In the depths of recession, after big-name retailers flipped off their lights for good, lenders everywhere warned landlords of the penalties for violating loan covenants. Marshall Loeb, president of mall owner Glimcher Realty Trust, remembers all too well when drowning retailers threatened to pull his company under.

As Glimcher lost rental income, the Columbus, Ohio-based real estate investment trust (REIT) drifted closer to the financial danger zone. The company risked losing its financing, and incurring punitive legal actions by the lender and tax consequences. But it navigated the dangers. “Most of those retailers we lost were struggling in a good economy,” says Loeb. “When things went bad — euthanasia is probably too strong a word.”

Like so many mall owners, Glimcher (NYSE: GRT) was highly leveraged and its debt acted as an albatross. But over the past 12 months, the REIT has made wrenching decisions to improve its balance sheet. The toughest was committing to sell a majority stake in two of its choicest properties, the 1.5 million sq. ft. Lloyd Center in Portland, Ore., anchored by Nordstrom and Macy’s, and the 1.1 million sq. ft. WestShore Plaza in Tampa, Fla., with its Main Street design, Saks Fifth Avenue, Ann Taylor and Maggiano’s Little Italy restaurant.

Glimcher made a deal with The Blackstone Group, the New York-based private equity goliath. Blackstone snapped up a 60% interest in each of the centers, a combined transaction valued at $320 million that closed in March. Glimcher continues to manage the two assets.

A year earlier when it needed capital, Glimcher had sold six lower-quality malls, but by early 2010 there was no market for underperforming properties. “We made sacrifices for the good of the company,” explains Loeb. Today, the retail REIT is still standing, as are others whose executives made sacrifices for the good of their companies.

Hard decisions

REITs have had little choice in making tough calls. “There were lots of companies on the ropes last year,” says Keven Lindemann, director of real estate at research firm SNL Financial, based in Charlottesville, Va.
The harrowing financial crisis that has bled nonfarm payrolls by approximately 8.2 million since December 2007 profoundly damaged consumer spending. Thousands of store closures compelled landlords to grant concessions to keep struggling mall tenants. That left owners with dangerously high levels of debt.

REITs had a dire need for capital to pay down their debt at a time when lenders balked at refinancing. And they needed cash to cover expenses. Options were few. Some REITs sold properties or sent them back to the lenders. Others raised millions of dollars of equity, which diluted the value of shareholders’ stock. They paid dividends in shares to conserve cash.

Glimcher warned shareholders in its 2009 annual report that bankruptcy and falling income among tenants could reduce the REIT’s cash flow, since its income depends on tenant payments. If conditions worsened, executives said, the company might be unable to redevelop or even operate its properties. Projects might have to be postponed and resume later at higher cost. At year’s end, it had $1.6 billion in debt, with several maturing loans that would trigger balloon payments.

Fellow REITs were saddled with similar debts. In some cases, they reflected too much ambition, too many mergers and acquisitions. But the mall companies have absorbed painful lessons. “They showed that they are human like any other group of people and they overdo things,” says William Morrill, managing director of CB Richard Ellis Global Real Estate Securities. “They had too much debt. They developed too many properties.”

Once retail REITs had tightened their belts, raised equity and accessed the debt markets, their balance sheets and prospects strengthened as stock prices soared. Yet that very success poses a predicament for investors, contends Morrill.

A year ago, Indianapolis-based Simon Property Group (NYSE: SPG) and Taubman Centers (NYSE: TCO), based in Bloomfield Hills, Mich., were trading at more than 50% discounts to net asset value (NAV), says Morrill. Today the mall REITs are trading at 30% to 40% premiums to NAV. “The stocks were screaming buys a year ago,” Morrill says. Now, he contends, they’re overvalued and far less attractive as an investment.

Too much, too soon?

Retail REIT stock prices have risen by at least 100% in many cases in the last two years. From a 52-week low of $2.20, Glimcher’s stock rose to close at $6.41 on April 28. Shares of Simon, the largest REIT, roared into the stratosphere from a 52-week low of $44.65 to close at $87.63 on April 28. And Taubman, considered by many analysts to own the crown jewels of regional malls, saw its stock price rise from $21.55 to $42.53 over the same period.

Investors should consider well-run retail REITs an ideal long-term hold for their portfolios, says Morrill. “But you wouldn’t go out and double up on them today because the stocks are overbought.” The next few months will be tough, as the mall operators continue to pay down debt and regain their footing, he says. “It’s going to be a slow comeback.” But the comeback has started, in his view, and there’s less pessimism about operating results than there was in May 2009.

“I think there’s a collective judgment in the investment marketplace that [retailers] are going to be ramping up their earnings, and that the next 12 to 24 months are going to be surprisingly good for them,” says Ralph Block, a REIT historian and author based in Westlake Village, Calif. Retailers are likely to open new stores, and they’ll have the clout to bargain over lease rates, he says.

Store openings would be welcome news for REITs. The national vacancy rate reached 8.9% in the first quarter — a 10-year high — up from 7.9% a year earlier, according to New York-based research firm Reis.

However, Bethesda, Md.-based data firm CoStar Group puts the vacancy rate at 7.5% for regional malls and 4% for super-regional malls, based on data collected by its staff of 1,500. “Fundamentals are improving,” asserts CoStar CEO Andrew Florance. Fresh leasing activity is an early indicator of an economic comeback, he says.

The most riveting comeback saga to date belongs to General Growth Properties (NYSE: GGP). The Chicago-based company, which filed for Chapter 11 bankruptcy protection a year ago after it was unable to repay more than $25 billion in debt, finds itself the focus of a bidding war.

