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AUSTRALIAN CAPITAL LANDS U.S. PARTNERS

BY DONNA MITCHELL

A recent flurry of joint ventures between Australian and U.S. retail developers highlights a lack of opportunity for new malls Down Under that is spurring a shift of capital to the United States.

“There is an increasing demand to go outside of the Australian market,” said Christopher J. Niehaus, a managing director at Morgan Stanley who oversees its real estate investment banking group.

Three recent deals between U.S. and Australian firms, representing a combined $1.7 billion in retail real estate transactions, underscore the trend.

• In August Prime Retail Group — a Melbourne firm unrelated to the similarly named Baltimore-based outlet developer — teamed up with Watt Commercial Properties, Santa Monica, Calif., to purchase 14 centers in California from M&H Realty Partners, San Francisco. The $488 million deal for grocery-anchored community centers and power centers carried an initial cap rate of about 7.4 percent.

• In September Developers Diversified Realty, Cleveland, and Macquarie Bank, Sydney, formed a limited property trust (LPT) called DDR Macquarie Trust. That entity will own 11 of DDR’s U.S. community centers, in a deal valued at $730 million with an 8 percent cap rate.

• Also in September, Chattanooga, Tenn.-based CBL & Associates Properties formed a joint venture with Galileo America REIT, the U.S. affiliate of Sydney’s Galileo America Shopping Trust, to form a publicly traded LPT that will invest in U.S. power and community centers, in a deal worth about $516 million. CBL contributed 90 percent of its ownership interest in 51 power and community centers to the trust.

“These investors have sucked a lot of money out of the [Australian] investment market,” said Graham Terry, COO of Centro Properties Group, an Australian LPT that owns Prime Retail Group. “I think it will take some time to tighten up again.”

The move overseas reflects the serious constraints Australian retail developers face at home. For one thing, there are only two major department store companies to anchor large regional malls: David Jones and Coles Myer, which operates the Myer/Grace Brothers chain. (Coles Myer also controls the country’s two major discount department store chains, Target and Kmart — not related to the U.S. companies of the same names — as well as two grocery chains, Coles and BiLo.)

That limits the opportunity to build department store-anchored centers, notes Clive Appleton, a director of The Gandel Group, an Australian retail property development and management company. “To anchor a mall, you need to deal with these two chains, and they will not anchor too many areas that cannibalize their own sales,” he said. The country, with a population of 19.5 million, now has some 65 regional malls, each averaging about 700,000 square feet of gross leasable area, as well as discount department store-based shopping centers and grocery-anchored centers.

Government building restrictions present other major hurdles. Obtaining approval to build a shopping center larger than 200,000 square feet is difficult except within the urban areas the government has targeted for strategic development. That has prompted many developers to expand and refurbish existing projects instead of attempting to build new ones, says Peter Leyshon, director of Leyshon Consulting, an Australian retail research firm.

Shopping center developers are also contending with what they see as an unfair advantage granted to other kinds of development, says Milton Cockburn, executive director of the Shopping Centre Council of Australia (SCCA), which oversees regulatory issues on retail development and operates under the umbrella organization Property Council of Australia (PCA). For example, some discount megastore developments are being permitted in areas outside of the cities that have been zoned for so-called bulky-goods centers, which sell furniture and other household goods, and require larger stores and parking lots. Shopping centers remain barred, however.

New competition is also arising from retail developments in and around the country’s airports, which the government began privatizing in 1996. Because they operate on federally owned land, airport retail projects are not subject to the restrictions imposed by state and local governments, says Cockburn. Brisbane Airport Corp., for instance, announced a commercial development in May that would include a factory outlet, a drugstore, a convenience center and a bulky-goods center. Meanwhile, Essendon Airport, in Melbourne, recently produced a master plan that calls for a major retail development that undermines the vision Melbourne officials have for area development, Cockburn says.

A further deterrent to domestic retail development is the concentration of Australia’s residents near the east and south coasts; the rest of the country is too sparsely populated to stimulate development. And even on the two coasts, the population is growing at a marginal rate of about 1.3 percent annually, according to Leyshon, stunting demand for new retail centers.

