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Shear Survival

Early this decade, Glimcher Realty Trust embarked on a tried-and-true real estate strategy to produce greater long-term shareholder value: purge community centers and underperforming assets to emphasize premium, market-dominant malls. Over the past five years, the Columbus, Ohio-based real estate investment trust (REIT) has shredded its real estate holdings from more than 70 assets in 22 states to 27 properties in 14 states.

Glimcher Realty still has three properties it wants to chop from its portfolio, and it anticipates disposing of two by the end of the year. The challenge is that the REIT is exercising the final leg of its strategy amid consumer spending cutbacks, rising retailer bankruptcies and a credit crunch that has knocked Wall Street titans to their knees.

Despite its progress, Glimcher Realty's strategy won't totally insulate it from economic turmoil. In the third quarter, for example, the landlord reported a 6% drop to $181.8 million in funds from operations — a closely watched measure of REIT operating performance — compared with the same quarter last year.

Meanwhile, the occupancy rate among non-anchor tenants in Glimcher Realty's portfolio fell to 92.6% in the third quarter from 93.5% during the same period a year ago. At roughly 22 million sq. ft., the company ranks as one of the smaller U.S. mall REITs, a fact that concerns credit rating agencies given the company's $1.6 billion in debt compared with its $2.2 billion market capitalization as of late October.

Still, executives with the 49-year-old company are wagering that their strategy will pay off in the face of expected weak holiday sales and a prolonged recession. Glimcher Realty's occupancy, for example, is on par with the mall REIT sector, points out Michael Glimcher, chairman and CEO of the company.

Glimcher Realty's re-leasing spreads, which are base rents for new leases and renewals in space that was previously occupied for 24 months, increased 19% in the third quarter. That figure is up from 15% in the second quarter.

“The work we've done has put us in a position to weather a crazy environment that nobody could have predicted,” emphasizes the CEO. “Clearly when you get into awful economic times like this, quality is going to be a differentiating factor.”

Recession on steroids

Whether those moves are enough to generate profits in this volatile climate remains uncertain. National retail sales dropped 1.2% in September compared with the same month in 2007, which represents the largest drop since a 1.4% decrease in August 2005, according to the Commerce Department. The National Retail Federation predicts that holiday sales will only grow 2.2% this year, or half the 10-year average.

As if that's not enough gloom, non-farm payrolls plunged 760,000 in the first three quarters of 2008. Plus, unlike past recessions, a worldwide credit freeze that nobody under the age of 80 has ever experienced could turn conventional downturn wisdom on its head.

“The average person is scared and is thinking, ‘Do I really need to spend $500 this Christmas, or can I spend $250?’” says David Bonser, a partner in the Washington, D.C. law firm of Hogan & Hartson, who represents REITs and other companies in capital raising, mergers and acquisitions, and other transactions. “It will have a direct impact on retailers and eventually will impact mall owners.”

Experts consider high-quality, well-managed Class-A regional malls to be recession-resistant assets because of their market dominance and long-term leases with strong tenants. Mall REIT managers that maintain low vacancies despite retailer bankruptcies and slowing store expansions will survive this downturn, too, experts maintain, particularly if they own malls in areas with high barriers to entry. Lower-quality malls, meanwhile, will suffer.

“In down times, there's a social component of people going to the mall on a weekend or at night, so I think the quality infill product is fine,” says Bernard Haddigan, senior vice president and managing director for the national retail group of Encino, Calif.-based Marcus & Millichap Real Estate Investment Services. “There just isn't a lot of traffic in B and C malls to begin with, so it's going to get a lot softer before it gets better.”

Case in point: Mark Taylor, a national retail senior director in Marcus & Millichap's Philadelphia office, has been marketing two borderline Class-B malls in the Detroit and Philadelphia suburbs for about a year. Since that time, he says, the vacancy rates among non-anchor tenants at both properties have jumped to more than 20% from roughly 13%, and delinquent rent payments are on the rise. The eroding fundamentals have jeopardized the sale of both properties: one is under contract and the other is subject to a letter of intent.

High leverage, high risk

Ultimately, the confluence of tough economic times and scarce capital will spur consolidation among mall REITs, predicts Louis Taylor, a REIT analyst with Deutsche Bank Securities. Although he declined to say how many would remain or who would be the most likely targets, speculation for months has centered on Chicago-based General Growth Properties as a candidate.

General Growth is saddled with some $27 billion in debt, and as of late October its market capitalization had plunged to $581 million from more than $12 billion at the end of 2007.

