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ARE PUBLIC RETAIL REITS NEXT IN LINE TO BE TAKEN PRIVATE?

By Steve Bergsman

The wave of publicly traded REITs being taken private by investment groups and opportunity funds has continued unabated this year, but it has not swept across the retail sector.

Over the past two years, about 20 REITs have either gone private or are about to. But it is hard to find a single one in the retail sector (unless you count the proposed buyout of Sizeler Property Investors, of Kenner, La., by a Canadian investment fund — and we shouldn’t count it, because Sizeler has a mixed portfolio of apartment and retail properties, of which the residential is far more valuable).

Not to say there has been no activity at all in the mall and shopping center sectors, but simply that almost all of it has comprised mergers between publicly traded REITs. The most recently announced retail deals include Kimco Realty Corp.’s acquisition of Pan Pacific Retail Properties and the purchase of Heritage Property Investment Trust by affiliates of Centro Properties Group, a publicly traded Australian company. Last year Centro affiliates acquired Kramont Realty Trust, a Philadelphia-based neighborhood shopping center REIT.

Mergers predominate in the retail sector because portfolio combinations produce efficiency and savings. This is an important consideration in regard to smaller REITs, given that the Sarbanes-Oxley law vastly increased the expense for accounting and regulatory filings. The issues for companies being taken private, on the other hand, have more to do with perceived marketplace underpricing — a phenomenon hard to find among the highly valued retail REITs. “Investors that take REITs private are finding there are certain segments that may be mispriced at any given time,” said Glenn J. Rufrano, CEO of New York City-based New Plan Excel Realty Trust. “So they buy a public company, break it up and create spreads over what they paid.”

Public REITs’ ability to grow has also been compromised by the debt covenants, said Jeffrey A. Barclay, an ING Clarion managing director, at ICSC’s capital markets conference in New York City in September. “If you’re not public, you can lever up to 80 and 85 percent without much incremental cost,” he said. “The ability to drive return on equity is fantastic for private buyers who can stack on extra leverage.”

The wave of privatization began in the hotel sector following the terrorist attacks of Sept. 11, 2001, Rufrano says. This was a depressed market, and a lot of private capital came in and decided to assume the lodging industry risks because pricing was cheap. Next came the apartment sector as investors sought out multifamily REITs with the aim of converting apartment complexes into condos. The third sector to catch fire was office space; investors believed the slumping office market was ripe for a turnaround, so they were anticipating rent spikes and higher returns. But as for shopping center companies, “retail people would say the sector has been reasonably priced over the last 24 months,” Rufrano said.

Historically, REITs have sold at net asset value, says Norman M. Kranzdorf, senior vice president of retail at Urdang Capital Management, Plymouth Meeting, Pa. “You will find that in most deals, the REITs were bought at a price below their NAV,” Kranzdorf said. “So the acquirer thinks it is getting a pretty good deal by buying assets under the NAV.” On the opposite end, despite a strong market for REIT stocks over the past several years, the conviction persists that some REITs are undervalued. “Ratings agencies have missed the mark when rating equity REITs,” Barclay said.

And yet the biggest reason so many REITs are being privatized is that too much capital is chasing real estate today, sources say. “The volume of funds flowing into the sector from a variety of sources around the world is so great that you have to come up with a lot of different ways to get a hold of real estate,” said Richard Moore, a managing director at RBC Capital Markets, Cleveland. “Eventually, some of that demand was going to turn its attention toward REITs.” In Moore’s view, two kinds of REITs are getting bought out: those that have poor management and strategy and those that are high-quality REITs but whose growth has slowed. The latter are in demand for the long-term cash flow they generate.

There are other, less conspicuous reasons why companies are being sold, both of which have to do with inflection points concerning REIT operations. Some companies have done a great job of developing into a regional powerhouse but lack the management or capital to go the next step, says Bruce Schonbraun, a managing partner at the Schonbraun McCann Group, a New York City real estate consulting firm. These companies sell out to a leading national REIT with the ability to create even greater shareholder value. Schonbraun puts Pan Pacific in this category.

Second, many companies are still run by entrepreneurial owners who are getting on in years and have neither the energy to take the company forward nor the desire to face such headaches as Sarbanes-Oxley, says Michael Frankel, national tax and REIT services director at Ernst & Young, in Dallas. Privatization can be at once lucrative for the shareholders and a welcome signal for these entrepreneurs to embrace retirement.

Leo Ullman, CEO of Cedar Shopping Centers, Port Washington, N.Y., is 67. Though he insists he is definitely not ready to retire, he acknowledges that interested parties having been knocking at Cedar’s door. In fact, just a year ago North Miami Beach, Fla.-based Equity One made a play for the company but then backed out. RBC’s Moore, too, has Cedar on his list of potential buyouts.

With under $100 million in annual revenue and a very regional concentration of properties, Cedar fits the profile of a REIT that has merged or been bought out. But Ullman is playing it cool. “It’s fair to say there’s probably not a REIT out there that has not had these discussions,” he said. “We never said we would or would not be for sale.”

The key benefit for real estate executives taking their companies public as REITs was the tax advantage, says Ullman. “Right now it may not be such an advantage, as the costs of getting to public markets or staying in the public markets are very high,” he said. “Private money, available at a lesser cost and without the attendant difficulties of being public, is attractive. With the dynamics of independent boards, audit committees, Sarbanes-Oxley, et cetera, as well as the cost of all the filings as a public company, for a small company like ours, the savings would be literally in the millions by going private.”

For retail REIT executives, entertaining offers means soothing egos or fulfilling objectives. “Many people in the REIT business think their stock is undervalued,” said Kranzdorf. Indeed, Ullman is among them. “There is some frustration by managements and boards,” said Ullman, “that we are not accorded the value that we think is banked into our products.”

Sarbanes-Oxley pressure can also make an exit from the public arena by means of a buyout or merger seem tempting. And this is especially so if the acquirer is waving a hefty premium. In witness of which, Babcock & Brown, a publicly traded Australian firm, made a bid in August for Charlotte, N.C.-based BNP Residential Properties at a 39 percent premium. “That,” said Kranzdorf, “tells you the whole story.”