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Kimco's focus on real estate, rather than retailers, pays off

By Phyllis Feinberg

Milton Cooper, chairman and CEO of New Hyde Park, N.Y.-based Kimco Realty Corp., might be bearish about retailers, but he's bullish about the real estate in which those businesses operate.

And he's looking for creative ways to make money from that real estate.

"Kimco has made investors a lot of money in the retail sector by focusing on real estate rather than on the retailer," said Gary Boston, retail real estate investment trust analyst at Paine Webber, New York. The stock went public in 1991 at $20 per share and reached a high of $28.17 before a 2-for-1 stock split in December 1995. After the split the stock was priced at $13.33 per share. It closed April 29 at $36 11/16 per share.

Or, as Mr. Cooper put it, "At Kimco, we have trained our sights on the inherent underlying value of commercial real estate, and have seized the opportunity, when it arises, to buy available properties for significantly less than their inherent value.

"Eventually, the hidden value is unlocked, and our shareholders benefit accordingly," he said.

The spin-off of "Baby Kimco," a highly leveraged REIT which will consist of properties that have "bond-like" lease structures, is one example.

"There are many real estate assets that have bond-like characteristics," said Mr. Cooper. "If you have a center that is fully leased and the tenants have 15 years to go on their leases, you have the ingredients of a bond."

The new REIT will be seeded with $100 million to $200 million in assets, and these will be leveraged up to 75% using nonrecourse, individual mortgage debt.

Kimco "Classic," as it has been dubbed by some research analysts, will retain 40% of the new entity, which will minimize the conflicts created by the external management of the leveraged REIT (Kimco Classic will receive 3% of rents as a management fee.)

Another deal that was essentially a play on the real estate involved was Kimco's purchase last year of 60 Venture stores for $170 million.

As this issue went to press, O'Fallon, Mo.-based Venture Stores had announced plans to liquidate the company after unsuccessfully attempting to reorganize the chain under Chapter 11 protection. Although the chain has struggled in its efforts to compete with giant discounters such as Sears, Roebuck and Co. and Kmart, its stores have excellent locations on main highways that could be very successful with the right tenants.

Venture has assigned the lease rights of 89 locations to Kimco, including most of its 73 current sites and many of the 20 stores now being closed. Venture will receive at least $95 million in cash, less certain closing costs, from Kimco.

Kimco is in negotiations to lease 49 of the stores to Kmart. Mr. Cooper pointed out that, "They will be paying considerably higher rent than what we were getting from Venture."

"Looking at the 60 Venture stores they bought, most people would have said that it wasn't a good idea," said Mr. Boston. "But Milt has such a great track record at dealing with problem real estate."

Kimco owns 6.4 million square feet of space currently leased to Venture. The company estimates that the rent on these stores is $4 per square foot below market rents.

With Venture's liquidation, Kimco can re-lease the properties and realize significant gains from what was basically a real estate play.

Venture's real estate was "a mispriced asset," Mr. Cooper said. After buying the properties, Kimco leased the stores back to Venture, providing Kimco a 12.75% yield.

"We saw inherent value in this real estate and we knew it could be re-leased to other retailers at much higher rents," he said.

But, Mr. Cooper said, "Even if we very conservatively assume that nothing more could be done with a Venture Stores property, we still create substantial value."

The same rental income from stronger tenants would be capped at, say, a 9% capitalization rate, he explained. Under that scenario, Kimco's rental stream would have a value of $240 million, or an increase of $70 million over its $170 million purchase.

If Kimco retains the property, the increased value of the $70 million would not be recognized by the investment community, which values stocks based on funds from operations, rather than net asset value, Mr. Cooper said.

In another scenario, he added, Kimco first finances the property with a $170 million nonrecourse mortgage (thus returning its entire investment), then swaps the property for operating units of a REIT at a valuation of $70 million.

"It would also be crystal clear that Kimco had 'earned' $70 million. Obviously, one of the most logical buyers for a property of this type would be Kimco's leveraged REIT."

The leveraged REIT "should not be viewed as merely a receptacle for higher-yielding properties," Mr. Cooper said. "The skill and experience of our management team, together with our contacts within the industry, allow Kimco to combine the significant yields on these properties with the most attractive available financing, thus creating value here as well."

Kimco will also be closing its $875 million acquisition of The Price REIT, San Diego, this summer. Joseph Kornwasser, CEO of The Price REIT, will become chairman of Baby Kimco. Mr. Cooper said he is still looking for a CEO for what he hopes will be his new bundle of joy.

At this time, Kimco is focusing on real estate plays and expanding its shopping center portfolio and the holdings of Baby Kimco. It has no plans to become a "paper clip" REIT, by forming a separate "C" corporation, a taxable company that can hold the operating businesses in which REITs are, by law, not allowed to participate.

However, many other REITs are going that route.

"I think we're going to see many more paper clip REITs," said Mark Patterson, a managing director and head of the real estate corporate finance group at Salomon Smith Barney.

"They're becoming very popular because there are plenty of things that don't fit into the operations of a traditional REIT; they can use these structures to purchase many different types of companies," he added.

Vornado Realty Trust, Saddle Brook, N.J., recently announced plans to form a "C" corporation. Vornado, which has amazed the REIT world by its broad variety of acquisitions over the last year -- since Michael Fascitelli left Goldman, Sachs & Co., New York, to become its president -- will use the C corporation to own operating businesses for certain acquisitions.

The C corporation will hold the business that operates the trade shows that take place in the Chicago Merchandise Mart, which Vornado recently acquired from the Kennedy family, Mr. Fascitelli said at a meeting of Women In Retail Real Estate in New York in April.

Excel Realty Trust, a strip center REIT based in San Diego, recently spun off a C corporation, called Legacy.

Legacy will get involved in a variety of businesses. One of the company's new ventures is involved in what a spokeswoman, Sharon Filbic, called "destination tourism," in which Legacy will develop and operate tourist areas in remote locations. The projects will be built in "environmentally sensitive" areas where tourists would not normally be allowed to stay. Legacy plans projects for a site just outside of Yosemite National Park in northern California, Hawaii and the U.S. Virgin Islands.

Legacy has also acquired, and will operate, a mixed-use complex in Scottsdale, Ariz. It has purchased the Scottsdale Galleria, City Center and Towers and will run those projects.

"As we look for new properties for the REIT, Legacy will be able to take advantage of opportunities that the REIT can't be involved in," said the spokesman.

Kimco, Vornado and Excel are taking different paths to expand their businesses. But they all claim one very important element in common: They say they are creating additional value for their shareholders.