PRINT THIS STORY:

CHANGE TEXT SIZE:

Balancing long-term goals with short-term reporting

By Kevin Kenyon

How do you balance the short-term expectations of Wall Street with the long-term view the retail real estate industry sometimes calls for?

It's a question which today's retail real estate investment trusts (REITs) face on a daily basis.

In an industry where 20-year leases are the norm for anchor tenants, developers today are being asked to forecast and produce earnings on a quarter-to-quarter basis.

"One thing that we've learned in our six-plus years of being public is that you really have two businesses -- you have the business of investing and buying real estate, and you have the business of being a public company," said Michael Pappagallo, CFO for New Hyde Park, N.Y.-based Kimco Realty Corp.

While the public arena has given owners unparalleled access to capital and new opportunities to grow, it has also added an element of accountability that developers, many of whom made their marks as private companies, have never faced.

It has also raised other questions.

Does this climate allow developers to make the entrepreneurial decisions -- such as investing in an anchor that may not pay off immediately -- necessary to achieve long term success? Is the future being sacrificed for the sake of producing next quarter's dividend?

Considering it has been over six years since Kimco Realty Trust began what is commonly known today as the new age of REITs, SCT spoke with representatives of four publicly traded companies to discover what they've learned through the years, and how they've managed to balance the short-term needs of their investors with their long-term development and management goals.

Becoming a public company added a whole new element to how Kimco operates as a company, Mr. Pappagallo said. The firm became a REIT in November 1991.

Each business, Mr. Pappagallo explained, requires its own particular set of skills. Consequently, developers need to learn, first and foremost, how to be a public company.

"Along with that comes the absolute requirement of a public company to articulate a strategy to differentiate itself, not only on a sector basis, but from what makes the individual company different from its peers," he added.

Kimco, for its part, tries to impress upon Wall Street that because its history long precedes 1991 (Chairman Milton Cooper started the company in 1966), the firm's portfolio contains a significant number of rents that are below market, allowing opportunity for future growth, Mr. Pappagallo explained.

Communication with Wall Street is even more important, he added, in today's age of rapid consolidation.

"As REITs become larger and larger, as they become more prevalent and market capitalization and liquidity increases, you can get in a position of falling more and more into the quarterly earnings pressure syndrome.

"Therefore, it's important to indicate exactly what the plans are and how over the long haul -- despite any short-term blips -- you can still generate sustainable increases in earnings and FFO (funds from operations)," he explained.

Norman M. Kranzdorf, president and CEO of Conshohocken, Pa.-based Kranzco Realty Trust, which followed Kimco by becoming a REIT in 1992, said it was not as much of a "culture shock" when it went public as it was for others, because of Kranzco's prior experience as a public company. Kranzco had been a public real estate firm known as Anterre Development Co., then went private in 1980.

"We were used to hearing comments like 'what are you doing in the next quarter?' when in fact we were dealing with 20-year leases," Mr. Kranzdorf explained. "We learned early on that you really have to balance the two and understand that when you're talking to Wall Street they are short-term focused."

In fact, Mr. Kranzdorf said, he often jokes that when Kranzco's leases come up for renewal, many of the analysts who cover REITs today will be either covering another segment or be retired.

"They often don't have the view as to what this real estate business is all about -- how it grows and what it's worth in 20 years. They're only focused on where you are today," he said.

All joking aside, Mr. Kranzdorf said analysts today have become more knowledgeable, and are starting to focus more on growth and how a REIT can grow its portfolio internally, not by just acquiring or building. Kranzco, too, has adjusted its thinking.

"On the other hand, I think we've become more aware of how they think on a short-term basis, and how you bring information to them -- how you report your earnings," he added.

Echoing thoughts expressed by Mr. Kranzdorf, John N. Foy, CFO for Chattanooga, Tenn.-based CBL & Associates Properties, said that investors and analysts have come a long way in differentiating retail REITs from other sectors, such as office or apartment.

"I think we were all sort of lumped together in one big bag, the thinking being 'a REIT is a REIT is a REIT.' That's really not the case and I think the markets have come to recognize that," he explained.

Before CBL went public in November 1993, Mr. Foy said he kept hearing how important it was to be clear, concise and straightforward with the investment community, a strategy he says the firm has embraced.

"We have a real proactive position when is comes to disclosure," he said, adding that CBL conducts conference calls quarterly, passes out transcripts and files them regularly with the SEC. "We give them all the specific information they need so they can put together models to project our earnings."

