Although somewhat lost in the glare of flashier commercial markets, retail REITs have a growth story to tell investors.

Investment returns posted within the public office, industrial and hotel markets seemingly have dampened the popularity of retail real estate investment trusts (REITs). Nevertheless, analysts remain bullish on public retail REITs, noting that investors are overlooking many strong companies.

"There are always favorites," says Bernard Winograd, chairman and chief executive officer for Prudential Real Estate Investors, Newark, N.J. He notes that retail REITs are getting lost in a rush to other types of commercial real estate. "There are significant opportunities in the retail sector, but they are being overlooked by most people," he says.

"It's the office and industrial sectors that are now on a roll," says Will Marks, an analyst at Montgomery Securities, San Francisco. "Their rents are increasing at a faster pace than [those] in retail centers, and, in the office and industrial sectors, there are newer companies that haven't been public for long.

"In the retail sector, there are so many public companies and more product types to chose from," he continues. "Some companies are not achieving the goals set for them, while others are performing very well."

At mid-year 1997, there were more than 45 retail REITs with a market value of more than $30 billion. "Retail is a large and important part of the REIT business," says Steve Wechsler, president and chief executive officer of Washington, D.C.-based National Association of Real Estate Investment Trusts (NAREIT). "The retail real estate business is represented through REITs more than other [commercial] sectors are."

REITs still dominate the retail industry in some specific markets. For example, they are taking an increasingly larger share of the regional mall business, which has long attracted private institutional investors like pension funds and foreign buyers.

However, as the public real estate market has boomed during the last 18 months, many retail-based companies have been left out of the investment community's shopping spree. In fact, according to NAREIT, for the first seven months of 1997, retail REITs posted an overall return of 8.28 percent, compared to the REIT industry average of 9.14 percent.

At the same time, hotels were turning out 16.35 percent returns, while industrial and office REITs together yielded 10.05 percent returns for the same period.

Lingering negativity Although returns for regional malls (9.11 percent as of July 31, 1997) and strip centers (9.30 percent) meet or exceed the average REIT performance, public retail REITs continue to suffer from market generalization. Years of retail consolidation and upheaval in the shopping center industry have produced a shyness among investors that still lingers.

"Retail REIT returns have clearly been impacted by a negative perception," says David Fick, an analyst at Legg Mason Wood Walker, Baltimore. "Many of the retail REITs that went public in 1993 and 1994 did not meet their projections, and the retail industry on average has taken an economic hit over the past few years.

"Too many investors and analysts have headed for the door rather than stay and figure out which retail REITs are in good properties and which may struggle," Fick adds. "This has depressed retail REIT prices and creates some good buying opportunities."

"The retail sector is still beaten down from the past," says Clint McDonnough, an analyst in the Dallas office of San Francisco-based E&Y Kenneth Leventhal Real Estate Group. However, he notes that a strong economy bodes well for retail sales as well as investment.

"The trend line is very positive," he says, adding that an upswing in retail REIT performance may not be far away. "It will take another three to six months before people get caught up to the fact that the great retail sales will result in more activity and better rental rates for shopping center owners," he notes.

Good news from outlet REITs Evidenced by the performance of several big-name REITs, generalization does not serve the retail industry well. For example, outlet REITs have historically posted the lowest returns for retail REIT investors (.79 percent as of July 1, 1997, according to NAREIT), but two of the largest outlet center REITs -- The Mills Corp., Arlington, Va., and Horizon Group, Muskegon, Mich. -- are taking steps to rid themselves of that shadow.

Since last summer, The Mills Corp.'s stock price has risen more than 30 percent. The developer will open two new outlet and entertainment "mega malls" -- Grapevine Mills in Dallas and Arizona Mills in Phoenix -- this fall, and it plans to open similar centers in Orange County, Calif.; Houston; and Charlotte, N.C.

"We originally wanted to do three of these every two years, but it may be possible to do more," says James Dausch, executive vice president for development. "Our pipeline has a number of candidates in it, and we have to cull it down."

Horizon Group, which owns 38 outlet centers, is no longer focused on creating new product, but is instead evaluating and repositioning its existing properties. "This company's mindset used to be development, development development, and it didn't have a hands-on management approach," says president James Wassell, who joined Horizon in May.

Earlier this year, Horizon restructured its corporate management and debt, resulting in a new focus on property management. "We don't have to worry about building critical mass," says Wassell. "What we have to worry about is obsolescence of our properties."

Acquisitions on the agenda A growing focus on existing properties is likely to emerge within the retail sector. Winograd notes that, in addition to a generalized wariness of retail performance, investors are concerned about the threat of overbuilding. "Retail square footage per capita is at an all-time high in the United States, and building continues," he explains.

In fact, some REITs do foresee a development slowdown. For example, CBL & Associates Properties Inc., Chattanooga, Tenn., is coming to the end of a blazing period of new development.

Since going public in 1993, the company has built more than 4 million sq. ft. of retail projects, reports John Foy, chief financial officer for CBL. Furthermore, as of the end of this year's second quarter, CBL had opened or was building 10 new shopping centers totalling more than 3.1 million sq. ft.

"We have consistently added new product, but this will be our record year," Foy says. Noting that new development has accounted for nearly 90 percent of CBL's growth, he predicts that new projects will slow in favor of acquisitions.

"We see a lot of acquisition opportunities where we can add value," he says. He notes that acquisitions will account for about 40 percent of the company's growth next year.

