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The Wrong Time for REITs?


The parking lot of the Addison Center strip mall outside Chicago was almost deserted on a recent February morning. With Kmart (KM), its anchor store, shuttered, there's little reason to go there anymore. Kmart Corp.'s January bankruptcy filing was a blow for the mall's landlord, Kimco Realty Corp., a New Hyde Park (N.Y.) real estate investment trust, or REIT, that owns 75 properties where Kmart is a key tenant. At least 23 of Kimco's Kmarts are expected to close. That will knock some 6%, or 20 cents, off 2002 earnings, which the company now says will be $3.02 to $3.10 per share. Kmart rents made up 12% of Kimco's $469 million in revenue last year.

None of these problems is apparent yet from Kimco's share price, which as of Feb. 26 was only 8.2% off its all-time high of $34.08. With bond yields and equity prices weak, investors have piled into REITs--publicly traded companies that own commercial properties. REITs, with a $155.3 billion total market value, offer safe-haven appeal: hefty dividend yields that average 6.7%. Retail REITs, which own shopping centers and regional malls and pay slightly more, are among the most popular. Their shares have rallied 20.7%, on average, over the past 12 months.

But the slow economy has forced retail chains to close stores--including J.C. Penney (JCP), Sears (S), and Toys `R' Us (TOY)--and pushed others into bankruptcy. So the profits these REITs pay out in dividends and their share prices could be in jeopardy. Keith E. Pomroy, senior real estate editor at financial researcher SNL Financial, says Kmart's bankruptcy will bite into REIT profits in the second quarter, after its expected Mar. 11 announcement of store closures.

While occupancy rates at many retail REITs are still high--above 90% at big players such as Kimco, Developers Diversified Realty, and Simon Property Group--the folding of an anchor tenant such as Kmart or J.C. Penney has a dangerous ripple effect. That's because they bring shoppers to the whole property. "The little shops next to Kmart pay much higher rents to be close to a traffic generator," says Leo Wells, president of Wells Real Estate Funds, a real estate money manager in Atlanta. "When that traffic generator leaves, their businesses often collapse." Since small stores have short leases--3 to 5 years, vs. 15 or 20 for big ones--many may leave the minute they can if the REIT can't attract a new anchor tenant. "Most of the damage to the bottom line will be felt this year," says Pomroy.

The recent wave of bankruptcies--Kmart, Ames Department Stores, Lechter's, and Casual Male--is particularly problematic. When a viable company closes a store, it still owes rent until the lease expires or it sublets. But bankrupt tenants stop paying. Kmart has petitioned in federal court to end 350 leases. Kimco, the largest retail REIT, also leases 28 stores to Ames, bankrupt as of last August, and 22 stores to Blockbuster Entertainment, which Morgan Stanley analysts see as shaky. "I don't think Kimco's stock will continue to enjoy the premium valuation it has always had relative to other REITs," says Richard Imperiale, manager of the Forward Uniplan Real Estate Investment mutual fund. Kimco wouldn't comment for this story.

REITs are especially vulnerable to a retail slump because they're highly leveraged (table). "If debt is 50% of the total capital invested in a REIT, its breakeven occupancy rate is 75%," says Wells. "Without any debt, the breakeven rate is only 25%." Kimco had a debt-to-total capital ratio of 27.9% and an occupancy rate of over 90% as of Dec. 31, so it will still turn a profit, but the company expects occupancy to drop to 87% in the first quarter of 2002.

Kimco has ample company. SNL says Simon Property Group, the largest regional-mall REIT, leases 116 stores to J.C. Penney, which closed 47 stores in 2001, plus 175 to Cole National, an eyeglass company also seen as weak. Simon did not return phone calls. Developers Diversified, which leases 31 Kmarts, has a 47.7% debt ratio. Developers' Executive Vice-President Daniel B. Hurwitz expects only two to close. "We will be able to re-lease those sites," he says. Other REITs may not be so lucky. Fat dividends and share-price gains made retail REITs must-haves for many investors. But empty parking lots at strip malls may mean it's time for them to shop elsewhere. By Lewis Braham in New York and Robert Berner in Chicago


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