Parched Retail REITs Seek Relief

Companies are digging for hidden springs, cashing in assets and raising equity to pay looming debts.

In the corridors of the country's most powerful retail real estate companies, as recession scorches the capital markets, chief executives are making wrenching decisions to quench their thirst for cash and assure their companies' survival.

Pressure from weakening fundamentals and tanking stock prices is forcing retail real estate investment trusts (REITs) to take drastic steps with long-term consequences, such as selling prized assets or raising equity in the company.

For instance, Kimco Realty Corp., a shopping center REIT whose stock lost 81% of its value over the past year, is selling 70 million shares to pay off a fraction of its $7.5 billion of debt and has raised $750 million, according to New York-based Fitch Ratings. Kimco, based in New Hyde Park, N.Y., announced the offering in late April, a month after Indianapolis-based Simon Property Group sold 15 million shares. Simon raised $550 million, Fitch says.

“The industry as a whole desperately needs equity capital,” says William Morrill, managing director of CB Richard Ellis Global Real Estate Securities. “Survival is the key here,” he says. REIT managers witnessed a sobering example of the dangers of a credit-deprived market in April, as the nation's second largest regional mall owner, Chicago-based General Growth Properties (NYSE: GGP), filed for Chapter 11 bankruptcy after it was unable to refinance its $27.3 billion debt and creditors would not defer loan payments.

But even for healthier REITs, raising cash has its pitfalls. The problem with unloading millions of shares in the current recession is that the short-term cash gain can prove expensive to a company in the long run. Shares are selling at far below their 52-week highs, and issuing equity gives buyers more power in company decisions.

But cash-strapped REITs with debts coming due are biting the bullet. “It pains them to do it, and it's diluting [stock values and equity stakes] so they are losing shareholders, but survival is more important than dilution at this point,” says Morrill.

Besides selling assets, other steps the retail REITs are taking to raise or conserve funds include forming joint ventures with credit partners, cutting dividends or paying dividends in stock rather than cash, renewing tenant leases early to keep income flowing, and paring operating expenses. Many companies have put development projects on hold — or abandoned them altogether.

Unloading malls

“Heading into the downturn we sold six malls out of 25,” says Marshall Loeb, president and chief operating officer of Glimcher Realty Trust, a shopping center REIT based in Columbus, Ohio. The last sale closed early this year. Glimcher projects net operating income to fall 3% in 2009 and its mall occupancy rate to decline 2.5%. The REIT is considering joint ventures and selling more assets in order to raise much-needed capital.

“Many REITs are net sellers in this kind of market,” says Keven Lindemann, director of the real estate group at SNL Financial, based in Charlottesville, Va. They're trying to shore up their balance sheets, he says.

Developers Diversified Realty (NYSE: DDR), based in Beachwood, Ohio, which has been beset by liquidity problems, sold 29 properties in the first quarter through mid-March, says Lindemann. “They bought 11 properties, but that's a net decline.” Kimco sold 19 properties and bought 14, while Regency sold 26 properties and bought only two. “That's a pretty significant decline,” he says.

Simon Property Group, the largest retail landlord in the U.S. with 246 million sq. ft., sold one property and bought none, Lindemann notes. Many analysts believe Simon is storing up cash to make large opportunistic buys of distressed portfolios in the near future.

REIT stocks have been sinking by 50% to 80%, in many cases. Glimcher's stock plunged from a 52-week high of $13.46 to $2.52 on April 23. “You empathize with all your investors,” Loeb says. Still, the stock prices have had little effect on operations, Loeb adds. The REIT's shopping center portfolio finished the year 94% leased.

A number of tenants have approached the mall owner recently for concessions in rent or lease terms, but Loeb's no pushover. “In most cases you end up not making adjustments to the lease. We have their occupancy costs, too, and a lot of times we think they're at a healthy number and they're okay.”

He may offer a tradeoff, perhaps a one-year rent reduction in return for the tenant's agreement to catch up the following year. “If they're really a critical tenant to the center and we think they need help, yes, we will work with them.”

Loeb is pinching pennies, generating revenue even as he slashes expenses. His company structured a solar roof project to earn half-a-penny a share from it, and earns royalties from setting up Wi-Fi at a shopping center food court.