Similarly, acquisitions have become a major element of Westfield America Inc.'s growth plans. The Los Angeles-based REIT went public in May, but has been a major owner of U.S. shopping malls for 20 years.

"We see our whole future in selective acquisitions," says Randall Smith, executive vice president of marketing for Westfield. "We go in and try to take the asset from one class to another. That could be through additional department stores, entertainment or big boxes."

As a subsidiary of Australia-based Westfield Holdings Ltd., Westfield America owns nearly two dozen shopping centers in the United States, totalling 20.5 million sq. ft. With nearly 45 percent of its U.S. holdings in California, the company is seeking to expand its holdings in the Washington, D.C., area and in the Midwest.

Adopting a similar focus on acquisitions, Santa Monica, Calif.-based Macerich Co. has, since going public in 1994, nearly doubled its size through major retail purchases. With 23 U.S. malls and more than 22 million sq. ft. of space, the company's market value totals more than $2 billion.

"We see the regional mall as an investment coming a little more into favor," says Ed Coppola, executive vice president for Macerich. "We were fortunate to buy over 11 million sq. ft. in the last two or three years when the market was soft.

"Finally, retailers are out making deals," Coppola says. "We have suffered through the Chapter 11s of the small tenants, and all the worst is really behind us. We are seeing more aggressive deals being made by retailers who need to expand."

The strip center-focused REITs, too, have acquisitions in their sights. Chicago-based Bradley Real Estate Inc., the oldest REIT (IPO in 1961), and San Diego-based Pan Pacific Retail Properties Inc., the youngest REIT (IPO in August 1997), both indicate that acquiring neighborhood and community shopping centers is their choice for growth. Bradley has designs on the Midwest; Pan Pacific, the West.

According to Bradley president and chief executive officer, Tom D'Arcy, the company has set an acquisitions goal of $150 million in 1997. By August, it had already acquired 13 Midwest shopping centers, totaling 1.3 million sq. ft. at a cost of approximately $89.5 million.

"We want to become the dominant owner of grocery-anchored community and neighborhood centers in the Midwest," D'Arcy says. "The economy in the Midwest is strong and the product type has performed well," he continues.

In just weeks after its IPO, Pan Pacific acquired a 228,960 sq. ft., 99 percent occupied shopping center in Las Vegas as well as a remaining 10 percent interest in Tanasbourne Village in Hillsboro, Ore.

"As we acquire, we will maintain the diverse tenant base already present in our 26 properties," explains Pan Pacific president and chief executive officer Stuart Tanz. "Wal-Mart accounts for about 7 percent of our total base rent, and no other tenant has more than 3 percent."

Optimism for opportunities Although many retail REITs live or die by a single property type, Columbus, Ohio-based Glimcher Realty Trust has adopted diversification as the key to its performance. The REIT owns 144 shopping centers -- including strip centers, outlet centers and entertainment projects -- in 24 states.

"We're doing strips, we're doing conventional malls and we are doing new value-entertainment projects," says president David Glimcher.

"Most of the people in this business [have a single focus]. We believe that growing through diversity will be a success in the future. If one part of the business is down, another is often growing."

In August, Glimcher opened its newest project: the 814,000 sq. ft. Great Mall of the Great Plains. Located outside Kansas City, the mall combines value, outlet and entertainment tenants.

The company has two similar projects under development in Los Angeles and Elizabeth, N.J. Glimcher expects these developments to be the first in a series of new centers.

The retail landscape still has room for projects of all types, Glimcher says. "We agree that the U.S. market is overstored, but we don't believe that it's overstored in good locations," he notes. "It's overstored in secondary markets."

Like Glimcher, Stanford Alexander, president of Houston-based Weingarten Realty Investors, foresees increased opportunity for investment and growth among retail REITs. "Our portfolio is 93 percent leased, and we are seeing more interest from retailers," he notes.

However, Alexander echoes predictions of an acquisitions surge. "In many markets, there is not as much construction, which increases demand for existing centers," he explains.

With more than 21 million sq. ft. of retail space, Weingarten is currently focused on acquiring new specialty and community centers. "We invested more than $100 million last year -- an 8 or 9 percent increase in our portfolio," Alexander says. "A substantial part of our money is going to acquire and reposition existing shopping centers."

Consolidation and the cost of cash Benefitting from a strong economy, increased retail sales and -- in some cases -- diversification, public retail REITs also enjoy a lower cost of funds than private companies, says Alexander. "The companies that have access to capital at attractive prices will have the most opportunities," he notes. Combined, these factors would appear to position retail REITs for an optimistic future.

Analysts agree that retail REIT investment is poised to increase, but they note that the industry also is poised for some fallout. "It's going to be critical for REITs to consolidate," says McDonnough. "We just have too many small companies, and size does play a factor in the cost of money."

Larger companies have more stock liquidity, which makes it easier for them to attract low-cost capital, he explains. "The winners in this game [are the companies that] can buy their money cheapest," he says.

Any true consolidation in the public real estate business is likely to be years away, predicts Winograd. "Consolidations won't become significant until the [real estate] market weakens," he explains. "Somebody will overpay and make some bad decisions, but that won't become obvious until there is a recession."

More immediately, Wechsler recognizes a shift in commercial real estate from private and institutional hands to public companies. "We are in the midst of what some see as a secular change, where real estate is moving from private hands to larger scale, publicly held operations -- more in tune with the rest of American business," he says. "There is tremendous room for the industry to grow."

Steve Brown is a Dallas-based freelance writer.