Sternlicht Searches for Yield at Second-Tier U.S. Malls

Investors including Barry Sternlicht and KKR & Co. are buying second-tier shopping malls in places from Lincoln, Nebraska, to suburban Chicago in a hunt for higher yields as retail sales at the properties rebound.

Sternlicht’s Starwood Capital Group LLC and KKR, run by Henry Kravis and George Roberts, have announced acquisitions of so-called B malls in the past month, and Pennsylvania Real Estate Investment Trust, the Philadelphia-based owner of such centers mainly in the mid-Atlantic region, is the best-performing mall REIT this year.

Growing interest in B malls is a turnaround from last year, when investors mostly sought the perceived safety of better-performing properties with higher average tenant sales in the most desirable markets. REITs with luxury department stores at well-located malls had outperformed landlords with retail centers in such small cities as Rockford, Illinois.

“The investor community just wasn’t ready to take on the risks associated with those malls,” said Dan Fasulo, managing director at New York-based real estate research firm Real Capital Analytics Inc. “They’ve started to trade again.”

Starwood, a private-equity firm based in Greenwich, Connecticut, agreed last month to buy majority interests in seven U.S. retail centers from Australia’s Westfield Group for $1 billion, and KKR on April 19 said it made an investment of about $196 million in a mall about 20 miles (32 kilometers) west of downtown Chicago. It was the New York-based buyout firm’s first U.S. acquisition under its new real estate division.

Pennsylvania REIT

Pennsylvania REIT, which is marketing five of its lower-quality malls in a bid to improve its portfolio, showed “some good results” in the first quarter, Jeffrey Lau, an analyst at Sidoti & Co. in New York, said in a telephone interview. Net operating income rose 3.4 percent from a year earlier, and tenant sales per square foot increased 5.3 percent to a record $376, the company said on April 24.

“That’s going to continue and that should bode well for the stock price,” said Lau, who has a buy rating on the shares. “These asset sales that the company is pursuing, that’s really going to help them further reduce debt.”

Pennsylvania REIT fell 3.4 percent to $12.35 at the close of New York trading. The mall owner’s shares have climbed 18 percent this year, more than the 11 percent increase in Bloomberg’s regional mall REIT index and the 5 percent gain in the broader Bloomberg REIT index.

Lower Yields

Demand last year for class A retail centers pushed down yields, driving investors seeking higher returns to B malls.

Capitalization rates, a measure of gains for real estate investors, average 5 percent to 6 percent for class A centers, said Rich Moore, an analyst at RBC Capital Markets in Solon, Ohio. For B malls, cap rates -- a property’s net operating income divided by its purchase price -- range from 7.5 percent to 10 percent. Top centers in smaller markets often have cap rates of 6 percent to 7.5 percent, Moore said.

Financing for buyers is improving as well because loan providers who sell their debt as commercial mortgage-backed securities are “opening up a little bit to the B-mall market,” Benjamin Yang, an analyst at Keefe Bruyette & Woods Inc., said in a telephone interview. A shortage of financing last year hurt sales of B malls, Yang said.

“Investors are gaining more comfort that the fundamentals are stabilizing and there’s an opportunity to grow” net operating income at B malls, Yang said.

More Food Options

Starwood plans to “repurpose” some of the properties it’s buying by bringing in more entertainment and food options, Sternlicht said in a May 1 Bloomberg television interview. While some of the properties are in such smaller cities as Fairfield, California, and Lincoln, they’re the dominant malls in their towns, he said.

The Westfield malls had sales of $373 a square foot and were 93.8 percent leased at the end of 2011, according to an April 18 statement from the Sydney-based company. The figures exclude Metreon, a San Francisco property that’s being redeveloped.

Sales at Simon Property Group Inc.’s U.S. malls and outlet centers totaled $546 per square foot for the trailing 12 months as of March 31, the Indianapolis-based company, which is the biggest U.S. shopping mall owner, said on April 27. Taubman Centers Inc.’s 12-month trailing mall tenant sales were $659 per square foot, the Bloomfield Hills, Michigan-based company said April 26.

Simon led mall REITs last year with a 30 percent increase in its share price, followed by Taubman with a 23 percent gain.

Nordstrom, Neiman

Class A malls, such as those that dominate Simon and Taubman’s portfolios, tend to have high per-square-foot sales and such luxury retailers as Nordstrom Inc. and Neiman Marcus Group Inc. as their anchor tenants. B malls have lower sales and higher vacancy rates and usually are anchored by lower-priced department stores such as J.C. Penney Co.

With sales rising at B malls, REITs are joining private-equity firms as buyers of the properties. CBL & Associates Properties Inc., a retail landlord based in Chattanooga, Tennessee, on May 16 said it bought Dakota Square Mall in Minot, North Dakota, for $91.5 million. The center had sales of $470 per square foot in the 12 months ended March 31, CBL said.

Rouse Properties Inc., an owner of B malls that was spun off from Chicago-based General Growth Properties Inc., the second-largest U.S. retail landlord, may also be shopping. The New York-based company’s strategy is to acquire the dominant centers in secondary markets.

“We’re seeing lots of deal flow, which is quite encouraging to us,” Andrew Silberfein, Rouse’s chief executive officer, said on May 16 on a conference call with analysts. “We are going to be selective and opportunistic.”

(Updates with closing share price in eighth paragraph.)
    Before it's here, it's on the Bloomberg Terminal. LEARN MORE