REITs are burdened with debt and fear they won't be able to refinance mortgages if banks don't free up cash soon. Their problems, in many cases, have beencompounded by rapid expansion in the five-year boom period preceding the collapse of Wall Street investment banks.

Now commercial development has ground to a near-halt and income is jeopardized by skittish consumers afraid to spend amid massive job losses — 663,000 payroll positions eliminated in March alone. So REITs are forced to hunt for cash to pay their maturing debts.

Pressure on cap rates

The tight credit markets, declining valuations, slumping sales and climbing vacancy rates are putting upward pressure on capitalization rates, the initial return based on the purchase price, real estate services firm Jones Lang LaSalle notes in its mid-year retail investment report. It estimates that cap rates will hit 7% this year for properties with assumable debt and double-digits for strip centers without grocery stores.

Foreclosures are rising and will likely peak in 2010, the report says. Mall and shopping center sales amounted to a relatively paltry $20.7 billion last year, a 71% decline from 2007.

Grocery-anchored centers are performing better than regional malls or power centers. In short, while people have to eat, they don't have to buy iPods.

Fundamentals are eroding across the sector. In the first quarter, the vacancy rate for neighborhood and community centers rose to 9.5%, up sharply from 7.7% over the same period of 2008, reports New York-based research firm Reis. Meanwhile, regional mall vacancy rose to 7.9% from 5.9% a year earlier.

Many smaller-market malls are having a tough time. Financial stress dealt a blow to the Macon Mall, a 1.4 million sq. ft. center in Macon, Ga., anchored by Macy's, JCPenney, Belk and Sears. “It's on the market because the existing owners put it into receivership. It was not able to meet its debt service,” says Kris Cooper, managing director of retail investment sales at brokerage Jones Lang LaSalle.

The mall needs an entrepreneurial hand, says Cooper, a new owner to take care of capital improvements and turn the property around. Opportunities are available across the country, since property values have dropped by an estimated 25% to 30%, depending on the area, Cooper notes. “Clearly we've taken a hit across the board.”

Skirting the banks

The trick to closing a retail deal today is not to beseech the big banks, but to skirt them. “Our sellers are carrying back financing, providing first mortgage financing, or there are loans that can be assumed,” Cooper says. “That's the only way they're getting done.” Some regional banks are lending for projects below $50 million, and local companies at times fund a hometown development.

REITs are pursuing joint ventures with partners able to provide credit or cash for maturing debts, development or acquisitions, although there aren't many buyers. Acquisitions by publicly traded REITs sank from $10.1 billion in 2007 to $1.3 billion in 2008, according to New York-based research firm Real Capital Analytics. So even with partners, buying is rare.

And joint ventures can backfire. Some partners run out of cash or credit. “You've seen a lot of these fund-type businesses fall apart. That's part of the reason Developers Diversified is struggling at the moment,” says CBRE financial analyst Seth Cohn.

DDR partnered with New York-based Coventry Real Estate Advisors to buy shopping centers, with DDR investing 20% and Coventry, 80%. However, in March, Ward Parkway Center in Kansas City, Mo. faced foreclosure after Coventry defaulted on its payment, according to the lender. The joint venture bought the mall in 2003 for $48.5 million. DDR declined to comment.

Regency also has had a troubled partnership, Cohn explains, with Australian fund Macquarie Countrywide Trust. “They have this agreement with Regency and it's not doing well. It's a big threat to Regency as a stock that Macquarie's not going to come up with the capital to keep these projects afloat,” says Cohn. “That's another example of some difficulties that lie ahead for these strip center REITs.” Regency also declined to be interviewed.

Despite the risks, joint ventures offer a solution for many cash-strapped REITs. “When you do a joint venture, you don't put the debt on your balance sheet,” says Morrill of CBRE. Since the joint venture represents a separate entity with its own expenses and revenues, some REITs loaded up more debt than they could handle.

Trading at discounts

Retail REITs have taken a beating during the recession, says Lindemann of SNL Financial. Their stocks, particularly regional malls, are trading at tremendous discounts to what analysts believe is the underlying value of their assets.

“Federal Realty, which is widely viewed as having one of the strongest portfolios of shopping center properties, is trading at about 75% of its net asset value,” Lindemann notes. Overall, shopping centers are trading at about a 50% discount to their net asset value (NAV), he adds. However, before General Growth's bankruptcy filing in March, it was trading at a 98% discount to NAV, Lindemann says.

