A contracting economy has thrown hundreds of thousands of Americans out of work. Kmart is operating under Chapter 11 bankruptcy protection and has left empty shells in shopping centers from coast to coast as it tries to staunch its losses. And there are questions about whether hundreds of regional malls will ever regain their luster (see cover story on page 18).
Yet shares of retail REITs continue to rise. On Wall Street, it seems, shoppers aren't as finicky as those out in the malls. Investors are snapping up REIT shares indiscriminately: Owners and developers of regional malls, power centers, grocery-anchored centers and factory outlets all are enjoying the rally in retail REIT stock prices — despite wide variance in their results and prospects.
Here's a sampling: By late April, shares of Indianapolis-based Simon Property Group (NYSE: SPG), the biggest retail REIT and a developer of high-end regional malls, were up nearly 40% from their 52-week low last fall, to around $34. In the neighborhood and community shopping center segment, shares of San Diego-based Pan Pacific Retail Properties (NYSE: PNP), the largest player in its niche on the West Coast, had risen 50% to more than $34. And, in the outlet sector, shares of Roseland, N.J.-based Chelsea Property Group (NYSE: CPG), which operates outlet centers in the U.S. and Japan, were up 34%.
That's an amazing performance, given the overall trend in equities in the same period: The S&P 500, after brushing aside its post-Sept. 11 lows, has given back half its gains and is now up only about 17%.
So, why do investors love retail REITs? In a nutshell: reliable returns. At a time when corporate profits are wobbly — and sometimes subject to painful revision — and the strength of the economy is in question, real estate of all kinds is a good defense and a hedge against possible inflation, says Lesia Bates Moss, vice president and senior credit officer at New York-based Moody's Investors Service. “Real estate is performing exactly like we would anticipate it to perform in an economic downturn,” she says.
And, after the wild ride of the bull market that left tech and telecom shares in a shambles, says Bates Moss, REITs look rock solid. “In effect, you've had a flight to safety,” she says. “REITs still provide relatively stable cash flows and consistent dividends during a period of economic volatility.”
But why retail REITs? For one thing, it's their turn, says Jeff Donnelly, a REIT analyst in the Boston office of Wachovia Securities Inc. During the height of business expansion in 2000, office space was in such demand that asking rents were hitting new highs.
Likewise, soaring home prices forced many potential home buyers to remain in apartments, keeping occupancy rates high and rents as well. So, REIT investors tended to favor those sectors over retail. “A lot of dedicated investors in REITs were forgetting about retail strip centers,” Donnelly says.
Also, retail REITs provide a better return than most other property types, says Stuart Tanz, president and CEO of Pan Pacific. “If you were to look at dividend yields through the retail sector and compare that with the yields that you are getting in the other sectors today given the current stock prices, you will find that the retail sector still offers one of the highest yields in the industry,” he says.
According to a recent Salomon Smith Barney report, dividend yields for shopping center and regional mall REITs ranged from 4.7% to 10% as of April 12. By contrast, the range was 2.1% to 9.4% for office REITs.
Rental Revenues Crucial
But, as they say in the disclaimers, past performance is no indication of future results. No part of the economy is immune to a widespread downturn and how quickly — and at what prices — operators can re-lease space this year will be a critical leading indicator. If rental rates fall, retail REITs won't hit the earnings projections that underpin their stock prices. Generally, about 12% to 15% of the retail leases expire each year, says Bates Moss.
For the most part, however, the current recession has been much easier on the retail sector and, by extension retail REITs, than on other sectors, such as office properties where double-digit vacancies are common in major downtowns. “The consumer has really held up nicely in this downturn,” says Matthew Ostrower, a retail analyst with Morgan Stanley Dean Witter. “There have been far fewer bankruptcies in the mall space than in previous recessions.”
The International Council of Shopping Centers (ICSC) reports that not all retailers are enjoying the benefits, however. In March, chain-store sales rose by 6.4%, driven largely by the drugstore and discount-store segments, up 12.1% and 10.3% respectively, according to the Bank of Tokyo-Mitsubishi, which tracks 81 retailers. Sales among apparel retailers, however, declined 0.8% while department stores slipped 0.4%.
Among individual companies, Wal-Mart's sales jumped 9.5% in March, while Target Corp.'s same-store sales climbed 6.8%. Eckerd drugstore reported a 10% increase in sales. However, same-store sales at the Gap Inc. fell 12%.
Timing is everything
So, developers who are heavily reliant on traditional retailers and specialty stores may be vulnerable. Consider the case of Taubman Centers Inc. (NYSE: TCO), which opened four major malls with 5.5 million sq. ft. of GLA last year — malls that were planned for a soaring economy that would arm consumers with plenty of disposable income.
