REIT shares have been standout performers in a withering bear market. But among the REITs, retail issues are the break-away winners. According to the National Association of Real Estate Investment Trusts (NAREIT), equity REITs produced total returns of 13.93% during 2001. That's impressive. What's more impressive is the total return on retail REITs, which reached a 30.42%. Total return numbers combine stock price appreciation and dividends.

And the trend continues this year. Through August, total return on retail REIT stocks was 17.51% vs. 7.73% for all REITs, according to the NAREIT index. Within the retail category, Mall REITs recorded total returns of 31.88% last year and 22.98% through August of this year. Shopping center REITs showed gains of 29.89% in 2001 and 14.92% year to date.

Why the big gains? Following the tech crash, investors seeking safety moved to REITs, which were available at relatively low prices.

Of course, given the weakened state of this summer's back-to-school sales and with retailers reporting lower-than-expected results exiting the third quarter, retail REITs may not be able to sustain their gains in the long term.

But so far, so good. According to Lou Taylor, senior retail analyst with Deutsche Bank Securities in New York, retail REITs have led the REIT sector for two reasons. “First, these companies had relatively low valuations to begin with,” he says. “Secondly, retail REITs have had the fewest occupancy problems compared to other property types.”

Clearly, investors see value in retail REITs right now, but which ones have proven most able to enhance shareholder value over time?

Analysts favor mall REITs

Analysts most frequently mention CBL & Associates Properties in Chattanooga, Tenn., and Chicago-based General Growth Properties Inc. among the strongest long-term mall performers.

“Quantitatively, CBL and General Growth have the best profitability track records,” says Matthew Ostrower, an analyst with Morgan Stanley of New York.

To measure profitability, Morgan Stanley follows seven numbers over five years and averages the results for each company. The numbers include historic growth of funds from operations (FFO), the ability to report surprisingly strong FFO growth, return on invested capital, trends in return on invested capital, profit margins, trends in profit margins and the percentage of revenue devoted to general and administrative costs.

Both CBL and General Growth ranked above average in all seven categories. CBL came in first or second in four categories, and General Growth scored first or second in two categories. When all the measures are averaged, CBL ranks first in the Morgan Stanley profitability index, with General Growth in second place.

These rankings coincide with the total returns produced by both companies over the very long haul. Since going public, CBL leads all mall REITs with an average total return of 16.5% per year. General Growth ranks second in this measure at an average of 16.1% per year.

Analysts generally agree that these two companies own good properties, make wise property acquisitions, and have the management skills necessary to keep adding value to their real estate.

CBL does not own malls in major metropolitan areas, notes William E. Hauser, a New York-based portfolio manager for Activest, a wholly owned investment management company of HVB Group in Munich, Germany. “CBL blows away the competition in markets that other operators might not want to be involved in,” Hauser says. “For five straight quarters, mostly recessionary, CBL has managed strong earnings growth even though the stores in CBL malls have seen sales declines. In the second quarter of this year, the company's FFO (funds from operations) per share was $1.07, compared with $0.94 per share for the second quarter of 2001. Over the same period, the company's same store net operating income grew by a very strong 5.5%. This kind of growth tells me that CBL has a good strategy and the ability to execute.”

Analysts attribute General Growth's performance this year to a depressed stock price at the beginning of the year and agile acquisition skills. “General Growth issued a lot of equity at the end of last year in anticipation of the success of their bid for Rodamco North America,” explains Taylor of Deutsche Bank. “That depressed the stock and so they started from a lower base. Then they didn't get the Rodamco deal.”

But the company was able to pivot quickly into a series of other acquisitions, including JP Realty, a $1.1 billion deal completed in July. “Since then the company's stock has bounced back,” says Taylor.

Strip center REITs anchor portfolios

Among shopping center REITs (which is a larger category with 26 companies in the NAREIT index versus only 9 mall REITs), analysts favor a number of names, among them Developers Diversified Realty of Cleveland, Federal Realty Investment Trust of Rockville, Md., Kimco Realty Corp. of New Hyde Park, N.Y., Pan Pacific Retail Properties of Vista, Calif., and Weingarten Realty Investors of Houston.

According to Taylor, four of these five have led the shopping center REIT category in total returns during 2002. “As of early September, Weingarten was up 25%, and Developers Diversified has produced total returns of 24%,” he says. “Federal Realty and Pan Pacific are both around 22%.”

Over the long term, Morgan Stanley's index shows Pan Pacific as the top performer, with average total returns of 19.8% per year since IPO. Kimco places second, with 19.1%.

