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REITs Explore New Capital Strategies

Continued capital constraints have not derailed REIT expansion. REITs are simply becoming more aggressive in tapping alternative financing sources.

"The retail market itself has been very good," says John Bucksbaum, CEO of General Growth Properties in Chicago. Business fundamentals in the retail industry remain strong, with a healthy demand for space and continued increases in rental rates.

"Where things have been disconnected is Wall Street's reaction to REITs," says Perry Grueber, vice president of investor relations at Cleveland-based Developers Diversified Realty Corp. (DDR). Despite the fact that REITs have outperformed other indexes such as the Dow Jones, Standard & Poors 500 and NASDAQ in the last six months, many REITs continue to experience depressed stock prices. "REIT shares overall are still trading at a significant discount compared to net asset value," Grueber says.

Although the low prices have been good news for investors shopping for bargains, it has made it difficult for REITs to raise capital in equity markets. "There just hasn't been a significant amount of new investment capital finding its way into the REIT sector," Grueber says. Investors have been slow to embrace REITs despite improving performance. As of April 28, the total return for retail REITs averaged 8.9% compared to 1999 returns of -11.8%.

One reason prices have not increased along with improving performance is because investors in general are more cautious. Volatility in the tech sector has sparked new interest in REIT stocks, but buying has not increased dramatically. "People are just a little uncertain of where the market and the economy is going," Grueber says. REIT shares will likely continue to trade at a discount to values until there is more clear evidence of where the market and economy are headed, he says.

Regardless of the struggles on Wall Street, REITs are not backing off expansion plans. "We continue to grow through what we call core acquisitions of real estate properties that have opportunity to add value, and we also do ground up development," says Scott Onufrey, director of investor relations for Kimco Realty Corp. in New Hyde Park, NY. One new Kimco development is Forum at Olympia, a 1.2 million sq. ft. shopping center in San Antonio. The 600,000 sq. ft. first phase is under construction with tenants that include Best Buy, Office Max and Target. A key ingredient to such expansion efforts has been to identify new sources of capital.

Securing capital One way REITs can obtain capital is by issuing equity. Considering the under-valued stock prices, this is not a viable option for most REITs. General Growth is one of the few firms that have risked an equity issuance in the current market. The regional mall REIT issued 10 million shares of stock in July 1999, an aggressive move that was partly to blame for a subsequent price drop. There was concern that the large issuance would dilute earnings, which has not proved to be the case, Bucksbaum notes.

General Growth raised about $330 million in its stock issuance, which it has used to further its acquisition strategy. "In the last five years, we have been very active in the acquisitions area," Bucksbaum says. The majority of the funds raised in last year's stock issuance went towards the purchase of the 1.8 million sq. ft. Ala Moana Center in Honolulu. "That is just a fantastic shopping center that is far and away exceeding expectations in terms of performance," Bucksbaum says.

Debt financing is another financing option. However, most REITs have been cautious about over-leveraging their balance sheets. "We're pretty fortunate because we have fairly low debt, about 32% of our total market cap. So we have quite a bit of room to add financing if we need to, but we're pretty careful about that," Onufrey says.

Houston-based Weingarten Realty Investors also is using debt financing to support its expansion strategy, which calls for the acquisition or development of about $190 million in properties for 2000. The A-rated REIT carries a low 33% of leveraged debt, significantly lower than the average in its peer group, which is closer to 50%. "We still have the ability to leverage the company and meet financial objections," says Martin Debrovner, Weingarten vice chairman.

Joint ventures Private capital is fast becoming the primary driver for REIT growth. Joint ventures with pension funds, insurance companies and other private investors are increasingly common. "We have established joint venture relationships with a number of institutions," Grueber says. One of DDR's most prominent joint ventures is a partnership with Prudential Real Estate Investors that resulted in the creation of the Retail Value Fund. The ongoing investment fund is overseen by a DDR subsidiary, Coventry Realty Investors. "Through Coventry and Prudential, we're able to tap into the private equity that's available from institutions today," Grueber says.

The Retail Value Fund is responsible for providing the funds for much of DDR's $500 million in development projects currently under way. One such joint venture project is the construction of The Centre at Hagerstown, a 750,000 sq. ft. power center being developed in Hagerstown, Md. The center is anchored by Home Depot and a Wal-Mart Super Center, and it is scheduled to open this summer.

Weingarten and Toledo-based Dana Commercial Credit Corp. recently formed a joint venture to acquire up to $200 million of real estate assets. In addition, Weingarten is pursuing partnerships with landowners. That land contribution typically saves about $25 per sq. ft. on development costs. "It's another way to implement a new development program where you don't have to put up all the capital in exchange for a proportionate share of the cash flow," Debrovner says.

Recycled capital Another avenue for raising funds is by "recycling capital" in wholly owned assets, Grueber notes. DDR is selling portions of properties where it once owned 100% stakes. By selling a percentage of the ownership to institutional investors, REITs can release capital tied up in those properties. For example, DDR recently converted the previously wholly owned Deer Valley Towne Center to a 50-50 joint venture with DRA Advisors Inc., a New York-based institutional investment advisory firm. Deer Valley is a 460,000 sq. ft. community shopping center located in northern Phoenix.

The Deer Valley joint venture is valued at about $26.7 million. DDR contributed the property and accompanying $18 million mortgage, and in return received $4.3 million in cash from the DRA fund's equity contribution to the venture. DDR is using those proceeds for a variety of purposes, such as to finance a stock repurchase program, repay existing debt and fund equity requirements in ongoing development projects.

