After U.S. retail REITs spent much of the early 2000s aggressively expanding their empires, this year brings a reversal in strategy. Eager to take advantage of a suddenly favorable sales climate and to boost NOIs, many publicly-traded REITs are marketing non-core assets.
Australian limited property trust Westfield Group and New Hyde Park-based shopping center REIT Kimco Realty Corp. are among the highest profile examples of this trend. Westfield has a portfolio of 17 malls it is currently marketing and Kimco has expressed a desire to dispose of as many as 150 shopping centers through smaller deals.
Other retail REITs, including Simon Property Group and General Growth Properties on the mall side and Weingarten Realty and Ramco-Gershenson Properties in the shopping center sector, are pursuing similar strategies according to comments REIT executives made during their NAREIT presentations this month. Some simply want to improve the overall quality of their portfolios and raise their NOIs, while others would like to use the money from the sales to invest in higher quality assets.
The question is whether the investment sales market has become robust enough to support all these dispositions. Today, there are certainly enough buyers out there to generate sufficient interest in these properties, according to Dan Fasulo, managing director with Real Capital Analytics (RCA), a New York City-based research firm, and even class-B assets can be moved in this market. The issue for mass sellers like Westfield will be finding buyers willing to take on huge portfolios at attractive enough prices.
“You are seeing a situation where private equity has capital to allocate, you have pension funds that are back buying properties, you have some foreign money,” Fasulo says. “Westfield is not a distressed seller so they can choose not to sell if they don’t find the pricing that’s attractive. But I do think there is enough demand in the marketplace to buy these properties right now.”
A big reason why so many REITs want to do dispositions is that the investment sales market has reached a sweet spot, according to David J. Lynn, managing director with New York City-based Clarion Partners. Interest rates are at record lows and cap rates have been approaching levels not seen since the boom years. Today, everyone from publicly traded REITs to private REITs to private equity firms to pension funds has capital allocated for commercial real estate acquisitions.
What’s more, the competition for core assets has intensified so much that investors have turned their attentions to class-B centers or to centers in secondary and tertiary markets. REITs want to take advantage of that sentiment before interest rates spike or other factors disrupt demand.
During Westfield’s presentation at NAREIT two weeks ago, the company’s U.S. CFO Mark Stefanek said of the portfolio the firm is marketing, “I can’t tell you how it’s pricing, but if we didn’t think it was going well, we would have stopped it.”
REITs also have an advantage in that even properties considered non-core by a publicly-traded REIT tend to be cash-flowing, quality assets, notes Lynn. In addition, some of the assets REITs are getting rid of are premium centers that just happen to fall outside their current geographic focus, adds Bill Rose, national director of retail with Marcus & Millichap Real Estate Investment Services, an Encino, Calif.-based brokerage firm.
For example, according to comments by Michael Pappagallo, Kimco Realty Corp. executive vice president at NAREIT, the firm is looking to reinvest in 25 markets where it has a significant presence or wants to have a more significant presence and looking to sell in other markets. Westfield’s disposition strategy, meanwhile, is based in part on moving assets where it does not think it has much ability to increase returns through redevelopment or expansion.
These sorts of high grade centers that don’t fit into one REIT’s goals may end up being ideal properties for other public or private REITs to snap up. Potential buyers for Westfield’s portfolio include partnerships led by CBL & Associates Properties Trust and General Growth Properties, according to The Wall Street Journal.
Meanwhile, lower-grade assets or those in secondary or tertiary markets might make a good fit for some of the value-add funds being put together by private equity players, according to Lynn.
Private equity firms tend to be more opportunistic, Lynn notes, so they are willing to take on centers with missing anchors or those that need cosmetic improvements in the hope that they can fix up minor issues and eventually raise rental rates.
“The guys running those REITs are pretty smart guys. They wouldn’t be bringing properties to market if they didn’t think they could sell them at attractive pricing,” says Fasulo. “We’ve seen an explosion of new offerings in the last few months and it’s because values have come up a little bit.”
Pricing, in fact, is the main issue facing the REITs right now. General Growth Properties CEO Sandeep Mathrani has said he’s anxiously waiting to see how much Westfield will get for its portfolio because it will be indicative of what General Growth could hope to get for its assets.
Today, core assets in infill areas are selling at cap rates as low as 5-plus percent, according to Joseph French, national director of retail with Sperry Van Ness, a commercial real estate brokerage firm.
Assets in secondary markets, however, might sell at cap rates as high as 8.5 percent or 9.5 percent, depending on the quality of the centers. And mall sales tend to be more challenging to close than power center or shopping center transactions because so few investors can manage and operate a large regional center. The most logical contenders are other REITs or privately held regional mall operators like Texas-based Coyote Management Co., according to Rose.
“On one side, malls are a business that will be here forever, but on the other side, there is a shrinking pool of anchors and a shrinking pool of tenants,” says French. “If you are buying a mall in a secondary market you have to be more creative to lease it. They are much more complicated to run, they are basically little cities.”
As a result, cap rates on class-B malls in secondary markets might have to be in the mid-8 percent range to make them an attractive proposition to the most likely potential buyers.
Westfield seems to be trying to deal with the wide spread on cap rates between class-A and class-B assets by marketing its 17 malls as a portfolio, rather than trying to sell them one by one. “Westfield is really smart. In their portfolio, there is a bunch of good ones and a couple of ‘all right, it’s in Ohio,’” notes Fasulo. The hope is that an investor, or a consortium of investors, will want the top assets badly enough to take on the lower grade properties.
But there hasn’t been a large retail portfolio sale in the market for some time, with the exception of the Blackstone/Centro deal that was announced earlier this spring and is slated to close later this year. That was for shopping centers, however, not malls. That’s making it difficult for brokers to gauge whether Westfield’s portfolio sale will go through in one shot or whether it will have to be broken into smaller pieces. It’s also making it hard to determine what kind of pricing the portfolio might achieve.
Fasulo thinks Westfield is most likely to close a portfolio deal if it sells to some form of a partnership between a private equity firm and a pension fund, with the pension fund providing the cash. Rose, however, questions whether anyone outside the REIT players might be willing to take on a bunch of malls in secondary markets.
“The uniqueness in the mall environment is really your ability to lease space and Simon, Macerich, Taubman, those are the top players,” he notes. “If you are not one of those operators you are going to find it very challenging.”