PRINT THIS STORY:

CHANGE TEXT SIZE:

Developers turn to REITs for joint-venture partners

By Phyllis Feinberg

Phyllis Feinberg is the former editor of SCT Xtra.

Scott Wolstein, CEO of Developers Diversified Realty Corp., says joint ventures with other REITs -- like Riverdale Village, Coon Rapids, Minn., shown here -- allow DDR to find new projects in the early stages of development.

Once, the real estate development axiom was "location, location, location." Today, particularly for publicly held developers, a new mantra might be "safety in numbers."

In the late 1980s and early 1990s, many private developers found partners to share in the perils and rewards of developing. Now, numerous real estate investment trusts (REITs) have entered into joint ventures with other developers and pension funds as a way to obtain financing and share the risk of buying and developing new projects.

Developers Diversified Realty Corp., Cleveland, has been one of the most active participants in joint ventures over the last couple of years. "There are a variety of reasons we enter into joint ventures," Scott Wolstein, CEO, told SCT. These deals can help DDR find new projects in the early stages of development, obtain financing and also provide help with more complicated transactions.

As an example of the last category, DDR entered into an agreement last October with Prudential Real Estate Investors (PREI), Newark, N.J., a subsidiary of Prudential Insurance Co.

Under the agreement, Prudential and DDR formed the Retail Value Management program, which plans to invest up to $800 million in retail projects nationwide. Prudential has made a $210 million equity commitment and DDR has invested $70 million. With a 65% leverage ratio, the amount available for investment is $800 million.

The venture invests in undervalued properties in need of substantial re-tenanting and market repositioning, and will make equity or debt investments in companies owning or managing retail properties, as well as in third- party development projects.

Mr. Wolstein called it an "opportunity" investment, similar to investments that pension funds make in real estate funds such as New York-based Goldman, Sachs & Co.'s Whitehall Fund.

"The Prudential joint venture is really looking for underperforming assets to invest in," he added.

At the time the venture was announced, Bernard Winograd, CEO of Prudential Real Estate Investors, told SCT Xtra, SCT's weekly fax newsletter, "Prudential wants to minimize the real estate owned in its general account, but this deal is being done for the institutional clients that PREI advises. This arrangement gives us access to DDR's deal flow and a good operating partner as well."

When DDR decided it wanted to get into this type of investment, Mr. Wolstein said the company had talked to several capital investment advisors before settling on PREI.

"I don't think pension funds' interest in opportunistic investments is new," said Mr. Wolstein, "What's new is doing it with a REIT."

He pointed out that with a typical "opportunity" fund, such as The Whitehall Fund, "Investors put their money in, and then the fund has to find a developer to operate the projects. Our venture with Prudential is unique because the promoter of the venture [DDR] is also the operating partner."

This puts investors in a much stronger position than they found themselves in a decade ago.

"Pension funds got burned badly during the recession, not so much by 'opportunity' investing, but by their core real estate investments," Mr. Wolstein said.

"When they had problems, they didn't have an operating partner who also had capital at risk," he added.

The first investment made by the DDR-PREI joint venture was the acquisition of 33 former Best Products stores, empty buildings that DDR has re-leased. It will next turn to the acquisition of distressed enclosed malls, which it will rebuild and re-lease, Mr. Wolstein said. One deal is under contract now and another is pending.

DDR's deal with the Ohio State Teachers Retirement System (OhioSTRS) was formed to own and manage certain shopping centers. "Pension funds would rather invest with someone like us, who has expertise in managing centers, than go out on their own," he observed.

Two shopping centers developed by DDR -- Macedonia (Ohio) Commons and Beldin (Ohio) Park Crossings -- were the first properties transferred to the joint venture. OhioSTRS made an initial cash contribution of $11.4 million to the venture, and DDR has a $5.4 million equity interest in the deal.

"There is an enormous appetite by pension funds to invest in real estate now," Mr. Wolstein said.

Pension funds like investing with REITs in part because they're sharing the risk with a partner who's also got money at stake, but also because there is a new type of exit strategy for pension funds, which often had no way out when their investments in real estate went bad in the late 1980s.

Pension funds that invest with DDR often get the option of converting their interest in the properties into shares of the REIT, allowing them to cash out of their investments. But DDR also has its own option.

"If we're not happy with the stock price when a pension fund wants to convert its property interest into stock, we have the option of buying them out," said Mr. Wolstein.

DDR has also entered into many development ventures with corporate partners, for a variety of reasons.

"First, we will partner with a company that has control of a site and is building a project we couldn't get involved in otherwise," said Mr. Wolstein.

Second, he pointed out, "since it's someone else's project, if we get involved at the beginning we get a better deal. We would most likely have to pay a higher price if we waited to invest until the project was completed."

And getting involved at the beginning, he added, "allows us to have input so the project can be developed the way we want it."

DDR recently formed a joint venture with The Sansone Group, St. Louis, to develop and manage strip shopping centers in the Midwestern United States. The REIT will acquire 15 neighborhood shopping centers, with approximately 1.67 million square feet, from Sansone. The price of the transaction was not disclosed.

DDR and Sansone have also formed a 50-50 joint venture to develop projects and to complete all projects in Sansone's development pipeline. In addition, DDR will acquire a 50% interest in Sansone's operating company for an undisclosed sum.

Late last year DDR formed two joint ventures to develop four shopping centers. The REIT is working with Rosen Associates Development, Miami, to build a 650,000-square-foot big box power center in Everett, Mass., and a 170,500-square-foot project in Salem, N.H. DDR and Petrie Dierman Kughn, McLean, Va., are developing two projects in Maryland: the 750,000-square-foot Centre at Hagerstown and a 230,000-square-foot property in Salisbury.

In March 1997, DDR joined with two limited partnerships controlled by North Olmstead, Ohio, developer Daniel E. Biskind to form The DDRC Great Northern Limited Partnership to own and manage the 600,000-square-foot The Plazas at Great Northern, North Olmstead. DDR contributed $38 million to the deal and initially was allocated 95% of the profits and losses of the partnership, subject to a priority cash flow return to the limited partners.

Forming joint ventures has provided DDR with enormous opportunities, and Mr. Wolstein said he expects more to follow.

The concept is not limited to DDR, nor its base in the community and power center industry. The Mills Corp., Arlington, Va., and Taubman Centers, Bloomfield Hills, Mich., recently announced an alliance to develop Mills-type value megamalls around the United States over the next 10 years.

General Growth Properties, Chicago, also has partnered with Ivanhoe Partners, the real estate arm of Montreal-based Canadian pension fund manager Caisse de dépôt et placement du Québec in the acquisition of centers in Omaha, Neb., and Gainesville, Fla. and is developing a center in North Dallas, Texas, through a joint venture with the New York State Common Retirement Fund.