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Are REITs and Wall Street feeling the seven-year itch?

By Phyllis Feinberg

The Wall Street/retail real estate marriage, now seven years old, has remade the shopping center industry, with many players now thinking about finding new partners.

Think of it as the seven-year itch.

The regional mall real estate investment trusts (REITs) have been getting the most attention recently from analysts and investors for another reason, as well: continuing consolidation in the category.

Andrew Jones, retail REIT analyst at Morgan Stanley Dean Witter, New York, believes that within about five years half of the 2,000 regional malls in the United States will be owned by publicly held mall REITs.

He argued that bigger is not only better, it is essential for mall operators. The recently announced acquisition by Simon DeBartolo Group, Indianapolis, of Corporate Property Investors' $5.8 billion portfolio has given the firm a big leg-up on its competition, he contended.

"The train has left the station. You can make a compelling argument that for long-term growth these companies need to be larger," said Mr. Jones.

"Regional malls are hard to manage; they require a lot of expertise. In order to get that expertise companies need to be big," he added.

Michael Fascitelli, president of Vornado Realty, Saddle Brook, N.J., recently said that he expects consolidation to happen rapidly in both the regional mall REIT and strip center REIT markets.

Many retail REIT analysts agree. The big question now is how these regional mall acquisitions will occur. And that is changing.

Until last year it seemed unthinkable that hostile takeovers would occur in the retail REIT industry. There seemed to be an unwritten gentleman's code of conduct obeyed by all of the public REITs.

That all changed with Simon DeBartolo's 1997 acquisition of Retail Property Trust (RPT), a private REIT with a portfolio of 12 high-quality regional malls, including The Westchester in White Plains, N.Y.

RPT had agreed to merge with New England Development, Newton, Mass., and The Richard E. Jacobs Group, Cleveland. The merged entity was planned to go public as The Jacobs/Karp Group.

Simon did an end run around RPT's advisor, The O'Connor Group, New York, by going directly to RPTs institutional shareholders, mainly pension funds, with a higher offer. An auction then took place, and Simon bought RPT for $1.2 billion.

"There's no room or time to be gentlemanly, the consolidation in the industry is happening so quickly," said Craig Schmidt, retail REIT analyst at Merrill Lynch, New York.

Some analysts view Simon's actions in the RPT situation a bit differently. "Simon educated the sellers as to who else was out there," said William Atcheson, retail REIT analyst at Salomon Smith Barney, New York.

"It's not like they came out with guns blazing; they simply showed investors that other alternatives were available," he said. "At that point, the advisor had the fiduciary responsibility to get the best deal for the shareholders."

The situation was not dissimilar with CPI. The company first was in talks with The Rouse Co., Columbia, Md. Simon again entered the picture with an offer, and another auction took place.

Although there has never been a hostile takeover bid by one public mall REIT of another, some analysts think it is a definite possibility. "I think there will be at least one hostile takeover this year of one public REIT by another," said David Fick, vice president and retail REIT analyst at Legg Mason Wood Walker, Baltimore.

REITs with high stock multiples may go after REITs with much lower multiples, he said. Mr. Fick pointed out that when David Simon, CEO of Simon DeBartolo, has been asked if he would pursue a hostile takeover, his response has been a coy "No comment."

"That's his style. He's a very aggressive, take-no-prisoners kind of guy," said Mr. Fick, describing Mr. Simon.

But whether the deals are hostile or friendly, they are expected to come at a rapid pace.

Merrill's Mr. Schmidt said there are about 100 "quality malls" on the market which the public mall REITs are going to scoop up very quickly.

The end result of the consolidation would then be a group of public mall REITs that own the best-performing regional malls in the United States.

"The mall REITs clearly have the best properties now as measured by sales per square foot," said Gary Boston, retail REIT analyst at Paine Webber. Their dominance is expected to grow with the consolidation.

The next big question is who is next among the sellers. At presstime, San Diego-based TrizecHahn Centers had agreed to sell 20 of its 25 centers to The Rouse Co. and Westfield America for $2.55 billion to focus its efforts on new development.

Mr. Fick said Cadillac Fairview Corp. of Toronto may also decide to sell its nine U.S. properties.

"They've said that unless they can expand in the United States, they won't hold the malls they already own," he said. "I don't think they're going to be able to compete with companies like Simon and Rouse for acquisitions. The best thing for them to do would be to take advantage of the high prices and cash out."

Consolidation is also expected to occur among strip shopping centers, including power, neighborhood and community centers. However, with about 40,000 strip centers in the United States, the effects won't be as apparent as with the regional mall sector.

"There are a number of players [among the strip center REITs] which have staked out regional areas," said Mr. Atcheson. He pointed to Regency Realty, Jacksonville, Fla., in the Southeast and Bradley Real Estate Trust, Roseville, Minn., in the Midwest as two strip center REITs trying to stake out territory for their organizations.

He added that some West Coast-based strip center REITs will attempt to "get critical mass" in that part of the country. He said Burnham Pacific Properties, San Diego, is one potential acquiror.

"A lot of people are harping about the cap rates coming down in strip center acquisitions," said Mr. Atcheson. However, he adds, "I don't think companies will continue to pay up for this asset class. To expect a 9% cap rate on the sale of a grocery-anchored center is silly."

Cap rates will remain higher in strip centers sales because, in general, they have tenants "of a lower credit quality," compared with the nationally known retailers anchoring most malls.

"I don't think some of the advantages of consolidation within the mall sector are the same for strip centers, but some of the larger REITs will do it," said Merrill's Mr. Schmidt.

The one attempted hostile deal thus far in 1998 involves strip center REITs. The Price REIT, San Diego, was the target of an unsolicited bid from Price Enterprises, also of San Diego, which had only become a public REIT last year.

Joseph Kornwasser, president and CEO of Price REIT, was strongly against that deal. He said that while The Price REIT had an investment grade credit rating, the combined company would have become a noninvestment grade entity because of Price Enterprises' plan to pay for the deal with convertible preferred stock.

Kimco Realty Corp., New Hyde Park, N.Y. -- which led the REIT revival with its initial public offering in 1991 -- came to its rescue when it announced early this year that it would buy The Price REIT for $835 million.

The merger with Kimco, a very strong REIT with an investment-grade credit rating, gave The Price REIT an alternative few, if any, competitors could beat.

Analysts expect more acquisitions between stronger strip center REITs and weaker ones.

Consolidation is taking place in almost every industry in the United States, with stronger, larger companies buying smaller, weaker ones. REITs, which have desired a place in mainstream corporate America for many years, are simply following the same pattern.