How do you grow in 12 years to become the third largest retail real estate owner with over 470 properties? With money, and lots of it. You can always go to the public market and issue stock, but investors can be fickle. That is why for the past 10 years Developers Diversified Realty has been one of the most aggressive and creative REITs using joint venture partnerships to fuel its growth.
“There are going to be times when common shares are going to be sold at good prices and times when companies are going to be locked out. We don't want to be left out by the whims of the marketplace,” says Scott Wolstein, CEO and chairman of DDR. “We want to have access to capital.”
So, starting in 1995, DDR began a joint venture program that allowed large institutions awash with cash to invest in the retail real estate market. It has helped the company more than triple its size in the past six years from 35.7 million square feet to 108 million square feet today. For these large institutional investors, it allows them to make money from investing in high-quality assets without having to worry about managing those properties.
DDR is now involved in about 10 different partnerships and has sold about $3 billion worth of assets into its joint ventures. These ventures control about one-third of the company's portfolio, or about 157 properties. “These joint ventures represent more than 30 percent of our business so they are very significant,” says Wolstein.
Monies that DDR has collected in joint ventures, including management fees, are used to fund new development, stock buy-backs and large acquisitions. Proceeds from joint ventures also help expand the company's borrowing capacity to make huge acquisitions, such as last year's $1.15 billion purchase of 15 retail properties in Puerto Rico from Caribbean Property Group LLC.
DDR earns additional income from property and asset management fees with only a small outlay of capital. Over the years, DDR's joint ventures have evolved into partnerships where a large investor with cheaper capital provides most of the money for acquisitions, while the Beachwood, Ohio-based REIT holds a minority interest and manages the assets. In 2004, DDR collected about $17 million, or 6 percent of funds from operations, in management and leasing fees from its joint ventures. While that may seem paltry compared to total FFO of $292 million, it makes a difference. “On the margin, the management fees are very important,” says Wolstein.
And while many REITs now have joint ventures of their own, The company was the first, says Wolstein. These days, DDR can be picky about its partners and can even demand a promote structure, such as its Macquarie DDR Trust with Australian Macquarie Bank Limited, where DDR takes a larger share of the profits after both parties initial investment is paid. “Now, we demand a disproportionate participation in the value creation because of the services we provide,” says Wolstein.
But back in 1995, when DDR started its first partnership with DRA Advisors LLC, it took a 50/50 partnership. DRA Advisors is a New York City-based real estate investor for large pension funds and college endowments. “I think we always realized that [minority ownership] structure had drawbacks, but in the early days we didn't have as many options to raise the capital,” says Wolstein. “We had to give the capital a better deal.”
Wolstein learned about joint ventures through his experience as a corporate lawyer in the late ‘70s. In 1981, he founded Diversified Equities, an investment company, which specialized in raising capital for investments with tax advantages such as real estate, river barges and cable TV stations.
Diversified merged with DDR in 1993 to form a company with more than $200 million in assets. Then in 1995, DDR started its joint venture program. Initially, many investors were skeptical of joint ventures because they added an extra layer of complexity and required additional work to understand the partnership's structure.
“But in the past few years, everyone has jumped onto the bandwagon and that criticism has fallen to the wayside,” says Wolstein.
According to Real Capital Analytics, REITs have bought $742.1 million in assets with foreign partners and $1.7 billion with institutions. By May, REITs had already done $1.4 billion worth of deals with institutions.
DDR still has a partnership with DRA Advisors, which holds $400 to $500 million in assets. However, if DDR were to do that venture today, it would demand a promote structure, says Wolstein.
Besides being a pioneer, DDR is also very innovative in how it creates private sources of capital. Wanting a similar structure that it had with DRA Advisors, but more control, the company created its own real estate investment management firm in 1998 called Coventry Real Estate Advisors. Coventry raises funds from private and public pensions and foundations for exclusive deals with DDR. Because these investors are seeking a high rate of return, DDR uses these funds to purchase underperforming properties for redevelopment. DDR invests 20 percent of the equity for acquisitions, and handles leasing, management and redevelopment. “The advantage of this fund is that our institutional investors get access to DDR's platform that they couldn't otherwise,” says Peter Henkel, president of Coventry. “It also helps to broaden DDR's access to capital. At least in retail real estate, DDR is the only public REIT that has created a relationship like they have with Coventry.”
Coventry's first fund raised $800 million of capital from private investors such as pension funds. The company also has a second fund worth $1.1 billion, of which only $300 million has been spent. The remaining amount is expected to be disposed of within the next two years.
Because Coventry is a close-ended fund, it only has a limited time to dispose of assets and provide a return. While Coventry provides DDR ready capital, its structure requires that the REIT divest itself quickly of properties it spent time and money redeveloping.
