Some call them “marginal” or “under-performing” properties. Others refer to them merely as “non-core” assets. They're malls and shopping centers that, for varying reasons, don't quite fit into the portfolios of the REITs that own them.

These properties can pose problems for REITs, particularly in a dicey economic environment. At the same time, however, many REITs are busy turning these unwanted centers into useful vehicles for generating capital for the benefit of their shareholders.

Portfolio deal impact

As a result of the many portfolio deals closed during the buying spree of 1996-1997, many mall REITs wound up owning some properties they wouldn't have bought individually, according to Ann L. Melnick, an analyst with A.G. Edwards & Sons, Inc., St. Louis.

“The theme for REITs during those years was ‘buy to get bigger’,” says Melnick. “The name of the game was growth through acquisition, and the focus was on increasing the number of properties owned, rather than on the quality of the entire portfolio of properties being purchased.”

In many instances, these portfolios included malls that couldn't compete well in the face of newer competition, or properties that were poorly positioned in the first place. “And while a lot of these properties may have done well in 1999 when retail was booming,” notes Melnick, “now that sales are slowing and you have some fairly major tenants closing, some of the REITs that own them are feeling the pinch.”

The pinch can be relative. “Interestingly enough, these properties don't have an earnings impact in most cases, because their net operating income is equal to the interest cost (associated with their purchase),” says David Fick, managing director of Baltimore-based Legg Mason. In other words, the rents are essentially paying off the mortgage.

As long as rents are paid, these centers can carry their weight. But in a market where several anchor retailers have announced either complete shutdowns or the closing of selected stores, these centers are more vulnerable to the risks of retailer bankruptcy, resulting in no rent being paid, says Pat Hickey, Atlanta-based REIT analyst for the Robinson Humphrey Co.

“And even if they just close a location and continue to pay rent,” he adds, “this can negatively impact the ability of the center to draw customers.”

Handling the challenges

REITs do have options available to deal with these properties when they become problems. For example, when Chicago-based General Growth Properties Inc. acquired the 26-center Homart Development regional mall portfolio at the end of 1995, “There may have been three marginal properties where it is questionable whether we would have bought them on their own,” notes CEO John Bucksbaum.

General Growth chose to undertake ongoing re-merchandising and improvement programs for these malls. One of these properties, the 809,225-sq.-ft. Tyson's Galleria in McLean, Va., “has turned into an absolute home run,” according to Bucksbaum.

“Tyson's Galleria was marginal in many respects — its occupancy, the direction sales were headed when we took it over — but it has turned into a terrific center,” says Bucksbaum. The other two centers, meanwhile, “are not taking the world by storm but we have continually been able to improve their leasing and increase their cash flows,” he notes.

Bucksbaum feels that larger REITs are better able to handle the challenges presented by under-performing properties. “Through their size, relationships with retailers, and the strength of their specialty leasing and sponsorship programs, the bigger companies have a better opportunity to make something more of these properties than would be the case if they were part of a smaller portfolio,” he says.

Disposition options

For Cleveland-based Developers Diversified Realty Corp., a REIT specializing in large, open-air community and power centers, non-core properties are those that don't meet credit, size or market-share criteria for investment-grade property, according to company executive vice president Doug Hurwitz.

“Some came to us in packages, and some where developed in the early days of the company,” he notes, “and a number of them have had rough histories.”

This REIT disposes of these properties through its asset management group. “We have found that there is an appetite for some of these properties,” says Hurwitz, “particularly among local and regional investors that are looking for opportunities that fall within their areas of expertise.”

Whether considered marginal or non-core, these properties do not necessarily cause problems for a shopping center portfolio. Indeed, many marginal centers are quite successful, according to Hurwitz.

“They are not all, by definition, problematic,” he notes. “They represent opportunities for a portfolio to generate capital to re-deploy in assets that are more in line with the core business,” adds Hurwitz, “and can generate a higher return for shareholders.”

Martin Sinderman is an Atlanta-based writer.

SIDEBAR: IRT undertakes asset recycling program

Atlanta-based IRT Property Company, a REIT specializing in shopping centers located in the Southeast and anchored by major grocery and discount retail chains, is currently engaged in a portfolio repositioning program that executive vice president and CFO Jay Levy calls asset recycling.

The company's strategy is to sell what it calls “limited growth” properties in tertiary markets, re-deploying the capital into both a stock buyback program and the development of grocery-anchored properties in major markets, according to Levy. “Some 10% to 12% of our portfolio is comprised of these limited-growth properties, which we feel are holding back the growth of the rest of our portfolio,” he notes. With their locations in out-of-the-way markets, these properties have no room for rent growth, says Levy. “And there is also often a lot of available land upon which someone can come in and build competing properties nearby.”

Faced with this situation, IRT decided to get rid of as many of these properties as it could over time, reports Levy. Through its asset recycling effort, the company (as of mid-January 2001) had sold five centers totaling 322,000 sq. ft. for an aggregate $17.4 million, with letters of intent in hand to sell three more centers. Buyers for these properties include 1031 Exchange buyers, “local individuals who know the markets and feel they can do something with the centers,” says Levy, as well as pension funds.