The owner of more than 200 quality malls, General Growth is being courted by Simon and Toronto-based Brookfield Asset Management (NYSE: BAM). In April, Simon raised the stakes by pledging a $1.5 billion line of credit for General Growth’s emergence from bankruptcy.

Some analysts credit the fight over General Growth with stimulating the REIT market. And Terry Brown, CEO of shopping center developer Edens & Avant, based in Columbia, S.C., believes General Growth’s ability to recapitalize was a turning point for the industry. “Clearly, a year ago or even six months ago, there was still uncertainty as to the survival of some of the mall REITs,” he says. “But I don’t think their survival is at stake anymore.”

Goldman Sachs ponies up

The priority for REITs is paying the bills, and some have found a helping hand with investment banker Goldman Sachs. Taubman got a $77 million commercial mortgage-backed securities (CMBS) loan from Goldman, reports CoStar. The loan is backed by Taubman’s 612,000 sq. ft. Mall at Partridge Creek in Clinton Township, Mich., and will help pay off an $81 million construction loan.

Taubman has had its share of troubles. In April, its mortgage lender sued the company for The Pier Shops at Caesars in Atlantic City, N.J., after a loan default, Taubman said in its April 22 statement. The property is expected to be auctioned off by the third quarter.

The REIT’s funds from operations (FFO) fell in the first quarter to 60 cents per diluted share from 70 cents a year earlier. The results are in line with expectations, said chairman Robert Taubman in a statement. He blamed lease cancellations and lower rents.

Like Taubman, Glimcher benefitted from a Goldman CMBS loan. The $55 million loan was backed by a 566,000 sq. ft. mall in Johnson City, Tenn. The mall generated $409 per sq. ft. in 2009 sales, making it one of Glimcher’s best performers. Glimcher refinanced the mall as part of an effort to resolve its debt issues.

Fitch goes negative

New York-based Fitch Ratings in April maintained a negative outlook for both the U.S. equity REIT sector and for retail REITs. Many companies are over-levered and fundamentals are weak, says Steven Marks, managing director of Fitch Ratings. “Those are probably the two biggest drivers, leverage and fundamentals.”

While Fitch provides an outlook on a company’s credit, it does not have a view on where equity is trading, Marks notes. REITs have strengthened recently, and some are preparing to buy private mall companies with debt problems, he says. “The private companies may need to sell. As buyers, I think REITs throughout this cycle are going to be the solution as opposed to the problem.”

But debt issues loom for the companies. “Leverage clearly is a four-letter word right now,” says Jeung Hyun, portfolio manager at Oakland, Calif.-based Adelante Capital Management, which has invested about $2.5 billion for mostly institutional clients. He foresees improvement in the REIT market.

“The uptick is seemingly a little bit stronger than one would suspect. I think you’re going to see some really good numbers for the first half of this year and then we’ll see whether the recovery is sustainable.” Adelante has invested in Taubman, Macerich, Simon and other mall REITs.

Still, investors are concerned about a drop in the underlying value of mall properties. U.S. commercial real estate values have dropped by 42% since the peak in 2007, and regional mall values have dropped by at least 25%, says Florance.

With values uncertain and credit tight, new projects are nearly at a standstill. The lone regional mall being developed in the U.S. is Taubman’s $1.5 billion City Creek Center in Salt Lake City, scheduled to open in 2012. Anchored by a 124,000 sq. ft. Nordstrom and a 150,000 sq. ft. Macy’s, the mall’s jazzy design calls for a retractable glass roof. “It’s a joint venture, so they’re not taking 100% of the risk on their shoulders,” says CB Richard Ellis financial analyst Seth Cohn.

On the tenant side, recession forced many retailers to abandon growth plans. In 2006, JCPenney, based in Plano, Texas, planned to open 50 stores a year for five years. “We opened 50 stores in 2007 and we were lining up new stores for the coming years, but we began to slow the pace in 2008,” says spokesman Tim Lyons.

JCPenney opened 36 stores in 2008, 17 in 2009, and two stores through early April 2010, he says. One store is planned for 2011. The chain has 1,110 stores in the U.S., about 100 more than five years ago. Most of the newer stores have been built in freestanding locations rather than in malls.

‘Halloween store’ factor

At the lowest point of the downturn in early 2009, as retail chains pulled out and left an empty storefront, mall landlords stepped in to disguise the loss, says CoStar CEO Florance. “A super-regional center will bring in a Halloween store before they will let the window sit vacant.” But he believes fewer temporary stores will be needed as the recovery takes hold.

As retailers strengthen, they likely will gravitate to stronger-performing malls, says Block, the REIT historian. “Everybody’s been saying the consumer is dead. But the consumer is not dead. Ninety percent of the people in this country are employed.”

For Loeb, the president of Glimcher, talk of recovery is welcome news, and may comfort shareholders when they gather in Columbus June 4. His mall store sales rose 4% in the first quarter. After renovating the Ashland Town Center in Ashland, Ky., and installing a Panera Bread restaurant, he hopes sales will rise to $400 per sq. ft. this year from $390 per sq. ft. last year.

Loeb is relieved about the partnership with Blackstone at the malls in Portland and Tampa, and unfazed by Blackstone’s size. “I’d rather have a big powerful partner than a weak one.”

He hopes the dark days when banks routinely denied loans to retailers are past. “They would look for the landlord to be the bank,” says Loeb. “We don’t have that kind of capital. We can’t be everybody’s bank.”
Denise Kalette is senior associate editor.