Sharpening its focus on multi-tenant community shopping centers, Developers Diversified Realty (DDR) is using $300 million in proceeds from the sale of grocery-anchored shopping centers to partially fund its $1.15 billion purchase of 15 malls in Puerto Rico.

“We're reinvesting our funds into a portfolio that better fits our core investment strategy,” says Scott Wolstein, chairman and CEO of the Beachwood, Ohio-based real estate investment trust (REIT).

DDR is steering clear of grocery-anchored retail because it carries a higher-risk profile, according to Michelle Mahue, DDR's vice president of investor relations. “A number of grocery stores are under pressure from increasing competition from Wal-Mart, Sam's Club and Target,” she explains. “Grocery is also much more difficult to re-tenant.”

Neighborhood grocery-anchored centers comprise only 4% of DDR's portfolio, and Mahue says that number will continue to shrink. “We continually cull our portfolio of smaller, non-core assets.”

As an owner and manager of about 460 shopping centers across the nation, DDR also will bring new U.S. retailers to Puerto Rico. The malls in the 5 million sq. ft. portfolio acquired by DDR from Caribbean Property Group LLC range from 132,383 sq. ft. to 711,379 sq. ft., and the stores boast retail sales that are 50% higher than the U.S. average, says Wolstein.

The acquisition in Puerto Rico is a sizable transaction to offset the dilution of recent assets, and it helps solidify earnings visibility for 2005, says analyst Michael Mueller, vice president of New York-based JP Morgan.

In an effort to significantly reduce its exposure to the neighborhood grocery-anchored sector, DDR completed two joint venture transactions this fall with Kuwait Financial Centre-Markaz and Prudential Real Estate Investors. Twenty of the 25 grocery-anchored centers contributed to these joint ventures were recently acquired through DDR's purchase of retail portfolios from Benderson Development Co. and its acquisition of JDN Realty Corp.

“The joint ventures made our JDN and Benderson acquisitions better aligned with our core investment strategy,” Mahue says.

DDR purchased the malls in Puerto Rico at a cap rate of 7.4%. Mueller says the same deal in the U.S. would have a cap rate of about 100 basis points lower. “If you look at the population size, demographics, density and sales levels, it's compelling relative to what you see in the U.S. There's a lot of population, and people are spending their disposable income. It's not necessarily underserved, but there is less retail per capita than you see here.”

New retail development in Puerto Rico also is limited due to a mountainous terrain and high construction costs. As a result, retail occupancy rates top 95%.

With the portfolio in Puerto Rico 97% occupied, where's the upside potential? Wolstein says that adding parking structures will generate additional traffic. “We've been reluctant to do that in the States, but it's much more common down there because it allows you to park in the shade.”

He also notes that the portfolio has a higher mix of small shops that have short-term leases, which resembles DDR's overall portfolio. “It will have a positive impact on our overall growth rate because we'll be able to roll leases more frequently.”

In addition to the proceeds from the recent sales of grocery-anchored centers, DDR will assume $660 million of debt to finance the purchase. The remainder of the acquisition will be financed through a combination of sources.