We’ve all heard and read the less-than-positive rhetoric about class-B malls—sales are down, department store anchors are going dark, inline tenants are leaving and e-commerce is stealing customers away.
So why did Brookfield Asset Management make an offer to buy Rouse Properties, the smallest cap REIT in the B mall sector?
No one is quite sure what Brookfield sees in Rouse, but one thing is certain: Brookfield has more than a passing familiarity with the New York City-based REIT, which owns 35 malls and retail centers in 21 states encompassing approximately 24.1 million sq. ft. Currently, Brookfield Property Partners LP owns a 33 percent stake in Rouse, which it acquired in 2012 when General Growth Properties spun off Rouse into a separate entity.
Analysts and other industry experts are surprised and confounded by Brookfield’s all-cash offer of $17 per share for Rouse’s outstanding shares. Indeed, the four publicly-traded REITs that specialize in class-B malls— CBL & Associates Inc., Rouse, WP Glimcher and PREIT—have been knocked around on Wall Street. They’re all trading at significant discounts to NAV.
Since the spin-off from GGP, Rouse has struggled, at least from a valuation perspective. As of January 15, Rouse was trading at a discount to NAV of roughly 33 percent, according to research firm SNL, and it had posted a negative 12-month total return of 29.31 percent.
“B malls are an intriguing space,” says Barry Brown, senior managing director with mortgage banking firm HFF in Dallas. “There’s been concern about them for a number of years, but some of these assets can be very attractive. It just depends on their place in the market and whether they have a reason for being.”
Rouse outperforming its peers
Rouse announced that it had entered into a standstill agreement with Brookfield and its affiliates and formed a special committee to evaluate the offer.
Brookfield’s offer for Rouse equates to an implied cap rate of 8.3 percent on in-place NOI and represents a 12 percent discount to BMO Capital Markets’ NAV estimate of $19.39 per share. The firm’s REIT analyst Paul E. Adornato says Brookfield’s offer is likely just a “starting point” for negotiations. The proposed price represents a 26 percent premium to the $13.49 per share closing price of Rouse on Friday, January 15, and a 19 percent premium to the 30-day volume-weighted average trading price.
In a research note, Adornato acknowledged that a slight discount to NAV would make sense “given the volatility in the capital markets and uncertainty surrounding class-B malls.”
Yet Rouse has led the group in terms of performance, according to data from SNL. It posted the highest NOI growth in the third quarter of 2015 of all class-B REITs (2.2 percent), and it has the highest projected FFO growth at 12.6 percent. Its occupancy is holding fairly steady too, at 91.6 percent.
“B malls are important for a lot of retailers,” Brown says. “Yes, they want to be in A malls because of the branding, but stores in B malls can be quite profitable because their occupancy costs may be less, and they still have a consumer who wants to shop, and that property might be the only mall within 50 miles.”
Flourishing as a private company
Brookfield has plenty of experience with REIT privatizations. Since 2000, Brookfield Asset Management has completed three REIT privatizations, including the acquisition of Trizec Properties in a joint venture with Blackstone in 2006. Most recently, it acquired Associated Estates Realty Corp., a multifamily REIT that specialized primarily in suburban assets with repositioning opportunities.
REIT privatizations were a hot topic in 2015 because many REITs were trading at discounts to NAV. Brookfield’s offer for Rouse continues the trend.
In general, malls tend not to trade hands frequently. According to New York City-based research firm Real Capital Analytics (RCA), only 86 malls sold in 2015, about the same number that sold the previous year. In total, about $10 billion worth of malls sold last year at an average price per sq. ft. of $136 and a cap rate of 6.3 percent. That cap rate represents one of the lowest in the past seven years.
Many experts suggest that Rouse would flourish outside of Wall Street’s scrutiny. The REIT is in the midst of a turnaround, which can be difficult to accomplish under the critical eye of analysts and investors.
Moreover, Wall Street has had its eye on Rouse’s balance sheet. The REIT’s leverage stands at 10x net debt/EBITDA.
“Wall Street is so concerned about immediate results and that can be a negative for a company like Rouse, which may have a lot of opportunities to recapture dark department store space and redevelop it,” says one expert who preferred to be quoted anonymously. “Traditional financing for class-B malls is challenging.”