty Corp. "Our stock has gone from a low of $11.50 a share to $16 a share, moving us closer to net asset value."

DDR is a Cleveland-based REIT with a total market capitalization of $2.4 billion. It now maintains a national portfolio of 205 shopping centers in 39 states, with 46.9 million sq. ft. of GLA. Schoff notes that in the past year-and-a-half, REITs have been trading at a discount to net asset value (the book value of their different classes of securities), but they're now moving closer to that benchmark. "Some are even trading at a premium or above net asset value," Schoff says. "So companies can consider issuing equity."

Plans put on hold Nonetheless, risk-averse capital markets recently forced Glimcher Realty Trust, which maintains a portfolio of 124 properties in 27 states with 30.3 million sq. ft. of GLA, to put certain financial plans on hold. William G. Cornely, executive vice president, CFO, COO and treasurer of the Columbus, Ohio-based REIT, expressed some disappointment.

"We wanted to bring more flexibility to our capital structure and finance debt with long-term loans with a seven-, 10- or 15-year mortgage," Cornely explains. "We wanted to deliver a balance sheet, wanted to get into the equity market. We weren't successful."

Milton Cooper, chairman and CEO of Kimco Realty Corp. of New Hyde Park, N.Y., acknowledges the slower pace of merger activity in the past few years. Despite the slowdown, Kimco succeeded in its June 1998 merger with shopping center developer Price REIT Inc.

Cooper also mentioned the merger of community shopping center REITs CV REIT Inc. and Kranzco Realty Trust in June 2000. That deal, which Cooper sees as a sign of relatively restrained times, produced Kramont Realty Trust, an umbrella partnership REIT with about 12 million sq. ft. of leasable space.

The pause in mergers and acquisitions doesn't seem to have reined in Kimco all that much. Cooper notes that Kimco formed the Kimco Income REIT (KIR), a joint venture with New York Common Fund, in April 1999, with more than $500 million in assets, described as "high-quality, well leased properties" financed primarily through non-recourse mortgages.

By October 1999, KIR had interests in 389 shopping centers, two regional malls, 59 retail stores and other real estate assets of about 60 million sq. ft. of GLA in 40 states. In the past few months, KIR acquired two Wal-Mart anchored shopping centers in Cincinnati with a combined 600,000 sq. ft. of GLA for $47 million. That deal was preceded by a $67.3 million purchase of seven Philips International Realty Corp. properties.

And there is more to come - KIR is in the market for properties that are at least 65% leased to national or major regional tenants, substantially at market rents, with a population of at least 75,000 people within a five-mile radius.

Understandable optimism Mary Lou Fiala, president and COO of Regency Realty Corp. (RRC), says the glass is half full, rather than half empty. The real estate veteran anticipates a fairly steady stream of mergers in the retail sector.

Small wonder she's is optimistic: Just before and shortly after the slowdown in merger and acquisition activity, RRC twice doubled its size through acquisitions. The Jacksonville, Fla.-based REIT now owns and operates 216 properties in 21 states, with nearly 25 million sq. ft. of retail space and assets of $2.7 billion.

The first acquisition came in 1997, when RRC acquired Branch Properties, L.P., the largest owner and operator of infill neighborhood shopping centers in Atlanta, for $213 million. The acquisition was a milestone for RRC, not only because it boosted the scale of its operations, but also because it set the company on the path to more and lar-ger acquisitions.

Last year, the expanding REIT swallowed Dallas-based Pacific Retail Trust, a leading neighborhood shopping center firm in the western United States. The transaction vaulted RRC to the No. 1 spot among developers of grocery-anchored centers in the United States. The company has since forged ahead with some 52 projects and more than 3.5 million sq. ft. under development.

Bigger companies with such critical mass and market clout really do rule. "The merger with Pacific Retail opened up Denver, Phoenix and Dallas markets for us and we're serving Kroger, America's largest retail grocery chain, as one of the key developers in those markets," Fiala says.

"As grocers continue to consolidate, whether it's Safeway or Kroger, it works for us because the national scope of our portfolio presents new opportunities. When we met with Starbucks last fall, for example, we had 16 of their locations in a 218-center portfolio. We showed them how our two respective demographic profiles matched, that we had the No. 1 and No. 2 grocers in our centers, and we now have 44 of their locations approved. We think we might be able to open up 50 Hallmark stores as well."

