March Issue: Investment–Something Old, Something New

REITs are pursuing JVs, makeovers and novel structures.
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REITs had a terrific year in 2014, but astute players are by no means resting on their laurels. Public and non-traded REITs alike are honing old strategies and rolling out new ones, the better to achieve still higher returns.
Chasing the kind of yield that few other asset classes can beat in a low-interest-rate environment, investors flocked to REITs in 2014, driving share prices up. Despite that vote of confidence, 2015 started with a note of unease. On the day the Bureau of Labor Statistics released its encouraging employment report for January, the Bloomberg REIT index dropped 2.8 percent, its biggest decline in months.

Presumably, the strong jobs report fueled speculation that the Federal Reserve would respond by hiking interest rates, perhaps as early as this summer. That, in turn, would not only raise higher capital costs for REITs but also create more competition from Treasuries and other investment vehicles.
Seasoned executives know well that a good run makes investors start to wonder whether the party is almost over. In this climate, REITs are doubling down on growth strategies. Some are old favorites, like teaming up with deep-pocketed capital partners or recalibrating portfolios. Others are newer, such as expanding into “exotic” categories or creating spinoffs to hold alternative assets.

And then there is Forest City Enterprises Inc., which in January announced plans to join the REIT club by 2016. Known for such projects as the Stapleton International Airport redevelopment in Denver and Pacific Park (formerly Atlantic Yards) in Brooklyn, N.Y., Forest City is seeking to rebalance its business lines among investment, development and operations.
“Our undervalued operating portfolio is well positioned to benefit from strong growth in key urban markets where we are focused, and we have an identifiable pipeline of additional opportunities in those markets that we believe will fuel further incremental growth,” David LaRue, the company’s president & CEO, explained in a statement at the time of the announcement.

Hot Commodities
For existing REITs, the most straightforward strategy is no different from that of any other major investor group, according to Brian Ruben, partner & non-listed REIT practice leader at Deloitte. They’re following hot property categories and markets.

“Net-leased properties, medical office buildings and hospitality are all hot commodities, and REITs with experience in those areas are going to double down on them,” he said. They’re also following population trends. As Millennials move to the urban core, REITs are following. As Baby Boomers do the same—or go into seniors housing—REITs are following them, as well.
Also, many REITs are becoming more focused. “That’s what investors want—there’s a penalty now for diversifying,” said FTI Consulting senior managing director Jahn Brodwin. “Allocators look for REITs that focus on specific property types or geographies. A company that does one thing and does it well is preferred.”

Ruben agrees. “REITs are simplifying their strategies and operating in core markets,” he said. “They’re disposing of non-core assets and taking a disciplined approach to growth.”

A recent example is Cedar Realty Trust. Until a few years ago, the Port Washington, N.Y.-based company held a variety of retail properties, including malls, strip centers, net-leased properties and land. Its geographic reach was similarly broad, extending from the Mid-Atlantic to New England and Midwest. As such, its returns were underperforming those of most other retail REITs.

After joining the company as CEO in 2011, Bruce Schanzer took Cedar Realty in a new direction. The company started paring down its portfolio to grocery-anchored shopping centers between the Boston and Washington, D.C., metropolitan markets. At most recent report, Cedar Realty owned 67 centers totaling some 10 million square feet. “One of the things we set out to do was to bring the company a more focused, well-honed portfolio that had both a strategic focus and a geographic focus,” Schanzer said at REITWorld late last year. Now that the refocusing initiative is largely complete, the company is pursuing redevelopment opportunities in its portfolio.

Teaming Up
Joint ventures, too, are springing up as REITs recapitalize stabilized properties or amass the funds to compete for high-quality assets.
PREIT and Macerich teamed up to redevelop The Gallery, a 1.4 million-square-foot, 38-year-old enclosed mall in Philadelphia’s Center City. Allied Properties REIT formed a joint venture with Duncan Street to acquire and develop property in Toronto for about C$23.5 million. And last September, Griffin Capital Essential Asset REIT, a non-traded vehicle, entered into a joint venture to acquire a data center. Its publicly traded partner in the $185 million deal: Digital Realty Trust, the San Francisco-based data center specialist.

Besides more effectively deploying capital, forming joint ventures can serve other purposes. Jeff Hoppen, managing director of capital markets for Digital, said that his company’s joint venture “has the ancillary benefit of reducing our tenant concentration while establishing an attractive private market valuation benchmark for our properties.” Then there’s the potential for Digital to earn management fees plus possible proceeds from excess cash flow.

The Digital/Griffin deal is also an example of a REIT forming a partnership to enter an attractive new property type—in Griffin’s case, data centers. Through its joint venture with Digital, Griffin acquired an 80 percent stake in a turnkey data center in Ashburn, Va. Part of an eight-building campus, the 132,280-square-foot facility is fully leased. “We’re confident the Ashburn community, already a key data center market, is positioned to benefit from the continued growth in the world’s technological demands,” said Griffin CEO Kevin Shields.

For its part, Digital will continue to operate the property.
Recent REIT joint ventures adhere to another tried-and-true reason for forming partnerships, as well: sharing complementary expertise. To redevelop the Gallery, PREIT will capitalize on Macerich’s expertise in developing and leasing vertical, multi-use projects in dense, urban environments. Macerich, meanwhile, will reap the benefits of PREIT’s Philadelphia-area relationships and local market dominance.

New Value
Another up-and-coming strategy is revamping assets to generate higher revenues. At a time when so many deep-pocketed investors compete for properties and bid up prices, this approach can offer a lower-risk way to deploy capital than acquisition.

In January, American Hotel Income Properties REIT L.P. kicked off a program to add guest rooms at its high-occupancy Oak Tree Inn railway hotels. For the first project, Vancouver-based AHIP struck a $2.7 million deal with SunOne Developments Inc. to build 24 guest rooms at the Oak Tree Inn and Penny’s Diner in Dexter, Mo. The 109-key property is operating at full occupancy and secured by a long-term railway contract.

“This development strategy provides us with the opportunity to capture organic growth at existing, high-occupancy railway hotels that have adjacent available land,” explained AHIP CEO Rob O’Neill in the statement announcing the move. Previously, the REIT had acquired newly built properties; O’Neill called the new strategy an opportunity to “unlock additional value from existing, high-occupancy locations.”

Finally, REITs are branching out into novel categories and structures. “The industry is maturing but still growing,” Brodwin said. “We’ll see REITs exploring new and interesting property types: more wireless towers, billboards, even wiring and other infrastructure.”

Among these innovators is Little Rock, Ark.-based Windstream, which recently spun off its telecommunications lines into a REIT. For now, the maneuver is mainly a tax play, which will probably save Windstream more than $100 million. But in time, Brodwin predicted, investors will be interested in these kinds of REITs for a more conventional reason: the returns they offer.