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REGENCY DEAL A NEW HIGH FOR OPEN-AIRS

BY DONNA MITCHELL

Shopping center owners, much like the consumers driving luxury sales these days, are more willing than ever to pay a high price for quality. Regency Centers Corp. and Macquarie CountryWide Trust proved that in February when they announced a joint venture deal to pay $2.74 billion for 101 grocery-anchored properties in premium locations owned by Washington, D.C.-based First Washington Realty.

The mall sector has seen its share of high-priced deals in recent years, but the First Washington buy is the first time an open-air deal’s cap rate has dipped so low. Regency expects a yield of about 6.25 percent, making this the most expensive open-air portfolio transaction in industry history and one of the most expensive of any portfolio type, period.

This only affirms what those who specialize in grocery-anchored centers have always known, says Terry S. Brown, CEO of Columbia, S.C.-based Edens & Avant Realty. “Neighborhood and community retail is a great, stable-performing asset class,” Brown said.

Jacksonville, Fla.-based Regency and Australia-based Macquarie expect to close their deal sometime in the second quarter. Regency will control 35 percent of the 133 million-square-foot portfolio, which First Washington owns with The California Public Employees’ Retirement System. Macquarie will hold the rest.

Other recent transactions, including Simon Property Group’s $4.8 billion purchase of Chelsea Property Group, involved more money, but the expected yields were also higher. General Growth Properties’ $12.6 billion purchase of The Rouse Co. was more expensive than the Regency deal, with a cap rate of 5.4 percent.

With only 10 percent of open-air shopping centers currently in REIT hands, expect to see even more consolidation along the lines of the First Washington deal, observers say. Now that Regency and Macquarie have thrown down the gauntlet, high-quality portfolios that seemed too expensive yesterday may have more appeal today for a landlord wanting to enter a mature market or boost its clout with national tenants, says Matthew Ostrower, a retail REIT analyst at Morgan Stanley.

At 6.25 percent, the First Washington deal’s cap rate is significantly lower than similar deals done in 2004, Ostrower says. The average cap rate for open-air shopping center portfolios during the period was 7.3 percent, according to Ostrower’s research.

Developers Diversified Realty’s purchase of 15 properties from Caribbean Property Group in Puerto Rico for $1.15 billion bore a 7.4 percent cap rate, for instance. And the cap rate on DDR’s $2.3 billion purchase of 110 grocery-anchored centers from the Benderson portfolio was 8 percent.

Call it ‘irreplaceable’
But Regency calls the price more than fair given the benefits the First Washington portfolio will bring. This collection of grocery-anchored centers is 96 percent occupied, with the enviable advantage of being virtually insulated from Wal-Mart. It also provides Regency with greater market share on both coasts, including such tough-to-crack markets as California and Baltimore. In addition to owning the centers, Regency will earn management fees amounting to 3 percent of their revenues.

“From our view, the First Washington portfolio is irreplaceable real estate,” said president and COO Mary Lou Fiala. “It would have taken us 10 years to develop and accumulate a portfolio like this.”

And Regency spread the expense to a partner, a strategy that goes down easier on Wall Street. “Regency is using attractively priced joint venture capital to offset an otherwise unattractive initial return and to minimize its own capital deployment,” Ostrower wrote in a report.

The deal is funded in part by about $900 million of secured property debt and an $800 million loan from Wachovia Capital Markets and JPMorgan. Regency will finance its portion with $400 million from its line of credit plus about $275 million of bridge financing from Wells Fargo Bank. Over the long term, the company will sell one center each in Chicago, Maryland, Pennsylvania, Texas and Wisconsin, Fiala says, and raise additional equity by selling stock.

Nevertheless, Merrill Lynch REIT analyst Craig Schmidt wonders how much more cash flow Regency and Macquarie can squeeze out of the portfolio. He says its existing rents are, at $20 per square foot, already higher than Regency’s $14 per square foot average.

