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KIMCO’S WINNING FORMULA

Finding profit beyond strip center core

By Anna Robaton

Kimco has outshined other REITs and the stock market.

With the U.S. economy sagging and rental rates flattening, 2001 could have been as ho-hum a year for Kimco Realty Corp., the country’s largest owner of neighborhood and community centers, as it was for many other landlords. The fact that it wasn’t — Kimco had a double-digit increase in funds from operations (FFO) — has nothing to do with luck, however. The REIT’s success comes from the fact that Kimco today is much, much more than simply an owner of shopping centers.

Last year the New Hyde Park, N.Y.-based company made a $21 million profit from a modest investment in the bankrupt Montgomery Ward chain that gave Kimco and its partners the right to find takers for 250 Montgomery Ward stores. This helped boost earnings to $468.6 million during a year in which revenues from rental income rose by only 2 percent.

Kimco began as a ground-up developer in 1958 and has evolved into one of the most diverse shopping center companies in the business. Founded by two friends, Milton Cooper and Martin Kimmel, Kimco still owns its first shopping center, Coral Way, which opened in Miami that year. Kimco went public in 1991, launching the modern REIT boom. Today, with Cooper as chairman and CEO, and Kimmel as chairman emeritus, it operates nearly 550 properties in 41 states and Canada.

Kimco has long relied on such opportunistic investments to supplement the stream of income from its shopping center holdings. More recently, it has taken full advantage of the REIT Modernization Act of 2001 that allows REITs to engage in and profit from business enterprises beyond property ownership. This two-pronged approach has helped deliver the kinds of returns that made Kimco a darling in its sector — even if its stock has sagged a bit of late over the company’s exposure to bankrupt Kmart Corp., its largest anchor tenant. FFO, the most commonly accepted measure of REIT performance, has more than tripled to $295.9 million for the five-year period ended last year.

With 66 million square feet of gross leasable space, Kimco is the largest of 26 REITs in the shopping center sector, according to the National Association of Real Estate Investment Trusts (NAREIT), and the company’s $3.2 billion equity market capitalization through March was almost twice that of the next-largest REIT in the sector, New Plan Excel Realty Trust.

To continue its eye-popping performance, Kimco is moving even more aggressively beyond the business of simply owning and managing centers. It got a major boost when NAREIT helped push through the legislation freeing REITs from restrictions essentially limiting them to being passive owners of real estate. Now REITs can more actively buy and sell properties and expand their management businesses, as long as they pay taxes on those activities.

“[Kimco CEO] Milton [Cooper] was very involved in engineering the taxable REIT act, because he knew he was going to have to create other entities to grow the company,” said Matthew Ostrower, a REIT analyst at Morgan Stanley Dean Witter in New York City.

Over the past year and a half, Kimco has been busy doing just that. It has put David B. Henry, its new chief investment officer and heir apparent to the 73-year-old Cooper, in charge of a taxable subsidiary that serves as an umbrella for five new divisions, ranging from a build-for-sale operation to a unit investing in securities backed by retail real estate.

“David Henry is rapidly remaking the company as a more diverse company that is focused not only on real estate, but [also on] the opportunity to make money beyond just ownership,” says David M. Fick, a managing director at Legg Mason Wood Walker, a Baltimore, Md.-based global financial services firm.

Some of Kimco’s new divisions are extensions of existing businesses; others are entirely new ventures. Ultimately, Kimco expects to generate as much as half its income from these divisions, though it faces new challenges as it pushes ahead, and the units still represent a small portion of operations. As it has in the past, Kimco is cashing in on current business trends through some of its initiatives, including a unit providing capital and services to distressed retailers and another that seeks to leverage the appetite among investors for strong grocery-anchored neighborhood centers.

“We are different from companies that are passive owners of real estate,” said Henry, 53, who came to Kimco in April 2001 from GE Capital Real Estate, where he ran a $20 billion portfolio of equity, debt and joint venture investments. “Our vision is to build a company that is a nice blend of core assets together with operating businesses that are profitable. That will provide incremental income if rents don’t grow.”

Empowered by the changes in the REIT rules, Kimco has begun providing funds to undercapitalized shopping center owners and developers. The preferred equity investments are used either to make acquisitions or to refinance power and grocery-anchored centers. In addition to earning a return on its investments, Kimco shares in the profits from individual properties once they reach a certain level.

