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MASSIVE OPEN-AIR DEALS POINT TO UPTICK IN U.S. CAP RATES

By Brannon Boswell

If two July megadeals are any indication, cap rates on U.S. open-air centers may start to creep upward, Wall Street analysts say. In one transaction, Kimco Realty Corp. agreed to pay $4 billion for Pan Pacific Retail Properties, a REIT with 22.6 million square feet of grocery-anchored centers. In a separate deal, Centro Watt, a partnership between Australia’s Centro Properties Group and Los Angeles-based Watt Commercial Properties, agreed to pay $3.3 billion for Heritage Property Investment Trust, a REIT with a 28.7 million-square-foot portfolio of grocery-anchored centers.

The Kimco deal assumes a yield of 6.3 percent and a price of $200 per square foot, according to Morgan Stanley. The deal allows New Hyde Park, N.Y.-based Kimco to upgrade its portfolio and penetrate the high-density West Coast. Kimco chairman and CEO Milton Cooper said in a press release, “This merger fits well with our strategy of owning the highest quality shopping center portfolio, growing our management business and generating solid investment returns for our partners and shareholders while conserving our own equity capital.”

The deal also leaves Kimco with two options: to keep the Pan Pacific portfolio on its balance sheet or to parse the assets into one of its many fee-generating joint ventures. “The joint venture option is the ultimate goal, especially given that cost of financing is likely close to acquisition yield,” said Scott Crowe, a REIT analyst at UBS Securities, in a note to investors.

The Centro Watt deal, meanwhile, assumes a yield of 7.2 percent and a price of $115 per square foot, according to Morgan Stanley.

The cap rates of both deals are higher than the 6.25 percent Regency Centers and Macquarie CountryWide Trust assumed in their $2.74 billion watershed purchase of the 133 million-square-foot First Washington Realty portfolio of open-air centers last year. The average price paid for open-air shopping centers in 2005 was about $225 per square foot, and the average price has almost reached $250 per square foot for the year-to-date.

In Centro Watt’s case, at least, the high cap rate may be more about the quality of assets than any weakness in the retail real estate market, observers say. Heritage posted average base rents of $9 in the first quarter, versus the $18.97 per square foot average of open-air leader Federal Realty Investment Trust and the $11.92 per square foot average for the open-air center sector overall.

“The primary lesson investors should take from this [Centro Watt] transaction is that lower quality shopping centers are becoming more challenging to sell, particularly in large quantities and for high prices,” Morgan Stanley REIT analyst Matthew Ostrower wrote in a note to investors.

But Kimco is acquiring a highly sought-after portfolio in hard-to-duplicate West Coast locations, and Pan Pacific’s average base rent for the first quarter was $12.86 per square foot. “While the transaction’s valuation can hardly be deemed bargain basement, it is below what we would have expected,” Ostrower wrote. He also wrote that the deal was exclusive between Kimco and Pan Pacific and wasn’t open to rival bidders. Observers say rising interest rates may also be to blame for the decompressed cap rate.