REITs continue to find a way around the cap rate conundrum to grow their portfolios. Generally speaking, REITs, bound by the requirements of being public companies, have higher return thresholds than individual investors or foreign buyers. They need returns in the 7 percent range to remain profitable. That creates a problem when trying to buy in some of the nation's hottest markets, where cap rates on straight acquisitions are in the 5 percent to 6 percent range. Thus, the dominant mode for REIT acquisitions has become the joint venture.
New Hyde Park, N.Y.-based Kimco Realty Corp. continued that trend this week when it acquired 12 properties in California and Nevada for $342.9 million. Of those, 10 are part of an existing co-investment partnership with UBS Wealth Management. The purchased properties total 1.1 million square feet of space, with a 98.7 percent occupancy rate.
The move is in line with Kimco's push to position itself as an asset manager. It has formed an array of joint ventures with similar structures that minimize the amount of equity it puts into deals and instead juice its returns by recouping fees through managing and leasing the properties in the joint venture.
Kimco officials are currently participating in NAREIT’s REIT Week in New York City. During the company's presentation on Tuesday, CEO Milt Cooper said that he still sees attractive opportunities for investment in states with high projected population growth. (Both California and Nevada fit that bill nicely). Cooper also noted that he would not be surprised if cap rates in these areas moved below their current levels, from the 6 percent range down to 5 percent or even as low as 4 percent. “On an adjusted basis, cap rates are currently not too low. They have room to go lower,” he said.
Analysts have so far been impressed by Kimco’s joint venture strategy, which now accounts for one third of Kimco’s net operating income. “Apart from reducing financial and operating risk, joint ventures provide lucrative asset-management fees that boost Kimco’s return on invested capital,” writes Morningstar analyst Akash Dave.
In addition, the latest deal will beef up the company’s holdings on the West Coast, historically the weakest link in its portfolio, according to Joseph French, national director of retail with Sperry Van Ness, a real estate investment brokerage firm.
Kimco acquired two of the centers directly, including the 120,000-square-foot D’Andrea Marketplace in Sparks, Nev. and the 49,000-square-foot Black Mountain Village in San Diego, Calif. Kimco spent $53.6 million, including $17.1 million in assumed mortgage debt, on those assets. The remaining 10 properties, six located in California and four in Nevada, were purchased as part of the company’s co-investment program with UBS Wealth Management for an aggregate price of $289.3 million, including $70.1 million in mortgage debt. Kimco's program with UBS was launched in early 2005.
“With the pricing being such as it is, it’s been difficult for them to make acquisitions in the West where they could get 7 percent returns,” French notes. “This is a big purchase for them, which is very much the trend right now. The trend is to sell in portfolios and not necessarily at any discount.”
In spite of some hiccups in the housing sector, the California retail marketplace still offers some of the best fundamentals in the country, says French. In San Diego, for example, where high land and construction prices have limited the supply of new product, retail rents will post a 5.4 percent increase this year, according to research from the national brokerage firm Marcus & Millichap, to $26.24 per square foot.
The average cap rate for retail properties in San Diego for the first quarter of 2007 was 5.9 percent, compared to approximately 6.8 percent United States national average, according to Real Capital Analytics, a New York-based provider of commercial real estate investment market information.
And in Nevada, where continuing population growth and a booming housing market have contributed to new retail demand, there is the added advantage that most of the product currently being offered for sale is new construction. “You still have a number of merchant developers [there] who are building with no intention of holding, so most of the assets are new and quite desirable,” says French.
The outlook for Las Vegas for 2007 is that asking rents will increase 5.6 percent to $21.65 per square foot, while vacancy will remain the same at 4.2 percent, according to Marcus & Millichap.
The majority of Kimco’s current holdings in California are concentrated around the four major hubs of Los Angeles, San Francisco, San Jose and San Diego, with the largest being the 613,006-square-foot Westlake Shopping Center in Daly City, Calif. The firm also owns 18 properties in Nevada, half of them located in Las Vegas. The largest is the 362,758-square-foot Cheyenne Commons in Las Vegas.
Most of the above properties ended up in Kimco’s portfolio after the company purchased West Coast-based shopping center REIT Pan Pacific Retail Properties Inc. last year for $4 billion. At the time of the acquisition, Pan Pacific owned 22.6 million square feet of retail space in California, Nevada, Arizona, Washington, Oregon and New Mexico.