While it hasn't been a good year for real estate investment trusts in general, the retail REITs have been holding their own during a turbulent period for the stock market.

NAREIT reports that through the end of July, REIT returns slumped 11.37% at the same time the S&P 500 was showing returns in the +16.46% range - a very wide differential.

The REIT group meltdown, according to Salomon Smith Barney, demonstrates the industry is at a crossroads, with the broad recovery in asset prices now over. "At this point in the cycle, it is appropriate that REITs trade at moderately lower valuations than has been the norm in the go-go recovery days of the past few years. But the fundamentals do not come close to justifying the meltdown."

About the only consolation in the discordant numbers was the performance of retail, which of all the REIT sectors performed the best with returns down slightly at -1.89%. Even better have been the regional mall stocks, which were the only REIT category or subcategory to be in the black, up 0.32%.

Perceived advantages In a tough year for REIT stocks, and of late for stocks in general as evidenced by the strong fluctuations this past summer in the Dow Jones Average, some investors have turned defensive. REIT stocks should be a defensive play, but instead have performed closer to growth stocks over the past few years. Nevertheless, shopping centers and a few other REIT sectors such as apartments are considered fairly defensive because they exhibit less volatility.

"One of the nice things about our business is that we bring to it a certain amount of stability in high-flying times," notes Lewis Sandler, chief executive officer and president of Houston-based United Investors Realty Trust, a newer REIT with a capitalization of $150 million. "Retail is probably the least attractive of the traditional REITs because we are less dramatic."

United Investors is strictly a neighborhood shopping center REIT, and in Sandler's opinion, REITs of this kind are even more stable because they are mostly grocery store and/or drugstore anchored. "People have to eat and still buy necessities," he says.

Sandler's view does get support from neutral sources.

"Anchored community centers and malls are certainly exposed to economic cycles, but to a far lesser extent than, for example, hotels. People are still going to shop or get their prescriptions filled," observes James Kammert, a first vice president with Robinson-Humphrey Co. in Atlanta.

Salomon Smith Barney has made the decision to upgrade those REITs that it believes have the deepest management teams and strongest public company skills, but previously were too expensive to rate as a "buy." Of the four REITs getting an upgraded rating, at least two are retail plays: Simon Property Group of Indianapolis and Franchise Finance Corp. of America, based in Scottsdale, Ariz.

In general, retail REITs are very solid, and the valuations of these companies didn't get too high, says Thomas D'Arcy, chairman, chief executive and president of Bradley Real Estate Inc., a $1.1 billion (including newly acquired Mid-America Realty Investments) grocery-anchored shopping center REIT based in Northbrook, Ill. "The fundamentals of retail remain very strong and it has been a good solid performer over the past few years, including this year when there have been a lot of disruptions in the marketplace."

To which D'Arcy adds, the better retail REITs are "well-run companies with solid earnings, strong balance sheets and the ability to add value in a lot of different ways."

Another retail real estate company that turned up on analysts' "buy" ratings was New Plan Realty Trust, a New York-based shopping center REIT with a capitalization of $1.8 billion. As Prudential Securities notes, "The company continues to stand out from other large-cap shopping center REITs based on its projected FFO growth ($2.20 in 1999) and access to low-cost capital."

The latter may be what spurred New Plan to merge with Excel Realty Trust in a $1.62 billion stock swap.

Urge to merge If hotels dominated the M&A news last year, 1998 has so far proven to be the year of retail. Among the major retail deals this year were Simon Property Group's merger with Corporate Property Investors in a $4.8 billion transaction, and its joint venture with Macerich Co. of Santa Monica, Calif., on a $974.5 million acquisition of 12 regional malls from ERE Yarmouth (now Lend Lease).

Other big transactions include the $2.55 billion joint acquisition of TrizecHahn's portfolio of shopping centers by The Rouse Co. and Westfield America Inc., and General Growth Management's purchase of eight properties from United Kingdom-based MEPC for $871 million.

"There have been two major shopping mall consolidations and a few large portfolio transactions. Most people, including myself, are projecting more consolidations," says Steve Hash, a senior REIT analyst at Lehman Brothers. "It is really just starting to take hold."

The retail market is glutted with about 60 different companies, many with a market cap at less than $100 million. Before this year, most of the activity in this sector has been in the mall category. But this year, the community shopping center sector has been rocked by two major deals, Kimco Realty Corp.'s $835 million acquisition of The Price REIT and Excel's $1.62 billion merger with New Plan Realty Trust.

Prudential Securities has been an adviser on the Excel-New Plan transaction. Richard Schoninger, Prudential's managing director and group head of Real Estate Investment Banking, notes, "This trend will accelerate. There will be a number of retail mergers in the strip-center business."

In one of the more recent deals, Bradley Real Estate Inc. acquired Mid-America Realty in a $157 million transaction. "The transaction made sense for us and it is good for our shareholders, but I don't see any compelling reason to get bigger just to create more size," says D'Arcy. Big does have its advantages, however, including greater diversity, more liquidity, increased notice on Wall Street and better ability to deal with retail chains.

"Expect more consolidation in all the retail REIT areas because of economies of scale, lower costs, lower costs of capital. And tenants are easier to deal with when companies are larger," notes Dale Anne Reiss, E&Y Kenneth Leventhal's real estate managing partner for the New York-Tri State region.