To a lesser extent, Glimcher Realty also faces leverage challenges. The REIT's debt load as of Sept. 30 represented nearly 72.7% of its total market capitalization, which is one of the highest percentages among mall REITs. Year-to-date, Glimcher Realty's share price plummeted 70% to around $4.20 through late October, although that percentage drop wasn't unusual among REITs given the market's volatility.

Regardless, on Oct. 23 Standard & Poor's Rating Services lowered Glimcher Realty's corporate credit rating to BB- from BB, a downgrade that signifies heightened uncertainty over an issuer's ability to meet its debt obligations.

“The rating actions reflect our concerns regarding the REIT's constrained financial profile and its smaller, less competitively positioned portfolio,” said Linda Phelps, a Standard & Poor's credit analyst, in a statement.

Glimcher contends that his company is addressing its debt obligations. As of mid-October, the REIT had refinanced all of its 2008 maturities of roughly $100 million. That excludes a $42 million mortgage on a money-losing mall in Charlotte, N.C., which came due in September. Glimcher Realty wants to dispose of the mall and intentionally defaulted. Options that executives are considering include restructuring the mortgage or giving the property back to the lender.

The company also is in the market to retire about $64 million in 2009 maturities. That assumes that the anticipated sale of the Great Mall of the Great Plains in Olathe, Kan., closes this year and wipes out a $30 million mortgage maturing next year.

“We've really tried to stagger debt maturities so that we have roughly 10% coming due each year over a course of 10 years,” Glimcher says. “That way we're not dealing with it all at once.”

Softening fundamentals

Given uncertainty about consumer spending and the credit markets, investors have displayed ambivalence toward mall REITs throughout much of 2008. The companies generated a negative 1.5% total return in the third quarter of 2008, for example, an improvement over the negative 5.3% total return they posted in the second quarter, according to SNL Financial, a Charlottesville, Va.-based research organization that covers REITs, banks and other industries.

Mall REITs fell short of the 6.8% increase in total returns that all equity REITs generated in the third quarter, but they still topped the S&P 500, which recorded negative total returns of 8.4%. Cohen & Steers, an investment firm specializing in REIT mutual funds, continues to overweight regional mall REITs because the publicly traded companies are big contributors to the positive returns posted by its funds over the long haul.

In fact, at the end of the quarter, mall REITs Simon Property Group, Macerich Co. and Taubman Centers occupied three of the top 20 portfolio positions in the advisor's flagship Realty Shares fund, totaling nearly 17% of $2.3 billion in assets.

In October, however, mall REITs lost what little attraction they had amid a panicked broad-market fire sale. The sector generated negative total returns of nearly 41.7% midway through the month while all equity REITs recorded negative total returns of 33.1%, SNL reports.

Against that backdrop, mall REIT fundamentals are softening. Occupancy at Macerich's malls slipped 30 basis points to 92.9% in the second quarter this year compared with the same period a year earlier. Indianapolis-based Simon Property Group, which owns 261 million sq. ft. of regional malls, outlet centers and other properties, experienced a 20-basis-point decline in mall occupancy to 91.8% over the same period.

All told, regional mall vacancies increased 30 basis points to 6.6% in the third quarter this year over the second quarter last year, according to Reis, a New York-based commercial real estate research firm. But Deutsche Bank's Taylor suggests that vacancy rates across all retail property types, including malls, could rise as much as 300 basis points early next year as an increasing number of retailers declare bankruptcy.

Some of the most vulnerable properties, Taylor adds, are those that have high exposure to struggling retailers contemplating bankruptcy or those that have already filed. In October, Mervyns announced that it would liquidate its remaining 149 stores throughout the holiday sales season. The department store chain, which predominantly operates in the Southwest, filed for bankruptcy in July. Other recent filers include Boscov's and Steve & Barry's.

“Retailers like that will get through the Christmas selling season, but what happens to them in the first quarter?” Taylor asks. “It's the centers that have lower-end retailers with weaker credit that could see some high vacancies.”

No REIT is immune

Even some high-end mall owners can't escape retailers in Chapter 11. Los Angeles-based Macerich, for example, acquired more than 43 Mervyns stores for $430 million late last year and early this year in a sale-leaseback deal it executed with the private equity owners of Mervyns. Thirteen of the stores are located in Macerich's malls, and the REIT intends to sell several other Mervyns located within shopping centers owned by different landlords.

