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A tale of two REITs

Two retail REITs made a splash on Wall Street in recent months, but for different reasons.

Rockville, Md.-based Federal Realty Investment Trust surprised most observers by announcing several major corporate changes in March, including a shift in its core business strategy. Meanwhile, in April Boston-based Heritage Property Investment Trust, Inc. kicked off the first major real estate initial public stock offering since 1999.

Both firms face a similar challenge: at a time when many retail REITs are trading near their 52-week highs, FRT and HTG are hoping to convince investors, shareholders and analysts alike that their business strategies — and their stocks — are on the rise.

Federal [NYSE: FRT] adopted a “new” business plan in March with related changes to management and the firm's capital allocation strategy. Federal is an equity REIT specializing in the ownership, management, development and redevelopment of shopping centers and street retail properties. Its portfolio includes 15.1 million sq. ft. in major metro markets across the United States.

About five years ago, Federal made a significant move into urban, mixed-use development. But investment in the time-consuming, high-risk Street Retail sector has produced mixed results for the REIT. Under its new business plan, Federal will move away from all ground-up development, including street retail, and focus on growing the income-producing properties in its portfolio, which includes traditional community shopping centers.

“What really precipitated the change was risk adjustment,” says Donald Wood, Federal president and COO. The decision to shift the firm's core strategy also coincided with succession planning for retiring CEO Steven Guttman. Wood was poised to step in to replace Guttman. “Part of that meant that I needed to forward the company with a business plan that I believe in,” Wood says. “I have a hard time getting behind ground-up, complicated, large-scale development as a means for Federal to provide value to shareholders.”

Instead, Wood has endorsed a strategy that involves growing the portfolio's high-quality assets — community shopping center properties — through redevelopment and acquisition. “There are many more opportunities within that core asset base that will allow us to continue to grow and pay a higher dividend in a less risky way,” Wood says.

The change does not mean that Federal is abandoning the Street Retail niche altogether, though. The REIT remains committed to projects already under development including Santana Row in San Jose, Calif., Bethesda Row in Bethesda, Md., and Pentagon Row in Arlington, Va. Federal also plans to hold onto its income-producing real estate — including more than 60 Street Retail assets — and sell the slowest-growing properties.

In the past few months, Federal has sold five of its street retail properties located in Connecticut, Illinois and New Jersey. Uptown Properties in Portland, Ore., is another Street Retail center currently being marketed for sale. The capital raised from those transactions will be redeployed into the redevelopment of existing assets.

Analysts weigh in

Federal's shift in business strategy is long overdue according to some. “Federal stock has gone nowhere in 10 years,” says Rob Norfleet, an equity analyst at Davenport & Co. in Richmond, Va. Currently, Davenport & Co. has Federal stock rated as under perform.

Federal's stock price over the past year has ranged from a low of $19.40 to a high of $28.50. The REIT also ranked among the top 10 poorest performers for first quarter 2002 FFO/share growth with a negative 30.3%, according to NAREIT. Federal stock closed at $25.99 on May 13.

“I think the change in strategy is the correct decision, yet management certainly can be criticized for waiting as long as it did to recognize that, in essence, they were heading in the wrong direction,” Norfleet says. “But they have a solid management team with an extremely high quality portfolio of properties, and over the long haul I think they will succeed in their endeavor.”

Wall Street has not been receptive to Federal's high-risk street retail developments. For example, Federal has $500 million invested in phase one of Santana Row, which is scheduled to open in September. The mixed-use project includes 680,000 sq. ft. of retail, 1,200 luxury rental units and a 214-room hotel.

When Santana Row is completed it will probably add significant value to the company at about $4 to $5 per share, Norfleet notes. However, returns for the project are in the 6 to 6.5% range — well below the company's cost of capital, he notes. “The market was just not willing to give Federal credit for that long term-value creation and risk that they have undertaken in leveraging up their balance sheet and placing a significant amount of operating income in this one project,” he adds.