In a roundabout way, the deflation of REIT stocks may encourage more mergers and acquisitions. "Stock prices reflect the fact that Wall Street believes there are fewer opportunities for REITs to acquire property and add value," explains Michael George, a principal of Mid-America Real Estate Corp. based in Oakbrook Terrace, Ill. "So, Wall Street started to back up on its enthusiasm for REIT stocks, and the prices reflect that. On the other end, investment bankers became disinterested in putting a lot of new capital into acquisition of property, which means some REITs may become somewhat dormant."

At that point, those REITs will be likely candidates to be acquired or merged. "I absolutely see more consolidations and mergers coming into the industry," George concludes.

Joint ventures Urban Retail Properties Inc., a $2 billion mall REIT based in Chicago, so far has stayed out of the merger game. "We look at all the deals and we compete where appropriate. We just haven't happened to win any of the big deals yet," says Adam Metz, executive vice president and chief financial officer.

This doesn't mean Urban Retail Properties won't continued to expand. Over the past year, the company bought four properties for $500 million.

To increase its own purchasing power, Urban Retail Properties also gets involved in joint ventures, usually with major capital players and institutional investors. "We have done four joint ventures and we will do some more," says Metz. "We like the joint-venture deals, and we think there is a lot of interest from institutions that want to work side by side with experienced operators."

Generally, institutional investors such as a pension fund will go in on a deal 50-50 with Urban Retail Properties, leaving the latter to operate and manage the investment. "In today's world, institutional investors have certain goals and they are set up to invest in a certain way," Metz explains. "Investing in joint ventures with experienced operators fits the kind of model they are looking for."

There are all sorts of ways to affect a joint venture. Simon Property Group and Macerich Co., for example, teamed up to buy the $974.5 million ERE Yarmouth portfolio of 12 regional malls. In Cleveland, Developers Diversified Realty Corp. entered into an agreement with Prudential Real Estate Investors to form Retail Value Management, which plans to invest up to $800 million in retail projects.

REITs and developers are also doing joint-venture deals. DDR has formed joint ventures with Rosen Associates Development in Miami and Petrie Dierman Kughn in McLean, Va., to build shopping centers.

"Joint ventures are a good strategy," says E&Y's Reiss. "People in general are leery of overbuilding, but the REITs still need to show growth. Joint ventures give the appearance of continued growth without the risk of overdevelopment. It's also a good idea considering the paucity of sites in some metro areas."

Glimcher Realty Trust is a $1.4 billion shopping center and mall REIT based in Columbus, Ohio. When Glimcher bought its first mall in 1996, it was in the form of a joint venture, and that pattern continued last year when it bought two more malls with a partner - usually a capital investor such as Capital Co. of America (formerly Nomura Capital).

A Glimcher deal usually comes down to both partners going 50-50 on the equity, with the capital partner providing the debt financing and Glimcher doing the management and leasing. "All of our developments are being done in joint ventures, sometimes with a third partner, which is a developer. For example, in a Kansas City deal, Glimcher and Capital Co. of America are 45% partners and the developer a 10% partner, says William Cornely, CFO of Glimcher.

One company well known for its partnerships is The Mills Corp., a $2 billion shopping center and mall REIT based in Arlington, Va. What makes Mills Corp. so well known is that it does its developments with other notable REITs such as Simon Property Group and The Taubman Co. of Bloomfield Hills, Mich.

Mills' joint ventures are unusual because REITs usually don't work together unless they are trying to acquire a portfolio, observes George of Mid-America. "From time to time, you see two firms team up and buy an entire portfolio and divide the properties along their own strategy lines."

The Mills Corp. has done all its new projects in joint ventures. Projects it is opening up this year and the next are joint ventures as well, says Ken Parent, Mills Corp.'s executive vice president and chief financial officer.

The company started working with Simon Property Group when it needed the large firm's financial strength to guarantee more than one construction debt. That relationship continues.

"We have concluded it is better to develop two or three projects a year rather than one, and to do that we need partners," Parent says. "These relationships give us greater market penetration, tie up more projects quicker and allow us to make smaller investments in each project than we would normally need to make."

Branding irons One other thing The Mills Corp. is known for is its branding. Its malls, which have a uniquely "Mills" entertainment look and feel, include Mills in the name, such as the Arizona Mills in Tempe, Ariz. In fact, the Mills malls have been so successful, the company is looking into selling its portfolio of community shopping centers.

Another strategy is to create a brand among merchants, says William Wolfe, president and chief executive of First Washington Realty Trust, a $585 million shopping center REIT based in Bethesda, Md. "In other words, we have many regional and national chains in our shopping centers, and when they see one of our shopping centers they will say it's a First Washington center."

On the other hand, developing a brand among a customer base is not easy, Wolfe says, and may be impossible. "Frankly, our customers may not even know who owns the centers," he says. "They just know Giant Food anchors it or Safeway anchors it."

Simon Property Group is also working on a way to present a brand image, but mostly on support components like credit cards.

"They have enormous properties all over the country, and they can utilize many more loyalty shopping and credit card programs, but we really don't see the need for it," Wolfe adds. "The most important thing is to build a name and a reputation among merchants, because it is really the merchants who are our customers. They are the people who pay our rent."