Officials with the mall REIT, which owns 72 regional malls totaling 77 million sq. ft., couldn't be reached. But Macerich executives told analysts in the company's second-quarter conference call that the potential value that would be created if they had to take back the space made the deal worthwhile.

Experts anticipate that additional bankruptcies to be announced early next year will increasingly affect malls. In response to the dismal economic outlook, landlords have become more aggressive in re-signing existing tenants, and in particular, securing retail operators for new developments.

Case in point: Chattanooga, Tenn.-based CBL & Associates, a REIT that owns malls and other retail centers totaling 158 properties, received commitments for 85% of the retail space in its 1.2 million sq. ft. Pearland Town Center that opened in July 20 miles south of Houston.

The project represents CBL & Associates' first foray into mixed-use, and retail tenants occupied about 70% of the 718,000 sq. ft. lifestyle center component for the grand opening.

“We pushed as hard as we could to get tenants committed and leases signed because we knew a strong grand opening was important in a weakening economy,” says Stephen Lebovitz, president of CBL & Associates. The company has instilled that attitude with leasing agents working on renewals, too, he adds. “We have a real sense of urgency because of the challenges that are out there.”

Glimcher Realty continues to see interest in its properties, as well. The company is redeveloping a former May Co. department store location at its Polaris Fashion Place mall in Columbus, Ohio, into a 160,000 sq. ft. open-air lifestyle center. The REIT has secured tenants for 90% of the $50 million project, and retailers have been moving in since late summer.

The company also expects to open the retail portion of its $250 million mixed-used development in Scottsdale, Ariz., this spring. As of early fall, tenants had executed leases to occupy 70% of the first phase of retail space, which totals 257,000 sq. ft. Phase two includes another 283,000 sq. ft. of retail space.

To a large extent, Glimcher credits strong retailer interest in the Scottsdale and Polaris properties to the years-long drive to purge the REIT's portfolio of undesirable assets. But he knows that just brings more work.

“There's a flight to quality, and whenever you push quality up, you create a new bottom,” Glimcher says. The company must keep pruning or improving underperformers, he insists. “It's one of those jobs that is never finished.”

Joe Gose is a Kansas City-based writer.

Capital-conscious REITs make liquidity a priority

The abrupt shutdown of the commercial mortgage-backed securities market last year and the recent global banking panic is forcing mall REITs to accept recourse financing and other onerous debt terms — if they can secure debt financing at all.

The new paradigm has clobbered Chicago-based General Growth Properties, the second largest U.S. mall landlord, which owns or manages more than 200 malls in 44 states. Earlier this decade, General Growth tapped significant amounts of debt to fuel a buying spree, which included its 2004 acquisition of Rouse Co. for $12.6 billion.

But a good chunk of the company's roughly $27 billion debt load matures over the next four years. In October, General Growth suspended its dividend after it fell $240 million short of raising $1.75 billion to retire loans due this year.

Among other cash-raising alternatives under consideration, General Growth plans to sell its Las Vegas properties. In a surprise move in late October, John Bucksbaum stepped down as CEO but will remain as chairman.

General Growth isn't the only mall REIT scrambling for debt. “REITs used to look at maturities a few months out and didn't worry about finding financing,” says David Bonser, a partner in the Washington, D.C., law firm of Hogan & Hartson, who represents REITs in capital-raising transactions.

“But now REITs are taking a hard look at their maturities farther out and are saying, ‘I need to get capital wherever I can, and I don't care what's it's going to cost me,’ ” adds Bonser.

Indeed, in September, Chattanooga-based CBL & Associates closed on $288 million in three financings and got a commitment for an additional $85 million in debt. An owner of 158 properties, the mall REIT received 10-year terms and fixed interest rates of 6% and 6.99% on two loans, while the others featured three-year terms with optional extensions and variable interest rates of 255 and 300 basis points over LIBOR (London Interbank Offered Rate). Additionally, one mortgage featured a 50% recourse provision and two included full recourse.

The loans addressed CBL's 2008 maturities and now it's looking to retire 2009 maturities, says Stephen Lebovitz, president of CBL & Associates. “There's so much uncertainty that the debt markets are almost frozen, so conserving cash in today's world is important.”
— Joe Gose

General Growth Properties At A Glance
Portfolio: Company owns or manages more than 200 shopping malls in 44 states
Stock Symbol: GGP (NYSE)
52-Week High:
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Closing Stock Price:
Sources: MarketWatch, company reports
TAGS: Distressed
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