The biggest question emerging from July's one-two punch of Centro Properties Group's proposed buy of Heritage Property Investment Trust and Kimco Realty Corp.'s proposed acquisition of Pan Pacific Retail Properties Inc., for a combined $7.2 billion, is whether the deals signal a cooling in prices for retail real estate.
In both cases, the premium being offered is far less than what REITs in other property sectors have fetched. Kimco's offer of $70 per share represents no premium over where Pan Pacific's shares had closed last Friday and the $36.15 per share price on Heritage is just a 3.3 percent premium. In contrast, Blackstone Group and Brookfield Properties Corp. proposed $9-billion acquisition of office REIT Trizec Corp. — announced in June — is a 15 percent markup over where Trizec's shares had been trading prior to the deal.
Richard Moore, a REIT analyst with RBC Capital Markets, says there were idiosyncrasies that help explain why the premiums seemed low. Pan Pacific's unsecured debt includes covenants that, if violated, necessitate immediate prepayment with penalties. As a result, the company needed to find a buyer with a credit rating equal to its own and Kimco is one of the only firms that fits that bill.
Moreover, when rumors began flying two weeks ago that Kimco was on the verge of completing a buyout, share prices on prospective targets — which included both Pan Pacific and Heritage, in addition to other shopping center REITs — began rising.
In the case of Pan Pacific, its shares began inflating on June 26, when the company's shares were $65 range. Still, even adjusting for that inflation, Kimco's offer is between a 6 percent and 7 percent premium — below what REITs in other sectors had been getting.
“Based on the cap rate on the NOI of the company we felt the price is a good price,” says Stuart Tanz, president and CEO of Pan Pacific. “We felt it was a good time to sell, given [market] valuations.”
Pricing on both deals also represents a discount to consensus NAV estimates for Pan Pacific and Heritage. Pan Pacific's consensus NAV stands at $71 per share. Meanwhile Heritage's consensus NAV is $41.00 per share.
“My reaction, along with a lot of other people's, is that maybe the community center sector is fully priced,” Moore says. “We feel very good about the sector and think there is plenty of upside. The fundamentals are very good and demand by tenants is very good. The deals seem to say otherwise, but my take is that these were unique situations and even though the premiums on these deals weren't that high, it doesn't mean that the rest of the sector can't go up.”
There is also disconnect between the deals in the assumed cap rates and price per square foot. Pan Pacific, with its portfolio concentrated in West Coast markets with high barriers to entry, is selling at a 6 percent cap rate with the properties garnering $200 per square foot. Heritage's portfolio, which is in the Northeast and Midwest, is considered second-tier and Centro's price comes to a 7.2 percent cap rate and $115 per square foot. According to data from Real Capital Analytics, of the $1.1 billion on grocery-anchored property deals in the first quarter, the average cap rate was 6.8 percent with an average price of $149 per square foot.
Morgan Stanley retail REIT analyst Matthew Ostrower wrote in a research note, “We believe the primary lesson investors should take from this transaction is that lower quality shopping centers are becoming more challenging to sell, particularly in large quantities and for large prices.”
That observation leads to another train of thought in that prices on B and C assets, like those in the Heritage portfolio, are stabilizing or coming down.
“That part of the market is starting to turn,” says Joe French, senior investment advisor for Sperry Van Ness. “So much is going after the top grocery-anchor strip centers. Buyers are still willing to pay 5 and 6 cap rates for those properties. Go to Bs and Cs, and it looks different.”
According to the terms of the Kimco deal, it will pay $70 per share for Pan Pacific's outstanding stock. Meanwhile, Centro has offered $36.15 per share for Heritage.
Wall Street had been expecting Kimco, the New Hyde Park, N.Y.,-based shopping center REIT, to make a deal for several weeks. It had been mentioned as a potential buyer of Lord & Taylor, Heritage and even New Plan Excel Realty Trust.
The deal will significantly increase Kimco's presence on the West Coast. It also advances the company's strategy of moving from property owner to asset manager, which Chairman and CEO Milton Cooper has been signaling to investors recently.
Pan Pacific is the largest shopping center REIT focused exclusively on the West Coast, with 22.6 million square feet of properties in states including California, Washington, Arizona, New Mexico, Nevada and Oregon. Kimco owns a number of shopping centers in the region, but they represent only a fraction of Pan Pacific's portfolio; the majority of the company's holdings are located in the Northeast and the South. The Kimco/Pan Pacific merger is expected to close in the fourth quarter of 2006.
In the other deal, Australia-based Centro Properties Group reached an agreement in July to purchase Boston-based Heritage Property Investment Trust, a REIT with 157 primarily supermarket-anchored properties with a combined 28.7 million square feet, in a $3.2 billion deal.
Heritage and Centro have been working on the deal for nearly eight months and concluded negotiations Sunday afternoon.
“The heavy work started in March 2006, with the signing of a confidentiality agreement and we've been in heavy negotiations since then until closing the deal,” says John Hutchinson, Centro's head of acquisitions, in a conference call with investors.
The deal more than doubles Centro's U.S. portfolio to 49 million square feet. When the deal closes — which the companies say will happen by October — Centro will rank as the 10th-largest retail property owner in the U.S, according to Retail Traffic's figures.