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Time For The Fall

As the shopping center REIT sector — along with all other REITs — continues to get massacred in a stock sell-off, industry observers are keeping a stiff upper lip. REIT managers and analysts point to the sector's rock-solid fundamentals, including healthy occupancies, a booming development pipeline and projections for rental increases, as reasons why investors shouldn't be so skittish.

Shopping center REITs — firms like Kimco Realty Corp., Weingarten Realty Investors and others that largely operate open-air community, neighborhood and power centers — have all seen their stock prices plummet. Many have hit 52-week lows.

On July 30, for example, the stock of Beachwood, Ohio-based Developers Diversified Realty Corp., owner of a 117-million-square-foot portfolio, hit a 52-week low of $47.38 per share. On Aug. 6, White Plains, N.Y.-based Acadia Realty Trust, which runs a 10-million-square-foot portfolio, reached a 52-week low of $22.00 per share, followed by Ramco-Gershenson Properties Trust on Aug. 9 (at $28.58 per share) and Inland Real Estate Corp. on Aug. 10 (at $14.27 per share).

So all indications are that the seven-year REIT bull run has ended with a loud thud. As a whole, shopping center REIT stocks are down 8.73 percent this year, according to NAREIT. (That figure understates the drop because at one point this year stock prices were up about 10 percent from where they ended in 2006.) The decline this year is in stark contrast to last year's boffo appreciation, where shopping center REITs were up 28.31 percent, the largest gain in three years and the seventh straight year of appreciation. Through July 31, total returns for the shopping center sector have declined 15.46 percent, compared to an increase of 34.87 percent in 2006.

But is this sell-off justified?

Analysts and REIT managers, pointing at retail real estate performance, say the answer is a resounding no.

“I think fundamentals remain strong, despite what's been going on in the larger macroeconomic arena,” says Steven Marks, managing director and REIT analyst for Fitch Ratings. Marks, like cohorts at Standard & Poor's and Moody's Investor Services, looks at the debt side of the equation, where he maintains that shopping center REITs have healthy balance sheets and relatively low leverage levels.

“The strongest REITs out there…have well-located portfolios, with relatively new assets in strong markets, management has been conservative in managing the balance sheets and relatively low leverage and strong coverage metrics,” he says.

John Kriz, managing director with Moody's, has a similar analysis. The agency's ratings for the sector tend to be relatively high. The stronger ones, like Developers Diversified, Federal Realty Trust and Kimco Realty Group, are at Baa2 or Baa1. “One of the benefits these firms have is access to unsecured debt, which provides them with strategic flexibility and is more and more appreciated,” Kriz says.

REIT equity analysts have similarly rosy views of the sector. So what's been at the heart of the decline? Like a lot of other problems these days, much of the blame is being laid on the meltdown in the subprime mortgage sector and the bursting of the single-family housing bubble. As implosions have rocked hedge funds, banks and lenders of all stripes, credit markets have tightened. At the same time, homebuilders — who overbuilt and got further exposed by dabbling in mortgages themselves — have collapsed as more and more homes go unsold. What has resulted is that all real estate has been tainted.

The market has not differentiated between single-family homes and commercial real estate. There's been a wholesale dumping of stocks of real estate related firms. Another problem has been that investors have been pulling out of real estate mutual funds, many of which invested in residential and commercial real estate at the same time.

All those concerns, however, are of little consequence to shopping center REITs, says Rich Moore, an analyst with RBC Capital Markets. The industry is in no way dependent on subprime loans, nor has there been rampant overbuilding of shopping centers, according to Brad Case, vice president of research and industry information with NAREIT. Steep construction prices have kept inexperienced, speculative builders out of the game in recent years and occupancy levels are stable, so long as the REITs' fundamentals remain strong, they will be able to weather the storm, he says.

Moore, meanwhile, compares current market conditions to what happened in 1998, when the emerging popularity of technology stocks, combined with the fallout from the collapse of Russian and Asian financial markets, caused REIT stocks to be severely undervalued. In 2000, REITs were priced at 8.5 times their FFO per share, while the S&P 500 was trading at 30 times earnings per share.

“Unfortunately, what's going on is a bunch of issues that don't have a direct impact on these companies, but the mortgage market and bad loans are a macro thing that everyone will think about for a while,” Moore says. “When we see something bad happening to the fundamentals of these companies, that's when we get concerned — not when some banks made some bad loans.”

Safety in numbers

The second quarter results for most shopping center REITs point to the underlying strength of the sector. Out of a total of 14, eight hit or exceeded analyst expectations. Meanwhile, of the six that missed, all but two missed by only $0.01 per share. The majority posted positive FFO and NOI growth, outperforming NAREIT's estimates for the sector, which forecast FFO growth of 6.91 percent from February 2007 to February 2008.

Kimco, for example, reported FFO of $0.71 per share, representing growth of 31.5 percent compared to the second quarter 2006. Its same-store NOI growth of 4 percent was slightly down from the 4.6 percent average the company posted during the past eight quarters, but Kimco's fundamentals remained strong and it has been diversifying its revenue sources through merchant building, joint ventures and preferred equity. This strategy should help the REIT weather the volatile fluctuations in the real estate market, wrote A.G. Edwards analyst Mark Hoffmeister. Kimco beat consensus expectations by $0.11 this quarter.

Developers Diversified exceeded expectations as well, by $0.06. The company posted FFO per share of $1.26, a 27.3 percent increase over the second quarter of 2006, and its same-store NOI rose 2.2 percent during the first six months of 2007 compared to the same period in 2006. With rental rates on new leases growing more than 30 percent in the second quarter, prognosis for DDR's future remains positive, wrote Lehman Brothers analyst David Harris. However, he noted that if the nation's retail sales continue to show the same lackluster performance as they did in recent months, rents could stagnate.

