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Financing Proves Pivotal in Retail REIT Purchases

While pension funds and private investors were busy gobbling up REITs in recent months, public REITs largely sat on the sidelines, rarely making acquisitions. The conventional wisdom among public REITs was that prices had climbed too high; a rich acquisition would dilute earnings and cause howls of protest from shareholders. Private buyers, in contrast, don't necessarily have such restless constituencies and can accept lower returns.

But in June, any signs of a drought ended. Kimco Realty Corp., the largest owner of strip shopping centers, stepped forward, announcing the purchase of Pan Pacific Retail Properties, a West Coast-based REIT, for $2.9 billion. The same week, Centro Watt, an Australian and American joint venture of public and private partners, announced that it had agreed to buy Heritage Property Investment Trust, a shopping center REIT, for $1.83 billion.

Did the public buyers suddenly decide to ignore shareholders? Hardly. Kimco, with ownership interests in 143.2 million sq. ft. of retail space, often sells part of its holdings to funds. Institutions and private groups invest in the funds, which are managed by Kimco. For its efforts, the REIT collects fees, a more profitable business than holding the shopping centers outright. Kimco's outside investors include Cerberus Capital management, a hedge fund, and UBS Wealth Management, which advises high-net-worth individuals.

The REIT has a long history of delivering returns, says Bob Gadsden, portfolio manager of Alpine Realty Income & Growth fund, a mutual fund. “If Kimco owns 20% of a property and then collects management fees, the REIT can boost returns to an acceptable level,” he says.

Jonathan Litt, a security analyst with Citigroup, estimates that Kimco will earn an initial yield of only 6% on its purchase. The deal will work because additional returns in the form of management fees could be a percentage point or more.

For both the sellers — Heritage and Pan Pacific — the offers may have been tempting because many public REITs are having trouble growing through acquisitions. By selling now, both companies ensured strong prices for their shareholders. Pan Pacific's stock sold for around $60 in October 2005. Since then, the shares have risen to around $70, the price Kimco agreed to pay.

Heritage shares sold for $31 in October 2005. Centro Watt paid $36.15. Heritage faced special pressures to sell, says Paul E. Adornato, an analyst for BMO Capital Markets Corp. Shareholders had criticized the level of executive compensation and complained that the quality of the portfolio was not high. “Investors were frustrated because the performance of the Heritage portfolio had been below average,” says Adornato.

In recent months, shopping center REIT share prices have been strong, says Adornato. During the first six months of 2006, shopping center REITs returned 10.3%, according to the National Association of Real Estate Investment Trusts (NAREIT). During the same period, regional mall REITs returned 3.6%.

Strip centers have enjoyed strong demand for space from both big-box retailers and grocers, says Adornato. For investors, strip centers are a defensive play. “If the economy slows, people may stop buying apparel at regional malls, but they will continue going to strip centers to buy groceries,” he says.

Analysts indicate that more shopping center mergers could take place in the next year. Big companies, who enjoy economies of scale, can grow by buying tiny operators, explains Richard C. Moore, an analyst with RBC Capital markets. “There are a bunch of small companies in the community center sector,” says Moore. “Some of them will disappear.”


Rancho Las Palmas, a shopping center in Rancho Mirage, Calif., is among Pan Pacific's holdings. Kimco's acquisition will give the REIT a strong presence on the West Coast.

Before the Merger After the Merger
Properties With Ownership Interests 1,117 1,255
Total Sq. Ft. 143.2 million sq. ft. 165.8 million sq. ft.
Source: Company data

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