Mr. Foy added that CBL is also recognized for its conservative accounting approach, mainly because it doesn't include straight-lining of rents or the sale of outparcels in its calculations, which tend to overstate FFO.

Reporting to Wall Street on a quarterly basis has also had another effect which can be viewed as both a positive and a negative, according to Mr. Kranzdorf.

"I think it has taken some of the gambler instinct out of developers, and I definitely see that among the REITs, you don't see many of them taking chances like they used to," he said.

While quarterly reporting may have imposed a certain discipline on the industry, Mr. Kranzdorf is not ready to give all the credit to Wall Street.

"Many of us who were private real estate entrepreneurs, especially in the years before the 1986 Tax Act, made some decisions that were based either on tax consequences or ability to obtain funds.

"Those chances were often paid for by Uncle Sam under tax losses. Today, those tax losses no longer count, so you have to be more careful," Mr. Kranzdorf said.

And REITs can still make long-term investments that may not show immediate results, Mr. Kranzdorf believes, as long as they don't put too much of a drain on their accounting.

"You can still make investments that have a future benefit as long as you don't overdo it, and it doesn't get too onerous on your balance sheet," he said.

Because of its ability to communicate with Wall Street and its positive relationship with its shareholders, CBL is basically able to operate as a private company, which it was from 1978 to 1993, Mr. Foy said.

"Over the years I think we demonstrated that we could run as a private company in a very conservative way," he explained. "Even when we went public, we had all our lines of credit in place. There was no necessity to go public; it just afforded us the opportunity to be in the capital markets.

"Because of our track record, and our ability to demonstrate that to our shareholders, we've been able to enjoy a situation where we don't have to balance the long-term with the short-term," Mr. Foy said.

That being said, Mr. Foy explained that CBL, like any other REIT, is looking for returns. "I think we're all focused on profitability right now. Market share isn't as significant as it once was. It's how profitable you can be, and that's how we're managing our company."

Meanwhile, Crown American Realty Trust, Johnstown, Pa., which went public in August 1993, is beginning to reap the benefits of long-term decisions that initially led to Crown American's stock being undervalued, said Mark E. Pasquerilla, president.

"The mall business is a capital-intensive business -- long-term -- and I think early on perhaps it might have been new to the investment community.

"We made some decisions early on to put money back into our malls, and I think in the last three quarters we've been getting some strong results which have borne out our strategy," he explained.

What differentiates the shopping center industry from other sectors, according to Mr. Pasquerilla, is that sometimes investments need to be made that may not show an immediate payoff.

"In the mall business you have a lag on return. When you invest in anchors, there's not a direct return, but they really drive the mall and eventually create value," he said, adding that his company has been busy placing May Co. department stores at several of its properties.

But before making major capital expenditures, developers should be prepared to map out a detailed strategy to investors, Mr. Pasquerilla said.

"If you're going to do something that is even marginally dilutive to earnings, you better have a good reason for it, because investors like to see things that are immediately accretive within a very short period of time," he explained.

While balancing the needs of investors with long-term goals may be a difficult proposition, Mr. Pasquerilla said he believes it has had several positive effects, including imposing a strong discipline on the industry.

"I believe in entrepreneurship, which I think is a requirement whether you're public or private, but it should be a disciplined entrepreneurship.

"There were a lot of crazy things going on in the early '90s that didn't make sense, a time often referred to as the 'mall wars' or 'retail wars,' and I think right now you have a much more disciplined group of companies," Mr. Pasquerilla said.

Even prior to going public, Crown American published an annual report of sorts that revealed much of the information it now must provide to investors. The availability of information from other public shopping center companies has also allowed Crown American to benchmark itself, which Mr. Pasquerilla believes is another blessing.

"Going public has made us a better company. Our improved reporting and the financial capabilities we've gained should increase our value as a company. It has already done that, so I'm very positive about the whole industry and where it's going," Mr. Pasquerilla said.

While it may seem like today's public companies have a delicate balancing act on their hands, it also is clear that many have made great strides toward discovering how to satisfy the short-term needs of investors without sacrificing their long-term aspirations.

To Kranzco's Mr. Kranzdorf, it's all about achieving a middle ground.

"You must run your business the way the business should be run, you can't allow analysts and reporting to force you into making bad decisions. But on the other hand, you can make decisions which alleviate the problems that Wall Street sees, and still run your business correctly."