(As of March 28)
|*Total return includes a stock's dividend income plus capital appreciation, before taxes and commissions.|
The Bloomfield Hills, Mich.-based company's new projects include:
Dolphin Mall, a 1.4 million sq. ft. center in Miami;
The Shops at Willow Bend, a 1.5 million sq. ft. center in north Dallas;
International Plaza, a 1.3 million sq. ft. center on the grounds of the Tampa International Airport; and
The Mall at Wellington Green, a 1.3 million sq. ft. centerpiece of a 470-acre planned community in Palm Beach, Fla.
In all, these projects boosted the REIT's shopping center portfolio by 30%. But, for the first time in Taubman's 10-year history as a public company, sales per square foot decreased from the previous year. In 2001, sales per square foot were $456 compared with $466 in 2000. The new malls have also dragged down portfolio-wide occupancy to 84.9% in 2001, down from 89.1% in 2000, according to the company's annual report. The company attributes the decline to the opening of the centers at occupancy levels lower than the average of the existing portfolio.
As of Dec. 31, leased space at the four new centers was 75% to 80%. Those figures were lower than the company had expected. Also as of Dec. 31, more than 100 stores needed to be leased at the centers to achieve stabilization. As a result, the company concluded in its annual report, the return on investment for the four centers would be under 9% for 2002.
President and CEO Robert S. Taubman told security analysts at the 2002 REIT CEO Conference in mid-March that sales at the upscale Shops at Willow Bend in Dallas were below expectations. He cited flat job growth, office vacancy rates in excess of 20% and a malaise among Dallas consumers.
“We do not expect the economic environment in Dallas to improve significantly for the rest of this year,” predicted Taubman, whose company owns and/or manages 31 urban and suburban regional shopping centers in 13 states. Even so, Taubman shares were trading above $15 in late April, only slightly off their 52-week high of $16.09.
Dolphin Mall, located five miles west of Miami International Airport, remains the biggest leasing challenge for Taubman. The center features more than 200 outlet, dining and entertainment venues arranged around a “racetrack” layout in a series of merchandise districts. “The retail environment in South Florida, although improving, continues to be the most difficult in memory,” says Taubman. “Dolphin opened with a greater proportion of local tenants than our typical mall.” Unfortunately, many of these local stores did not have the balance sheets to ride out the post-Sept. 11 economy, he says.
Grocery stores in favor
If there are questions about how traditional mall operators can continue to deliver the returns that drive the stock-price gains, few investors seem to have much doubt about grocery-anchored centers. When a well-located, grocery-anchored center goes on the block, there will be 10 to 20 bidders, according to industry experts, because investors perceive this sector as a safe haven.
“We've always thought that segment of retail was very resilient to economic downturns, given the fact that in good or bad times, necessity-driven needs by consumers don't generally wane,” says Bates Moss of Moody's.
The dealmaking is intense, helping to keep prices strong. In April, Pan Pacific Retail Properties announced that year-to-date, it had acquired three grocery-anchored neighborhood centers in Hacienda Heights, Calif.; Hillsboro, Ore.; and Las Vegas. The properties, which together encompass approximately 600,000 sq. ft., were acquired through separate transactions for a total of $60.5 million.
In its “Weekly REIT Strategy Report” of April 19, Salomon Smith Barney recognized Pan Pacific for having grown net asset value (NAV) with a compounded annual growth rate of 10.6% since the company went public in 1997.
Also in April, Weingarten Realty Investors (NYSE:WRI) announced it had acquired eight supermarket-anchored shopping centers. Seven properties totaling 1.15 million sq. ft. are located in Raleigh-Durham, N.C. The eighth center, at 189,000 sq. ft., is located in Plano, Texas. These properties are all currently more than 95% leased.
So far this year, Weingarten has invested $141.7 million in acquisitions, including a shopping center in Fort Lauderdale, Fla. The acquisitions total 1.6 million sq. ft. and will result in an average initial return of 9.9%, says the company.
According to Tanz of Pan Pacific, the competition for grocery-anchored shopping centers has grown especially fierce in recent years, driving sales prices up and cap rates down. On the West Coast, the highest cap rates for such properties have declined from 9.7% to 9%, he adds.
The competition for grocery-anchored properties makes perfect sense, Tanz says. The retail sector as a whole is one of the most stable asset classes in real estate, and grocery-anchored properties provide the most consistent cash flow within the group. As Tanz says, “All of this is driving these high stock valuations.”
NREI Senior Associate Editor Stephen Ursery contributed to this report