“Typically, the partner wants to sell when the market offers the highest price,” says Wolstein. “That puts us in the horns of a dilemma, because do we want to buy them out at the top of the market or end up losing some choice assets?” That is why DDR's modus operandi going forward will be infinite-life partnerships such as Macquarie DDR Trust. Founded in 2003, it is an Australian limited property trust that takes capital from Australian pension funds and invests it in U.S. real estate. A joint venture of DDR and Macquarie Bank Limited, the trust currently has $2.25 billion worth of assets and trades on the Australian Stock Exchange.
It is typical of many of DDR's recent partnerships where a large investor buys a majority ownership interest; in this case 85.5 percent, and DDR holds a smaller interest but handles day-to-day management. Macquarie DDR Trust invests in DDR's core asset — power centers — looking to hold those properties. “Our investors are looking for secure lines of income,” says Mark Baillie, head of real estate, North America and Europe for Macquarie Real Estate Inc., also a subsidiary of the Australian bank. “They are bringing best of breed asset management skills and we are bringing best of breed fund and capital management skills,” says Baillie.
Since 1995, other REITs, including Kimco Realty Corp., Regency Centers and Inland Real Estate Group of Cos., have taken advantage of joint venture partnerships. “It allows us to grow and control more assets, and scale and size are very important in our business,” says David Henry, chief investment officer of Kimco. “The more leases you have with a tenant, the better relationship you have.” Kimco currently manages about 170 properties through its joint ventures representing about 20 percent of its portfolio.
Recently, Regency also has formed a trust with Macquarie, called Macquarie CountryWide Trust. The joint venture was part of the largest shopping center portfolio deal ever in the U.S.: the $2.74 billion purchase of 101 centers from First Washington and CalPERS. That purchase accounts for 35 percent of Regency's portfolio. “We wouldn't have been able to do that without a joint venture partner because of the amount of capital it required,” says Lisa Palmer, senior vice president of capital markets for Regency.
While Wolstein says the company is not actively seeking new partners, it intends to continue programs it started. Of its Coventry II Fund, it still has about $800 million in acquisitions of under used shopping centers to make in the next two years.
“There are billions of dollars in pension funds,” says Wolstein. “It's incumbent upon the industry to give the pension funds and other investors a chance to invest with these other public companies.”
How do you triple your size and increase your revenue stream without having to constantly raise capital from the public stock market?
Allow large private investors, such as pension funds, a chance to increase their own income streams by investing in retail real estate through joint ventures. Awash with plenty of cash, the investors provide a majority of the capital, while REITs like DDR use their management skills to control the properties.
Since DDR began joint ventures in the REIT sector in 1995, it has become increasingly commonplace. Joint ventures also allow DDR to earn extra income from property management and asset management fees paid by the venture partner.
DDR's joint venture program now controls about 157 properties, or about one-third of the company's portfolio. Seeing the success of joint partnerships, REITs have already purchased $1.4 billion worth of deals with capital from institutions such as pension funds, according to Real Capital Analytics.
Macquarie DDR Trust
- Australia-based Macquarie Bank Limited formed joint venture with DDR in March 2003
- Currently holds 35 community centers with over 14 million square feet worth over $2 billion
- DDR maintains a 14.5 percent ownership stake
- Also has JVs with Regency Centers and ProLogis
Coventry Real Estate Funds
- Has exclusive rights to buy under performing assets from DDR for its institutional clients
- Coventry I Real Estate Fund raised $330 million in equity capital from private and public pensions
- Coventry II Real Estate Fund raised $1.1 billion
- Both are closed-ended funds
Kuwait Financial Centre-Markaz
- A Kuwaiti publically-traded company
- Joint venture formed in 2003
- It holds about 20 properties with over 2.3 million square feet and worth about $360 million
- Kuwait Financial Centre also owns distribution centers in the US with Robert Pattilo Properties
Service Merchandise portfolio with Klaff Realty and Lubert-Adler
- Formed in March 2002, the partnership bought asset designation rights for retail real estate interests of Service Merchandise Corporation for $242 million
- By the end of 2004, the portfolio consisted of 63 retail sites totaling about 3.4 million square feet
- Klaff Realty also has a joint venture partnership with Kimco for Kmart leases
Prudential Real Estate Investors
- DDR's newest joint venture was formed in October 2004 and holds 12 grocery-anchored properties worth $128 million (eight are from the Benderson portfolio)
- DDR maintains 10 percent ownership
- Formed in 1995, DRA Advisors is 50/50 partner
- Still has about $400 - $500 million in assets
- Many assets bought by Macquarie DDR Trust
- Finite life venture