Finally, a government stamp tax on Australian residential or commercial real estate transactions places an undue burden on buyers, discouraging such transactions, critics say. The levy, typically five percent of a property’s purchase price, goes toward maintaining the country’s infrastructure, explains Cockburn. The PCA is trying to convince the federal and state governments to eliminate the tax and fund infrastructure improvements by raising debt, he says.

With all these constraints, no new malls have been built in Australia in years. The last major project — the 904,000-square-foot Robina (Queensland) Town Centre — opened in 1996 in a suburb of Brisbane.

Consequently, a great deal of money has nowhere to go domestically. With a market capitalization of A$600 billion ($415.5 billion), LPTs comprise the third-largest publicly traded sector on the Australian stock market. Although the amount of capital targeted at Australian property investment is growing at about 10 percent per year, stock volume is growing at only 2 or 3 percent, says Michael O’Brien, fund manager for General Property Trust, a real estate investment fund and affiliate of Lend Lease, both in Sydney.

That mismatch of demand and supply breeds intense competition for available properties, especially between LPTs and direct property vehicles, which allow individual investors to buy ownership stakes in shopping centers, says Centro’s Terry. Yields on shopping center investments have tightened by as much as 150 basis points over the past two years, he adds.

The availability of capital and the voracious hunger for investment properties won’t soon fade away, either, thanks to a government requirement that workers contribute 9 percent of their salaries to pension plans or superannuation funds. And there is talk of increasing that rate to 12 percent, says Mark Baillie, director of real estate in North America for Chicago-based Macquarie Real Estate, a subsidiary of Macquarie Bank.

Little wonder, then, that Australian developers are looking elsewhere to grow. And little wonder, too, that the U.S. market in particular attracts them. Beyond a shared language, the U.S. and Australian shopping center industries have some structural similarities that make the U.S. market a comfortable fit for Australian investors. Both have a similar array of property types, are commonly set up around trusts (LPTs or REITs) and have institutional investors, such as pension funds. (By contrast, in Asia the REIT industry is just beginning to take hold and in Europe is not as widespread.)

“We’re in many ways a microcosm” of the U.S. market, said Tony Dimasi, managing director of Melbourne-based Dimasi Strategic Research, a consulting firm focused on retail and retail development. The distinction, he added, is that “everything happens on a much smaller scale, population- and spending-wise.”

Another incentive to invest specifically in the U.S. is financial, O’Brien explains. Australian firms receive a tax credit back home that offsets their payment of U.S. withholding taxes, which amount to about 10 percent of earnings.

For their part, American companies are welcoming the infusion of capital from Down Under. CBL, for example, will use it to pay for mall acquisition and development, says Charles Willett, the company’s senior vice president of real estate finance. And by retaining a 10 percent stake in the properties it contributed to its joint venture with Galileo, CBL will continue to benefit from the centers’ profits and to maintain relationships with the retailers that drive its development pipeline, he says.

Another advantage to the surge of Australian investment is that it may help drive down cap rates for the community and power center segments involved, says Morgan Stanley’s Niehaus — although, he points out, that capital is hardly the only influence on rates. (The $1.7 billion in recent Australian investment is a fraction of the $25 billion in retail real estate transactions that typically occur every year.) And, he warns, any new influx of capital raises concerns about the possibility of overbuilding.

But though the Australian presence in the United States is likely to expand, U.S. retail property professionals should not anticipate a full-scale Australian invasion, say their counterparts in Sydney. Australian industry players are not looking for a completely foreign solution to their development and investment constraints at home.

“We would expect [the current partnerships] to grow and acquire more properties,” said Paul Snushall, the head of property trust research at Merrill Lynch’s Sydney office. “We don’t know whether we will see another joint venture.”

Underscoring his point, Regency Centers, the Jacksonville, Fla.-based owner of neighborhood and community centers, announced in mid-September an expansion of its existing joint venture partnership with Macquarie CountryWide Trust. Regency sold three of its U.S. properties into the venture for $103 million.

And mall development in Australia has not entirely ground to a halt. At least one new center opened recently, and another is under way, which should sop up some investment capital. In August Westfield Holdings opened Westfield North Lakes, a 269,100-square-foot regional center on the northern outskirts of Brisbane, and Lend Lease is building the 538,200-square-foot Rouse Hill Regional Centre in a mixed-use project under development in Sydney. Rouse Hill should be completed in 2006.

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