So far it has made an investment of $3.7 million in two shopping centers in Florida and has commitments for $16 million more. It expects to invest a total of $100 million over the next five years.

Kimco has also entered the business of building shopping centers for sale. Working with Kohl’s, Target and other fast-growing anchors, Kimco helps them expand their market share by building preleased power and grocery-anchored centers that it intends to sell quickly to real estate companies, syndicators and other buyers. In March Kimco had 18 projects under development, and at press time the sale of four properties was pending.

Capital and consultation
In another venture, Kimco is using its experience as a landlord to bankrupt retailers and its long history of vulture investing to expand a division that provides capital and consulting services to retailers. Among other things, Kimco wants to replicate the success it has had with deals in which it bid on the right to control the real estate of Hechingers, Montgomery Ward and other bankrupt chains, and turned a profit by quickly finding takers for those stores.

Milton Cooper

It is also providing working capital to retailers in bankruptcy, including a $55 million loan to Ames Department Stores and up to $30 million to the Troy, Mich.-based Frank’s Nursery & Crafts chain. Kimco expects to invest more than $100 million annually through its Retail Property Solutions business, which has also struck a deal with Strauss Discount Auto to finance the development of new sites; the South River, N.J.-based chain will then lease those sites from Kimco.

“It seems natural to try to put capital to a profitable use in these areas, since we are leveraging off our core strengths,” said Henry. “We know what to do with the real estate if we have to own it.”

To grow its shopping center holdings, Kimco isn’t going it alone. Over the past several years, it has formed a number of joint ventures to access capital for acquisitions without taking on more debt and threatening its strong credit rating.

Last year the company formed a venture with Henry’s old employer, GE Capital, which until then had only dabbled in retail real estate. The venture is acquiring shopping centers that it plans to overhaul, boosting rental revenues as a result. It closed its first deal in April, when it bought 12 centers from The Rouse Co.

The joint venture with GE is a slight twist on the Kimco Income REIT (KIR), a partnership with institutional investors that has fueled the recent growth of shopping center holdings in Kimco’s parent REIT. KIR has seen its assets balloon to more than $1.3 billion, from $430 million at its inception in 1999.

Kimco has beefed up the returns on its investments by using higher levels of debt to fund KIR acquisitions, while limiting its exposure to any investments that could sour by using individual nonrecourse mortgages.

Crossing the border
Kimco has also embarked on an international expansion through one of its fledgling joint ventures. Last year it partnered with RioCan REIT, Canada’s largest REIT, to develop and acquire shopping centers there. The venture made Kimco the first U.S. shopping center company to enter Canada in a big way. The partners have already invested about $290 million in 12 properties.

Kimco was drawn to Canada, said Henry, because occupancy rates there are higher than in the United States and rents are on the upswing. That’s because Canada, where the development process is far more difficult, has about half the retail square footage per capita of its neighbor immediately to the south. Now Kimco has set its sights on Mexico, where it is contemplating acquisitions with local operators and possibly with GE Capital, which already has a real estate team there.

“What Kimco does is use its human capital to make money, rather than just using their money to make money,” said Edward Sonshine, CEO of Toronto-based RioCan. “They take advantage of the relationships, expertise and knowledge that they have built up over the years. It’s better to be with them than against them.”

Still, there are risks. Kimco has a lot at stake, given that its shareholders have high expectations for the company. But though Kimco has said that store closings resulting from Kmart’s bankruptcy will dampen growth this year, Cooper says he is confident the company is well positioned to continue on its stellar path even if some of its new units don’t produce steady streams of income.

“Lumpy is bad in oatmeal,” quips Cooper. “If you seize opportunities and have earnings, the fact that they are not as constant as a stream of income doesn’t make them less appetizing, and there is not greater risk.”

Cooper has raised some eyebrows on Wall Street by staying at the helm longer than expected to work out issues related to the Kmart bankruptcy. But he has also built up a deep reserve of confidence in the company.

“We are willing to go along for the ride when it comes to some of the new things Kimco is undertaking,” said Morgan Stanley’s Ostrower. “Experience would suggest they are going to be very successful.”

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