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Marching On

In the first half of the year, it seemed retail REITs announced joint ventures on an almost daily basis. But will the recent troubles in the debt market make this once-popular investment play more difficult to pull off?

If recent deals are any indication, the volume may be slowing, but such partnerships are not disappearing entirely. On Sept. 19, for example, Orlando, Fla.-based National Retail Properties, Inc. (NNN), a REIT that operates a 9.3-million-square-foot portfolio of freestanding single-tenant retail assets, announced plans to target $220 million in acquisitions in partnership with an affiliate of Crow Holdings Realty Partners IV, L.P., a Dallas-based privately held real estate investor.

The partners will focus on convenience store properties, with NNN taking a 15 percent stake in the deal. Citigroup analyst Jonathan Litt praised the venture, saying it will lower NNN's dependence on the equity markets and raise its going-in yields to 10 percent from 8.5 percent compared to if it had done the deal alone. These types of joint ventures have become a REIT staple because they raise capital, but keep REIT balance sheets clean. REIT managers have also hit upon a particularly attractive formula when partnering with banks, pension funds and institutional funds that generate higher returns than making solo investments.

The structure calls for the fund to front most of the money with REITs contributing minority equity positions. In exchange, the REITs identify portfolios for the fund and manage and lease the properties. Along the way they collect fees in addition to sharing the return generated by properties in the portfolio. Moreover, they stand to get healthy promotes after return thresholds are met. In all, this model delivers higher returns for REITs than the 5 percent or 6 percent returns available on straight acquisitions.

Since the beginning of 2007, retail REITs have announced 28 joint venture transactions with institutional investors, according to data from Charlottesville, Va.-based research firm SNL Financial. By comparison, 2002 saw a total of 13 joint venture deals in the sector, with only two or three of those involving institutional players. The majority of the transactions involved other REITs.

The reason for the shift is, in the past two years, institutional investors realized that partnering with REITs on real estate transactions brings in higher returns than investing in commingled funds and separate accounts, says Brad Case, vice president of research and industry information with NAREIT. Three academic papers, by professors at the Massachusetts Institute of Technology and the University of Chicago, show that when institutional players put their money into REITs, they get annual returns of 13.0 percent, compared to returns of 9.9 percent for direct investment in real estate, Case points out.

Meanwhile, joint ventures save REITs from having to issue more stock or take on uncomfortably high debt levels when doing acquisitions, according to Jason Lail, senior research analyst in the real estate research group of SNL Financial. Plus, the long-term management contracts set REITs up with steady revenue streams for several years.

However, the structures of the ventures announced this year vary slightly from the types of transactions REITs were making a few years back. In the past, most partnerships were structured as 50-50 joint ventures. Today, most REITs limit stakes to 30 percent or less, according to Andy Sucoff, chairman of the real estate practice group with the national law firm Goodwin Procter LLP. Sucoff, who represents both REITs and institutional investors in joint venture agreements, says the majority of deals get split 85-15 or 80-20, an assertion that SNL data bears out.

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