When DLC Realty Trust, a Tarrytown, N.Y.-based private REIT, announced it was going to undertake an initial public offering in the summer of 2010, the timing seemed to be just right. DLC specializes in grocery-anchored shopping centers and power centers, and throughout 2010, grocery-anchored retail has ranked among investors' favorite asset classes. The firm had a respectable track record in commercial real estate (it's been in operation for 19 years) and its reasons for going public — to fund new acquisitions and pay development expenses — were solid.

The bigger picture looked right as well. Through most of 2010, the public REIT market seemed to be rallying. In April 2010, when DLC filed with the SEC, REIT share prices were on an upswing. By July, when DLC set the terms of the IPO, they were down from the peaks achieved in April, but still well above 2009 lows. For example, at the time, shares of Cedar Shopping Centers, a public REIT that runs a portfolio similar to DLC's in size and quality traded 37 percent above 52-week lows.

In addition, existing REITs were having no trouble tapping public markets for debt and equity. By the end of the year, U.S. REITs raised $26.3 billion in secondary offerings and $19.2 billion in unsecured debt offerings, according to NAREIT.

DLC planned to sell 31.25 million shares priced between $15 and $17. By early August, the company reduced the range to $12 to $13 per share. By Aug. 12, the company announced its intention to postpone the IPO altogether because of unfavorable market conditions.

DLC declined to comment for this story, but it was hardly alone in having to lower its expectations when conducting an IPO last year. Excel Trust Inc., a San Diego-based REIT with a focus on shopping centers and power centers, completed its IPO in April 2010, but not before cutting its initial share prices 22 percent, to $14 per share.

At the time of the offering, Excel had only four assets in its portfolio (16 additional properties were under contract) and its small size might have played a role in it being under-valued, says Spencer G. Plumb, the company president and COO.

“You never know what kind of market factors are going to come into play at the time of your IPO, but we didn't have a large portfolio to start out with,” Plumb notes. “I think the institutional investors need us to be more liquid, they need us to be bigger.”

The IPO allowed Excel to raise $210 million and secure a $125 million credit facility. As a result, Excel's portfolio has since grown to 23 properties worth approximately $414 million. Given the chance to wait to complete the IPO later in the market cycle, Plumb says he would have still opted to do the offering last year.

Another retail REIT to complete an IPO in 2010, Houston, Texas-based Whitestone REIT, also had to lower its offering price when it went public in August, to $12 per share from the planned $14 to $16 per share. Whitestone's shares now trade for more than $14 per share.

“We based our initial valuation on the net asset value of the company and we weren't as concerned about how we would price because we weren't going to do that large an offering,” says Whitestone Chairman and CEO James C. Mastandrea. “But we wanted to get ourselves in front of institutional investors and share our story and our track record and to create some currency other than cash.”

Whitestone's primary reason for going through with the IPO was to build up extra capital to acquire value-added community centers, which had been selling at attractive discounts at the time.

After the offering, the company purchased two such properties, totaling about 142,000 square feet. Mastandrea still believes the REIT's timing was right. Whitestone would like to do a secondary offering, perhaps as early as this year, and with its stock already trading, he feels investors will see it as less risky than initial shares of an unknown REIT.

“I think our timing was perfect,” Massandra notes. “It's prepared us to do another offering, and we have a track record now. Usually, investment bankers see some risk in an IPO. NOw there is more interest in us.”

In fact, risk perception was likely at the heart of the troubles DLC, Excel and Whitestone experienced with their share prices last year, says Michael R. Grupe, executive vice president of research and investment affairs with NAREIT. In the summer of 2010, the outlook for commercial real estate remained hazy and the retail sector in particular was still showing no signs of emerging from its three-year funk.

As a result, REIT investors likely added a sizable risk premium to any new REIT shares hitting the market, Grupe notes. Meanwhile, the rally of publicly traded REITs may have given aspiring newcomers a bit of false confidence because shares of public companies that have been trading for some time have risk premiums already built into their pricing.

“When you are talking about an IPO, the market's judgment about the risk is not transparent,” says Grupe. “The investors are all operating blind and when that happens they will build a higher risk premium into the price they are willing to pay.”

“And whenever you have an event taking place in the market that increases the level of uncertainty [for example, the raging financial crisis in Greece that for a while threatened the global economy] that increases the risk premium,” Grupe adds.

Better prospects

Things are looking different in 2011 with the economy increasingly on firmer footing and a brighter outlook for commercial real estate as a whole.

Overall, in 2010, companies completed nine REIT IPOs in the U.S. that raised $2 billion. In 2011, the number may be higher, industry sources say. As of Jan. 10, there were already about 12 REIT IPOs “on file or waiting to launch,” according to a report by SNL Financial, a Charlottesville, Va.-based research firm.