Even strong players like Simon and Taubman Centers are trading at big discounts. Simon was trading at roughly a 57% discount in March, Lindemann says. Its stock closed at $48.41 on April 23, down from a 52-week high of $106.43.

It's not only stocks that have fallen. According to the National Association of Real Estate Investment Trusts, total retail REIT returns declined 36.6% from January through early April 2009 following a drop of 48.4% in 2008.

And the industry has been consolidating. Long before the recession, the sector began shrinking from 14 public regional mall REITs in December 1998 to just nine by December of 2008. The number of public retail REITs contracted from 55 in 1998 to 29 by December 2008, SNL reports. Across all property types, including office and industrial, the number of public REITs dropped from 198 to 121.

But while the number of REITs has shrunk, the business model won't go away soon, says Steven Marks, managing director at Fitch Ratings in New York. For one thing, few mergers are taking place. And who has the debt capital to finance taking a REIT private? That would involve buying a massive number of shares, and the trend is deleveraging, not bulking up.

“They have challenges. They're going to have to rethink their tenant strategies,” says Lynne Sagalyn, director of the Paul Milstein Center for Real Estate at Columbia University.

Who will survive?

Fitch gives Simon an A- rating and Regency a rating of BBB+. On March 27, Fitch downgraded DDR to BBB- with a negative rating outlook, despite a cash infusion of $170 million and a $60 million secured mortgage from the Alexander Otto family in Germany.

Marks estimates that DDR has $250 million of secured debt coming due in 2009, and $1.1 billion in 2010. That doesn't include maturities under the company's revolving line of credit with banks. The company has to lighten its debt load to survive, analysts say, and they question whether it can.

“They're clearly in some trouble,” says Mike Magerman, senior vice president at Realpoint, a credit rating agency based in Horsham, Pa. “They have already drawn substantially on their credit lines, so they don't have a whole lot of flexibility.” Forced sales may be their only option, he says.

As with General Growth, which vows to recover from bankruptcy, DDR's portfolio is widely regarded as attractive. But will the two REITs be around in a year or two?

Morrill of CBRE Global Real Estate Securities has his doubts. “I would be surprised if General Growth is. I think it's 50-50 on DDR.”

Denise Kalette is senior associate editor.

Tanger takes a bow as outlet centers shine

A mid the downbeat news of faltering fundamentals and scarce credit, an unlikely star is turning heads in the world of real estate investment trusts (REITs).

Tanger Outlet Centers, based in Greensboro, N.C., is garnering praise for the performance of its stock and bottom line at a time when many shopping center and mall owners are struggling to stay afloat. The outlet REIT's stock price closed at $35.03 on April 24, down from a 52-week high of $46.30, but up 3% from the previous close. Considering that some retail stocks have plunged by 80%, Tanger's stock is considered relatively robust.

The company operates 33 outlet centers in 22 states, offering upscale labels such as Nike, Liz Claiborne, Polo Ralph Lauren and Tommy Hilfiger. Tanger's 2,000 stores feature factory direct merchandise, which the REIT says can lead to consumer discounts of 20% to 40%.

In the first quarter, CEO Steven Tanger announced that the company would increase its common share dividend for the 16th consecutive year. Same-center net operating income increased 2.4% for the quarter compared with 2.5% in the fourth quarter of 2008 and 5.7% in the first quarter of 2008.

“That's an absolutely excellent story. The outlet center space is a place where retailers are opening lots of stores. The demand for outlet center space is very high,” says Rich Moore, an analyst with investment bank RBC Capital Markets. Other outlet companies also are flourishing, he says.

William Morrill, managing director of CB Richard Ellis Global Real Estate Securities, ranks Tanger's chance of surviving the recession as high as that of the far larger Simon Property Group. “Tanger has a very good debt structure.” And consumers want to save cash by buying goods at lower prices, he adds.

Unlike many REITs, Tanger stock is trading at prices that closely reflect the estimated value of its underlying assets, says Keven Lindemann, director of the real estate group at SNL Financial in Charlottesville, Va. “That does suggest that the market believes them to be a bit more resilient and maybe better positioned to perform well in this kind of market.”

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