The biggest question emerging from this week’s one-two punch of Centro Properties Group’s proposed buy of Heritage Property Investment Trust and Kimco Realty Corp.’s proposed acquisition of Pan Pacific Retail Properties Inc., for a combined $7.2 billion, is whether thesignal a cooling in prices for retail real estate.
In both cases, the premium being offered is far less than what REITs in other property sectors have fetched. Kimco’s offer of $70 per share represents no premium over where Pan Pacific’s shares had closed last Friday and the $36.15 per share price on Heritage is just a 3.3 percent premium. In contrast, Blackstone Group and Brookfield Properties Corp. proposed $9 billion acquisition of office REIT Trizec Corp.—announced last month--is a 15 percent markup over where Trizec’s shares had been trading prior to the deal.
Richard Moore, a REIT analyst with RBC Capital, says there were idiosyncrasies that help explain why the premiums seemed low. Pan Pacific’s unsecured debt includes covenants that, if violated, necessitate immediate prepayment with penalties. As a result, the company needed to find a buyer with a credit rating equal to its own and Kimco is one of the only firms that fits that bill.
Moreover, when rumors began flying two weeks ago that Kimco was on the verge of completing a buyout, share prices on prospective targets—which included both Pan Pacific and Heritage, in addition to other shopping center REITs—began rising.
In the case of Pan Pacific, its shares began inflating on June 26, when the company’s shares were $65-range. Still, even adjusting for that inflation, Kimco’s offer is between a six and seven percent premium—below what REITs in other sectors had been getting.
Pricing on both deals also represents a discount to consensus NAV estimates for Pan Pacific and Heritage. Pan Pacific’s consensus NAV stands at $71 per share. Meanwhile Heritage’s consensus NAV is $41.00 per share.
“My reaction, along with a lot of other people, is that maybe the community center sector is fully priced,” Moore says. “We feel very good about sector and think there is plenty of upside. The fundamentals are very good and demand by tenants is very good. The deals seem to say otherwise, but my take is that these were unique situations and even though the premiums on these deals weren’t that high, it doesn’t mean that rest of the sector can’t go up.”
There is also disconnect between the deals in the assumed cap rates and price per square foot. Pan Pacific, with its portfolio concentrated in West Coast markets with high barriers to entry, is selling at a 6 percent cap rate with the properties garnering $200 per square foot. Heritage’s portfolio, which is in the Northeast and Midwest, is considered second-tier and Centro’s price comes to a 7.2 percent cap rate and $115 per square foot. According tofrom Real Capital Analytics, of the $1.1 billion on grocery-anchored deals in the first quarter, the average cap rate was 6.8 percent with an average price of $149 per square foot.
Morgan Stanley retail REIT analyst Matthew Ostrower wrote in a research note, “We believe the primary lesson investors should take from this transaction is that lower quality shopping centers are becoming more challenging to sell, particularly in large quantities and for large prices.”
The leads to another train of thought in that prices on B and C assets, like those in the Heritage portfolio, are stabilizing or coming down.
“That part of the market is starting to turn,” says Joe French, senior-- David Bodamer advisor for Sperry Van Ness. “So much is going after the top grocery-anchor strip centers. Buyers are still willing to pay 5 and 6 cap rates for those properties. Go to Bs and Cs, and it looks different.”