Kimco fails to make the list of current performers because of Kmart. “Kimco's portfolio contains a total of 31 closed Kmarts,” says David Havens, executive director and fixed income securities analyst with UBS Warburg in New York. “Twenty-seven of those leases have been rejected by Kmart in bankruptcy proceedings. These leases represent 4% to 5% of the Kimco's net operating income. The company reports some progress toward re-leasing 24 of these locations. Management thinks they will be able to mitigate the issue over the next 12 months.”

Weingarten, the year's top performer to date, draws praise for performing well in tough economic times. “It is not the most exciting REIT, but you can count on them doing a good job in tough times,” Hauser says. “In addition, they don't just buy and maintain properties, they enhance value through improvements.”

Taylor adds that Weingarten has assembled a loyal shareholder base. “A lot of shareholders have held these guys for 10 years and more,” he says. “Companies that consistently put up numbers over time develop shareholder loyalty, which enhances valuation and in turn lowers the cost of capital. A lower cost of equity enables companies to make acquisitions at more accretive spreads.”

Developers Diversified has performed well this year and over time, returning an average of 16.2% per year since IPO. But a complicated balance sheet has limited its appeal to investors. “People may not give Developers Diversified enough credit for their property management skills and the quality of its portfolio,” says Havens. “Investors tend to focus on the company's complicated balance sheet and its off balance sheet joint ventures. This makes it more difficult to analyze the company, and in today's environment that's not a selling point.”

Despite Federal Realty's strong performance so far this year, the company's five-year performance has been middling. Morgan Stanley's data on total returns show the company averaging 9.8% per year since 1997. Analysts have questioned the company's five-year-old strategy of moving into urban mixed-use development. In June, Federal Realty decided to return to its neighborhood center roots, a shift that may account for the company's higher 2002 returns.

Pan Pacific has climbed to the top of the grocery-anchored REIT category, logging strong 2002 returns through August.

Ann Melnick, an analyst with A.G. Edwards & Sons of St. Louis, attributes Pan Pacific's success to a singular focus on grocery-anchored retail in four western states: California, Nevada, Oregon, and Washington. “Ownership of grocery-anchored centers on the West Coast tends to be fragmented,” Melnick says. “Pan Pacific is the dominant player in the region, and they benefit from the fact that a lot of the properties they purchase are not widely marketed or bid on by other REITs. When a family owner decides to do estate planning, it tends to go directly to Pan Pacific and make a deal.”

Mike Fickes is a Baltimore-based writer.

Acquisition skills at General Growth

Good REITs know how and when to buy good real estate. Analysts agree that REITs with savvy acquisition skills generally see their stock prices rise.

General Growth Properties of Chicago tested this principle during 2002. In November of last year, the company issued $2.55 billion of non-recourse commercial mortgage pass-through certificates representing ownership interests in the REIT. General Growth intended to use the proceeds to purchase a portion of the Rodamco portfolio then on the market.

But that deal fell through, and General Growth found itself with a lot of cash and no acquisition to make. Fundraising tends to dilute stock prices, but even so, General Growth's stock held up fairly well, ending 2001 at $38.80, down from the year's high of $40.50.

To prevent an eventual dilution of its stock price, the company needed an accretive acquisition. In early March, General Growth announced a $1.1 billion agreement to acquire JP Realty, Inc.

On the surface, the acquisition looks smart. JP Realty was a relatively small owner of 18 regional malls and 26 community centers located in the inter-mountain area of Idaho, Wyoming and Utah, a region with virtually no competition from other major mall owners. “Competition in this region was somewhat limited,” says Ann Melnick, an analyst with A.G. Edwards & Sons Inc. in St. Louis.

General Growth is pursuing other transactions as well. In March, the company bought Victoria Ward Limited, a privately held Honolulu company, for $250 million. Victoria Ward owns 65 acres located two blocks from a premier General Growth property, the Ala Moana Center. At the end of August, the company acquired four regional malls in a $634 million joint venture. Most recently, in mid-September, the company acquired Pecanland Mall in Monroe, La., for $22 million in cash and the assumption of a $50 million existing loan.

During 2002, while these acquisitions were being made, General Growth's stock moved up from $38.80 to just north of $50 as of September 30. Investors, it seems, approve of the General Growth acquisition strategy.

“This company remains one of my favorite names within the REIT universe,” says William E. Hauser, the New York based portfolio manager for Activest, a wholly owned investment management company of HVB Group in Munich, Germany. “Many benefits from General Growth's portfolio changes will be derived in ensuing years. I firmly believe that General Growth is very well positioned to continue to increase market share and shareholder value via additional creative transactions.”
— Mike Fickes