One executive whose company also bid on the First Washington portfolio said the ultimate selling price was simply too high. “I would love to be back in the days when cap rates were 7 percent or 8 percent,” said G. Joseph Cosenza, vice chairman of the Inland Group of Cos., adding that his company would have paid much less. “But I don’t believe they will return for many, many years to come.”

At any rate, the current Inland Group business model focuses more on buying and managing newer properties that do not lend themselves to repositioning, says Cosenza.

“I’m giving my people about 10 to 15 new properties a month to manage,” he said. “If I gave my people deals that presented opportunities for repositioning to get higher yields — along with all the other ones I gave them — I would bury them.”

Regency, of course, is up for the repositioning challenge. The properties possess excellent demographics, offer significant redevelopment opportunities and can attract top national tenants, says Regency Chairman and CEO Martin E. Stein Jr. All of this will enable the centers to post excellent net operating income growth, he adds.

“The price is reflective of the current market, given the quality of the centers, their prospects for growth and the unique value of a high-quality national portfolio that would be impossible to replicate,” said Stein.

The deal will make Regency an even more important national player than it was before. After the close, the firm will be the ninth-largest owner of retail space in North America, with 392 centers totaling 49 million square feet in 26 states. That means Regency will have a considerable amount of muscle when negotiating with tenants.

In addition, the deal’s sheer size will probably renew investor interest in other REITs with high-quality portfolios, Ostrower says. “The transaction is likely to raise more speculation about additional consolidation in the sector, bringing new attention to companies recently viewed as take-out candidates,” he wrote in a report.

Vista, Calif.-based Pan Pacific Retail Properties, a much-coveted collection of high-quality, grocery-anchored properties on the West Coast, was such a candidate last year, market sources say. Inland was said to be in talks to buy Pan Pacific but then backed off when the stock price hit $58 per share.

Since then, Pan Pacific has only risen in value. Anyone interested in buying it these days might have to pay as much as $65 per share, observers say.

Were Pan Pacific to go on the block again, says Cosenza, the company would entertain a purchase, but it could not afford to do so through its Inland Western REIT.

Federated Realty Investment Trust is another open-air portfolio considered attractive but expensive, valued at about $210 per square foot, according to Morgan Stanley research. Miami-based Equity One and Boston-based Heritage Property Investment Trust have similarly valuable open-air portfolios but aren’t likely to be interested in selling anytime soon, sources say.

Companies with existing joint venture partners, such as Regency or DDR, will continue to be willing and able to pay those high prices in the future, says Ryan Dobratz, a REIT analyst at Chicago-based Morningstar. But not every company will, by any means.

Firms that are larger and equally well-capitalized, such as New York City-based Vornado Realty Trust and Kimco Realty Corp., of New Hyde Park, N.Y., have not been biting.

“It tells me that they are not willing to accept today’s prices,” said Dobratz. “The markets tend to punish REITs for taking on a lot of debt.”

Smaller companies, too, such as Heritage Property Investment, are cautious about paying up for prime properties. The company is mulling joint ventures with institutional investors, but not to throw money at the property market, says Patrick O’Sullivan, Heritage Property Investment’s vice president of accounting and finance.

As if competition were not already stiff, mall REITs could start bidding on open-air center portfolios within the next 10 years, as their growth mandates push beyond the existing supply of malls, speakers said at ICSC’s Conference on Open-Air Centers in Phoenix in February.

Acquirers will also almost certainly have to face off against private investors, which traditionally held a majority of neighborhood and community shopping centers and want very much to stay in the game. Despite the larger REIT and institutional buyers, these private investors are maintaining their market share, according to data from Real Capital Analytics, a New York City-based research firm.

First Washington, for one, will take the $2.74 billion and continue to invest in open-air centers along with CalPERS, says First Washington Chairman Stewart Halpert. “We look forward to actively and aggressive deploying the proceeds in acquisitions over time,” he said.

And of course, the yield-hungry Australians will keep the bidding interesting. After all, both the Regency-First Washington deal and DDR’s purchase of the Benderson centers involved proceeds from the acquirers’ partnerships with Macquarie.

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