General Growth recently sold a 50% stake in three of its shopping centers to New York State Common Retirement Fund. The exchange of ownership strengthened General Growth's existing relationship with the pension fund, Bucksbaum says. General Growth and the NYS Common Retirement Fund are jointly developing a new shopping center in Dallas. "It's a wonderful platform to go forward on future acquisitions together," he says.

Internal growth REITs also are becoming more aggressive in searching for ways to boost funds from operations (FFO), considered a key growth indicator for REITs. "There are numerous ancillary income opportunities that are now providing internal revenue growth," Bucksbaum says. REITs are generating revenue through efforts that include re-tenanting, specialty leasing, sponsorship programs and strategic alliances.

DDR recently entered into a five-year strategic marketing and vending alliance with The Coca-Cola Co. The soft drink company has been granted the exclusive right to place soft drink vending machines within the common areas of DDR shopping centers. DDR also entered into a strategic marketing alliance with Columbus, Ohio-based Tower Resource Management, which allows TRM to negotiate and administer all telecommunications access rights at DDR-owned and -managed shopping centers. "We think, over time, these new initiatives will represent significant incremental income for the company," Grueber says.

Meanwhile, General Growth is exploring new business opportunities available through the Internet. General Growth has created, an Internet shopping portal. Currently, the site offers informational content. Visitors to the site can enter their zip code to obtain information on the General Growth mall closest to them. Beginning in June, the site also will be launching an e-commerce feature that allows users to shop General Growth tenants in an online venue.

"The purpose of the mall has been to build it, merchandise it correctly and then attract people so they come in and buy things," Bucksbaum says. General Growth is applying the same concept to its cyber-mall. "We are taking e-commerce and keeping it at the local level," he says. For example, a shopper who wants to buy a new leather jacket at Wilson's Leather Store can go to their local mall and buy the jacket, or they now have the option to go to, which links the consumer to that same mall store to buy the item online. General Growth also is exploring plans to bring kiosk areas into malls that will give e-tailers an outlet in traditional mall venues.

Whether it's e-commerce or joint ventures, REITs continue to tap new sources of capital to boost revenues and finance ongoing expansion. "I think 2000 is shaping up as a reasonable year," says Michael Grupe, a vice president and director of research at NAREIT in Washington, D.C. Earnings growth looks to be stabilizing, and the economy appears to be reasonably healthy and balanced. As Grupe points out, the sound economic fundamentals and improving REIT performance bode well for retail REITs.

Retail REITs are hoping that their bumpy ride on Wall Street is nearing an end.

REIT returns have been increasing ever since the REIT sector bottomed out in mid-December. "If you look at the general REIT market, things are much improved from where they were in 1999, which was a pretty dreadful year," says Mark Zeisloft, a vice president and retail analyst at RREEF Securities in Chicago.

Year-to-date REIT returns are at 9.3% as of April 28th. "The only sector that I track that has done better than that has been the utility sector," says Michael Grupe, a vice president and director of research at NAREIT in Washington, D.C. Returns in the retail sector through April 28th are at 8.9%, up considerably higher than the -11.8% (negative figure is correct) return retail REITs reported in 1999.

"Like most property sectors, the retail sector continues to benefit from a very robust economy," Grupe says. Two key factors play a significant role in the upswing in the retail REIT market. One, retail was hit hard in 1999, so the positive gain in 2000 is due in part to a market rebound, Grupe says.

Two, the retail sector was also negatively impacted last year due to investor concerns over e-commerce and a potential shift in traditional buying patterns. Some of those fears have dissipated, he adds.

Other factors also have helped boost performance among retail REITs. "It's always difficult to pinpoint what the drivers are, but having one of the strongest holiday periods in probably the last 10 years has helped," Zeisloft says. Preliminary projections call for another strong year for retailers in 2000.

And while retailer bankruptcies have continued, the fallout is less than what occurred during the same period in 1999. So that should help REITs in maintaining high occupancies, Zeisloft notes. In addition, retailers have improved profitability through functions such as better inventory management and merchandising. "People are a little more comfortable with the fact that retailers have used this time to improve their own financial condition," he says.

"I think the performance of REIT stocks has been rocky, but actual earnings of companies has been good," says Scott Onufrey, director of investor relations for Kimco Realty Corp. in New Hyde Park, N.Y. "Kimco earnings increased about 19% for 1999, which is pretty high for our industry, and I think analysts project us to grow at around 11.5% to 12%," Onufrey says.

Kimco attributes its strong performance to continued demand for space, healthy consumer spending and opportunistic investment. In 1998, Kimco acquired about 98 properties from Ventures Stores Inc. that totaled about 10 million sq. ft. The average rents in the portfolio were about $4 per sq. ft. at the time of the acquisition. "We were able to almost double average rents in that portfolio in about one year's time," Onufrey says.

In addition, recent volatility in the growth and technology sector has helped spark new interest in REITs. "The sell-off in NASDAQ and tech in general has been a positive," Zeisloft says. Investors are not fleeing growth and tech stocks, but there has been a definite shift towards companies that possess proven business models.

As of April 28th, the average dividend yield in the retail REIT sector was 8.7%. Due in part to the volatility in the stock market, investors now view that as an attractive investment, Zeisloft says. "Institutions are looking more at the old economy as maybe being a safe place to park investment dollars right now."

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