Chain store sales rose 2.3 percent during the period between February and June, dropping 1.6 percentage points from the 3.9 percent growth experienced during the same period in 2006, according to ICSC. In July, same-store sales rose 2.6 percent.

Both Kimco and Developers Diversifed ranked in the top 10 in Credit Suisse's “Defensive REITs Rankings,” which explored the safest stocks in the REIT world. Kimco, which ranked as the No. 2 defensive REIT overall out of 61 stocks, made the top 10 in size, leverage, FFO stability, dividend growth and FFO growth. Developers Diversified, ranking as the No. 8 defensive REIT overall, made the top 10 in FFO stability, but was held back by its Beta and dividend yield rankings.

Meanwhile, Miami Beach, Fla.-based Equity One, owner of an 18-million-square-foot portfolio, posted a 17 percent decline in FFO per share, at $0.34, but same-center NOI was up 4.6 percent. The company has benefited from the fact that chairman Chaim Katzman's firm Gazit-Globe owns more than 43 percent of its stock, to an extent protecting the REIT from gross undervaluation, according to Bear Stearns analyst Ross Smotrich. As of Aug. 14, the price of Equity One shares was down 6.7 percent, compared to 13.9 percent for the shopping center sector as a whole.

Back to the future

Based on good second quarter results (see story on p. 28), REIT analysts are predicting a stable future for the shopping center sector. “The market is still a little bearish right now, but it presents a good opportunity [for stock buybacks and property acquisitions],” says Niti Nguansiri, manager of real estate research with SNL Financial, a Charlottesville, Va.-based research firm.

A recent report from RBC Capital Markets notes that troubles in the subprime sector could put pressure on the weaker retail tenants and result in short-term revenue losses, but REITs with strong underlying fundamentals will survive. The report praises international expansions, mixed-use projects and the use of joint ventures, in particular, as effective ways to position REITs for growth.

The REITs are taking note. Developers Diversified Realty is also planning to complete up to $100 million in asset sales over the coming months, a figure that could increase to several hundred million, according to David Oakes, chief investment officer. Developers Diversified's long-term plan is to rid its portfolio of second-class assets, look for more joint venture partners and complete $4 billion in development.

Joint ventures are “something we've been doing for 12 years now, but we have continued to come up with more attractively structured programs,” says Oakes. In June, the company formed a $1.5 billion DDR Domestic Retail Fund I with a consortium of institutional investors for the acquisition of 63 shopping centers. The move is a first for Developers Diversified in that it targets multiple investors, rather than forming a venture with just one partner.

Inland Real Estate Corp. is also targeting joint ventures with institutional investors, including its $100 million development partnership with Northbrook, Ill.-based Pine Tree Institutional Realty, LLC. The venture will target shopping centers throughout the Midwest over the next four years.

At the moment, Equity One and Federal Realty are the most highly valued stocks in the shopping center REIT universe. As of Aug. 14, Equity One was trading at $25.34, 14 percent below its 52-week high of $29.51, and Federal Realty was trading at $75.24 per share, almost 24 percent below its 52-week high of $98.92.

But despite so many companies being off their highs, Oakes says it's unlikely that any of the REITs are unduly worried.

“It causes concern when you see this much volatility, but the stock market is open for business every day and stock prices can move very rapidly,” he says. “The fundamentals of our business haven't changed, they are strong, so we are trying to…deliver value to shareholders over the long term.”

Reported Company Name Ticker Closing Price ($) FFO/Share Growth (%) Price/FFO (x) Quarterly Estimate ($) FFO per Share ($)
Regional Malls
Alexander's, Inc. ALX 404.25 -40.3 20.4 NA 4.96
CBL & Associates Properties, Inc. CBL 36.05 -2.6 12.2 0.79 0.74
General Growth Properties, Inc. GGP 52.95 14.5 18.6 0.74 0.71
Glimcher Realty Trust GRT 25.00 N/A 15.6 0.48 0.40
Macerich Company MAC 82.42 8.3 19.8 1.03 1.04
Pennsylvania Real Estate Investment Trust PEI 44.33 1.2 13.5 0.79 0.82
Simon Property Group, Inc. SPG 93.04 4.0 17.8 1.33 1.31
Taubman Centers, Inc. TCO 49.61 23.6 18.2 0.61 0.68
Shopping Centers
Acadia Realty Trust AKR 25.95 -13.3 25.0 0.29 0.26
AmREIT AMY 8.75 -25.0 36.5 0.05 0.06
Cedar Shopping Centers, Inc. CDR 14.35 -9.7 12.8 0.31 0.28
Developers Diversified Realty Corporation DDR 52.71 27.3 10.5 1.15 1.26
Equity One, Inc. EQY 25.55 -17.1 18.8 0.33 0.34
Federal Realty Investment Trust FRT 77.26 9.6 21.2 0.90 0.91
Inland Real Estate Corporation IRC 16.98 6.1 12.1 0.35 0.35
Kimco Realty Corporation KIM 38.07 31.5 13.4 0.60 0.71
Kite Realty Group Trust KRG 19.02 10.7 15.3 0.30 0.31
Ramco-Gershenson Properties Trust RPT 35.93 -4.8 15.0 0.65 0.60
Regency Centers Corporation REG 70.50 1.1 18.8 0.96 0.94
Saul Centers, Inc. BFS 45.35 8.1 16.9 0.68 0.67
Urstadt Biddle Properties Inc. UBA 18.14 96.4 8.3 0.31 0.55
Weingarten Realty Investors WRI 41.10 10.3 13.7 0.73 0.75
Data reflects values as of the end of the second quarter
Source: SNL Financial
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