Regency isn't big on joint ventures but just might buy a portfolio, as long as the fit is right, Fiala says. Meanwhile, the company is developing $400 million to $500 million of new properties each year while pruning $50 million to $100 million worth of low-growth centers from its holdings.

Martin E. Stein, Jr., RRC's chairman and CEO, has projected operating and financial synergies of more than $5 million a year from the Pacific Retail deal. "Our debt-to-asset ratio is now approximately 39%, and 70% of assets are unencumbered," Stein notes. "This provides Regency with more than $550 million of credit capacity for future investment opportunities."

Enter the dot.coms Diversified Realty Corp. went public in 1993 with a portfolio of 52 properties. By mid-1998, it had added, at first one or two at a time, about another 100 shopping centers worth about $1 billion. Soon after that, the share values of REITs plunged as investors fled to tech stocks and dot.coms. The pace of the decline did slow, but share values nonetheless kept on dwindling, despite the solid earnings of many real estate companies.

Interest rates started to lurch forward, which didn't exactly encourage investment. "We have a capital-constrained market where we can't go out and issue new shares to raise capital because the stock is undervalued," Schoff says. "Interest rates are higher, so positive spreads are narrowed. A property that might have been worth a 9.5% or 10% cap rate a year ago is now 10% or 10.5%. It has become a very dysfunctional marketplace. Sellers think their properties are more valuable. Buyers look at the cost of capital and say, `I can't afford it,' so a lot of transactions don't get done."

Build, don't buy In this dysfunctional market, DDR might have found itself stuck with no place to go. Instead, it mobilized its development arm and built rather than bought. "We knew that some day development would be the way to go, so by 1998 we probably generated $200 million to $400 million of development deals, which we can usually build at 11% to 12% return on cost, which is a much better allocation of capital resources."

In the last two to three years DDR has added another $300 million to $400 million worth of development. "We're putting the same assets in our portfolio, but we're building them instead," Schoff explains. "If the return is 11% to 12%, it's as if we acquired them at the same cap rates."

DDR is building centers in downtown Boston, Hagerstown, Md., Austin, Texas, and San Antonio, Texas. Some of these projects, all of which are about 600,000 sq. ft., are joint ventures with Prudential Real Estate Investors, a unit of The Prudential Insurance Co. of America. DDR accesses capital through such joint ventures mainly through what are called "off-balance sheet" developments, Schoff explains.

"We would have a joint venture with a local developer who identifies a site, works through the entitlement and handles day-to-day supervision of construction, with our support," he says. "Prudential and DDR, for example, would provide the equity, financing and expertise to complete the project, at which point we would buy out the local developer. Then we would buy out Prudential's interest or sell the property and split the proceeds. We prefer to retain those centers in our portfolio because, by being involved from the beginning, we could control the layout of the site and tenant mix, for example. We don't have that opportunity in an acquisition.

"It's a good deal all round," Schoff continues. "In a capital-constrained market we would run short of capital, so we'd have to turn down opportunities. This way we join with an institutional investor with abundant capital. It's also good for Prudential because Prudential has DDR, a major public company, between it and the local developer, to make sure the job is completed. Prudential provides capital as a partner and gets its share of the debt. There are also some accounting benefits, since REITs are all trying to maintain debt ratios and raise equity at the same time."

There is some incentive for the local development firm to live up to its cost and revenue projection, because the buyout amount depends on financial performance, up or down. Says Schoff, "If the local developer can achieve his projected rents and meet his costs, and when it's all done at a 12% cash-to-cost return, we buy 50% of the project for what it's worth. If it's 11.5%, then he might end up with a 40% interest, so his interest goes down as his yield goes down."

Consolidation and consumers What are the implications of consolidation, or the lack of it, for mall shoppers? According to Kimco Realty's Cooper, there are none. Cooper points out that centers don't sell to consumers, they sell to retailers.

Is there a risk that ongoing consolidation could ultimately squeeze out retail tenants who don't have the depth to appeal to a shrinking number of shopping center companies? "No one owner has a monopoly," Cooper replies, "and tenants are strong enough to go where they want to go."