Other analysts are skeptical of the new business plan. “I didn't see much of a change in their strategy at all,” says Lou Taylor, a senior real estate analyst at Deutsche Bank Securities in New York. Federal's core business is community development. Moving away from some of the street assets they had is not enough of a significant move, Taylor says.

The key factor that will influence Federal's performance in the coming years is the performance of Santana Row. The first phase of the project represents roughly one-fourth of Federal's $2 billion asset base. “People are very concerned about how it is ultimately going to do,” Taylor says. “Everything else they do is secondary to the performance of Santana Row.” Deutsche Bank Securities currently has Federal rated as a market perform.

Heritage goes public

The stock price for Heritage Property Investment Trust, Inc. has remained relatively flat since the REIT went public at $25 per share on April 24. “I attribute that largely to caution,” says Keith Pomroy, senior real estate editor at SNL Financial LLC in Charlottesville, Va. Investors have been wary that the offering was priced too high. They're looking for more information on the quality and performance of the portfolio, he adds.

Heritage acquires, owns, manages, leases and redevelops primarily grocer-anchored neighborhood and community shopping centers in the Eastern and Midwestern U.S. As of December, the portfolio encompassed 142 shopping centers totaling 23.2 million sq. ft. The IPO comes about 18 months after Heritage acquired the former Bradley Real Estate Investment Trust.

The primary motive of the IPO was to access capital and pay down debt. Currently, Heritage's debt comprises 62% of the company's total capitalization, or as much as 69% when redeemable preferred stock is included, Pomroy notes. Typically, most REITs operate with debt in the high 40 percent range. Heritage executives were not able to comment for this article due to the SEC Quiet Period that expired May 20.

Heritage [NYSE: HTG] has maintained a steady price since it began trading — ranging from a low of $24.50 to a high of $25.34. The stock closed at $24.60 on May 13. One reason for the flat pricing is the timing. “They came out right at the moment where the appetite for REIT shares in general had plateaued,” Pomroy says.

At the same time, investors had questions about the company itself. The management team does not have a track record operating a public company. In addition, people were simply not familiar with Bradley's performance while it was private, Pomroy notes. Bradley took the firm private in 2000.

Since the offering, more observers have come out with positive positions on the portfolio. Standard & Poors recently gave Heritage a BB+ credit rating. The portfolio occupancy is stable at 93% with 10% of the leases set to expire over the next five years. Another attribute is a well-diversified tenant base with little exposure to major bankruptcies. TJ Maxx is the largest tenant, accounting for less than 6% of the base rent, Pomroy notes.

Most of the centers are located in suburban in-fill locations where barriers to entry are high. “It's a good portfolio,” Pomroy notes. “There may be some sideways trading for a little bit, but I think investors in general will begin to buy at some point.”

Beth Mattson-Teig is a Minneapolis-based writer.

Two REITs at-a-glance

Federal Realty Investment Trust

1626 E. Jefferson St.

Rockville, Md. 20852-4041

Phone: (301) 998-8100; Fax: (301) 998-3718


Total GLA Owned: 15,200,000 sq. ft.

Steven J. Guttman, Chairman/CEO; Donald Wood, President/COO; Chris Weilminster, VP Anchor Tenant & Mixed-Use Leasing; Cecily Ward, VP/Chief Financial Officer; Lisa Denson, VP Information Technology & Special Projects; Kristine Warner, Director of Corporate Communications

Heritage Property Investment Trust, Inc.

535 Boylston Street

Boston, MA 02116

617.247.2200; 617.266.0885 fax

Thomas C. Prendergast, President & Chief Executive Officer; Gary Widett, Chief Operating Officer; David Gaw, Chief Financial Officer; Louis C. Zicht, Esq., Vice President & General Counsel; Barry Rodenstein, Vice President, Leasing; Bruce Anderson, Vice President, Acquisitions; Robert Prendergast, Vice President, Property Management & Construction; Cayce Montero, Director of Corporate Development; Mary Kate Herron, Vice President, Lease Management; Patrick O’Sullivan, Vice President, Accounting & Finance; Matthew Abusheery, Controller.

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