Of the nine IPOs completed last year, only two — Excel Trust and Whitestone REIT — involved companies that exclusively specialize in retail properties.

As the industry began to recover from the downturn equity investors might have overlooked the retail sector because it showed less of a bounce back than hotel or industrial properties, Grupe notes. (That was largely because retail properties did not experience as sharp a decline in values in 2008 and 2009, he adds).

Plus, property fundamentals in the retail sector continued to show slow deterioration until the third quarter of 2010, which likely made many retail center operators feel that if they were to go public, their shares would be undervalued by investors, says Rich Moore, an analyst with RBC Capital Markets.

As a result, “I think there were a lot of guys who wanted to go public but didn't, because they didn't think the conditions were right,” Moore notes. “Today, there is recognition that commercial real estate will be fine, if not great. The retail guys are definitely going to think about IPOs.”

In January, for example, American Assets Trust Inc., a San Diego, Calif.-based firm that specializes in retail and office properties, sold 27.5 million initial shares at a price of $20.50 apiece, raising approximately $563.8 million. American Assets' shares priced at the higher end of its expected range, which was initially set between $19 and $21.

The transaction was also the largest REIT IPO in more than a year. American Assets wants to use the money for acquisitions, to repay its debt and for other working purposes.

In addition, Schottenstein Realty Trust, a Columbus, Ohio-based owner of office, retail and industrial properties, filed a statement with the SEC indicating its plans for an initial offering in December. Schottenstein operates 109 retail centers, totaling 11 million square feet of space. Its total portfolio includes 156 properties.

The company hopes to raise as much as $518 million in the initial stock offering, according to a filing the company made with the Securities Exchange Commission. Proceeds will be used to pay $250 million in debt, to buy or improve properties and for other purposes.

In fact, in 2011, conditions seem particularly favorable for retail REIT IPOs. To begin with, retail REITs ended 2010 with the highest returns in six years, at 33.41 percent, according to NAREIT. They significantly outpaced the S&P 500, says Robert McMillan, a REIT analyst with New York City-based Standard & Poor's Equity Research.

Today, most publicly traded retail REITs trade at or above their fair value, notes Todd Lukasik, senior equity analyst for the real estate sector with Morningstar. The fact that occupancy levels at malls and shopping centers began to shape up in the third quarter likely made investors more confident in the sector's impending recovery. At the same time, there remains some room for leasing spreads to improve in the coming quarters, creating a potential for upside, notes McMillan.

Add to that the news that U.S. chain stores posted the strongest gains in same-store sales since 2006 in November and December, at 4 percent, and new retail REITs start to look like a very sound investment, says Grupe.

There is also precedent for a rise in IPOs on the heels of a recession. In 2004, the U.S. REIT market experienced a historic peak in IPOs, with 29 new offerings, according to NAREIT data. Still, the fallout from the financial crisis, will cause recovery to be more protracted this time around, says Grupe.

In addition, companies seeking to go public will continue to face stiff competition from the 153 publicly traded REITs already in the market that show no signs of slowing efforts to issue new shares and debt in public markets.

Lowered expectations

Not everyone, however, will be able to benefit from a more favorable outlook for retail REIT IPOs. The companies that stand to gain the most will be those that already have established property portfolios that investors can analyze, says Lukasik. Firms with few or no holdings will likely be discounted as too risky.

In addition to assembled portfolios, equity investors want to see evidence of an experience management team, financial discipline and a product or service that offers a compelling “story,” according to Moore and Grupe. As an example of a good “story,” Grupe cites the two hotel REITs that went public in 2010, Cheasepeak Lodging Trust and Chatham Lodging Trust. Their quick recovery from the downturn made them compelling to investors.

“A good reason to do an IPO is access to growth capital and it's also a good way to recapitalize,” says Moore. “Some bad reasons are: ‘We are in a mess, we just don't know what to do, and so we are going to look to the public market to get us out.’”

Moore says he has seen some attempts to use IPOs to get out of trouble in the current cycle, but would not disclose any names. According to the SNL Financial report, there might be some real estate companies on the verge of bankruptcy looking to do IPOs in 2011.

Surprisingly, the REITs that might get the most favorable treatment from investors over the next year might be those that specialize in regional malls. Grocery-anchored shopping centers have gained a reputation as a stable asset and investors preferred them when the market was in the deep of the recession, says Grupe.

But as the industry begins to see signs of recovery and the general economy expands, properties that rely on discretionary spending will offer more of an upside than necessity-based retail.

Standard & Poor's McMillan, for example, says that his two top REIT picks at the moment include Simon Property Group and CBL & Associates Properties, two of the largest regional mall REITs in the country.

“There is probably less risk with malls, just because there is less development and some of the grocery anchors are trying to pull back” on growth, McMillan says.