Robert Welanetz, president and CEO of the Atlanta-based retail division of Jones Lang Lasalle, notes that in the past few years the retail market has been inundated with portfolio mergers and acquisitions. "It's really a grab for market share by the REITs, which have been dominating the scene relative to some of the consolidation on the ownership side."

The end result of that consolidation may be four or five large players that are very active in the luxury brand category, Welanetz notes. "LVMH (Moet Hennessy Louis Vuitton) and the luxury brands they are assembling, as well as Gucci and Prada, are all finding ways to acquire high-profile luxury brands and re-invigorate them for today's market," he says. "They are leaning to the need for growth and the United States. market is targeted for a re-launch of some of those branded concepts, some in malls, a lot of them free-standing."

Department stores are also trying to rationalize disparate real estate groupings. Then there are department store chains involved in regional plays, such as Gottchalk's, a California department store chain acquiring a 30-store Pacific Northwest chain.

Sometimes consolidation turns out to be a wrong move. Proffits department store chain acquired Saks Fifth Avenue and tried to incorporate its luxury brand into a less upscale retail environment. Now the owners are going to restructure Saks as a separate, publicly owned entity.

"Even if management wants to achieve market share and cover diversified lines of business, sometimes if it emasculates and homogenizes the business and loses its personality in its ability to penetrate the consumer base, it may not necessarily be an effective strategy," says Welanetz.

"Saks is being broken back out as Saks Fifth Avenue Enterprises, Inc., because it is such a unique merchant and has to be handled as such."

The market for buying and selling shopping centers isn't exactly on fire these days, but it's important not to exaggerate that point. There is still some life in transacting everything from "Class A" regional malls at a digestible price to under-performing retail dogs that can be acquired and turned around.

Here's a look at Diversified Realty Corp.'s current criteria for acquisitions:

- Community and power strip shopping centers in the continental United States.

- 250,000 sq. ft. to 1 million sq. ft., worth at least $25 million.

- Two or more strong national tenant anchors such as Wal-Mart, Target, The Home Depot, a major regional or national supermarket, etc.

- Financing: all cash, REIT stock or operating units will assume existing debt.

- Small shops: 20,000 to 80,000 sq. ft. of shopping center GLA

Joint ventures call for the same criteria, except that there is a 10.5% priority return on capital.

Meanwhile, Kimco Income REIT (KIR) is in the market for portfolios and individual shopping centers, as long as they meet the following investment criteria: 100,000 sq. ft. or greater, anchored by national credit tenants, well-located in key growth areas or in established regional markets, or candidates for redevelopment with value-added opportunity, for a minimum transaction size of $8 million.

Kimco is an all-cash buyer and can structure a deal to allow for potential deferral of capital gains to accommodate a seller's financial objectives. The firm typically closes a transaction in 45 to 60 days. Some recent examples range from Palm Plaza (421,392 sq. ft.) in Temecula, Calif., to Magnolia Square (42,000 sq. ft.) in San Ramon, Calif.

CenterAmerica Property Trust, L.P., acquires neighborhood shopping centers anchored by grocery stores, typically 60,000 to 250,000 sq. ft., and preferably in its home state of Texas, in Florida, or nearby states easily served from Texas. Portfolio acquisitions in other southern states are also do-able, as long as they would support a regional leasing and management office. CenterAmerica says it "closes transactions quickly, for all cash".

You can count the top tier of shopping center developers in Canada on the fingers of one hand - all, in fact, are owned by the country's largest pension funds. The shopping center REITs, on the other hand, have caught the same cold as their U.S. counterparts, although their piece of the Canadian ownership pie is insignificant.

But one factor that could make a modest difference to the merger and acquisition picture in the U.S. is the participation of deep-pocketed Canadian pension funds in shopping center investment.

Ontario Teachers' Pension Plan Board, for example, invested $150 million in The Macerich Partnership L.P. , Santa Monica, Calif., in June 1998. Eight months later, a Teachers' and Macerich joint venture company invested $544 million to acquire the Safeco portfolio, bringing their combined investment in malls to more than $1 billion.