“The only way for a REIT to have done well between early 2007 and the March 2009 bottom would have been to have vanished and then reemerged after the storm, which brings us to two REITs, neither of which had to suffer through those 25 months: Pan Pacific Realty, which specialized in neighborhood shopping centers— popularly known as strip malls—sold itself to Kimco Realty in mid-2006 and Retail Opportunity Investments Corp. (ROIC – yield 3.70%), this month’s recommendation, that emerged in October 2009 and acquired its first property two months later.
“Compared to other REIT subsectors, neighborhood shopping center REITs in the post-2009 recovery have lagged, an acknowledgement of how tight consumer spending has been. We see ROIC not just as an opportunistic way for us to get into its retail submarket but also an opportunity to participate in a recovering west coast economy, especially here in California, which many observers believe never will regain its swagger. We’re always willing to wager against pessimism. Aside from both REITs’ focus on neighborhood shopping centers, Pan Pacific and Retail Opportunity have one other thing in common: their CEO. Stuart Tanz built Pan Pacific, and after two years away from running a public company, was recruited to do the same at Retail Opportunity. ...
“ROIC has its origins in NRDC Acquisition Company, a special purpose acquisition company (SPAC), better known as a ‘blank check’ company (its prospectus names no specific line of business the company might pursue) that came public in October 2007 just as commercial real estate was stalling out. Nonetheless, it was obvious that NRDC would focus on retail real estate, since its principals’ companies owned strip and shopping malls and also were involved in retail. But NRDC had a schedule: it had two years to acquire assets, and if it couldn’t, the company’s remaining cash would be returned to shareholders. We don’t know whether NRDC’s principals anticipated a collapse in real estate that they intended to feast on, or were just late to the frothy commercial property fest, but as that two-year window was about to close, nothing had transpired: few commercial real estate transactions were occurring because neither buyers nor sellers had any confidence about where the bottom in pricing might be. At the last minute (October 2009), NRDC announced it would recharacterize itself as a REIT to be called Retail Opportunity Investments Corporation and had recruited Stuart Tanz as its CEO.
“Tanz started with substantial immediate advantages: NRDC’s $400 million plus in cash, no long-term debt, no problem properties, no tenants closing their doors and a core team of executives and employees that could be expanded as properties were added. Meanwhile, ROIC’s competitors had portfolios with significant debt, much of it scheduled to be refinanced in a lenderless market, shoppers with closed purses, tenants with their own cash flow and credit problems either going out of business or struggling to pay their rent. Every strip mall REIT during that period needed either to float new equity at rock-bottom prices or work out unfavorable debt agreements. Tanz, along with most of the commercial real estate world, expected a cascade of fire sales or foreclosures. He’d be waiting with his hundreds of millions in cash. [As expected,] ROIC has taken advantage of distress situations, but the reality is that fewer financially crippled properties have emerged than had been expected. Instead, ROIC is depending on Tanz’s intimate knowledge of the west coast neighborhood shopping center market: properties, owners, brokers and lenders. Anybody can make money at a fire sale. It takes something more to profit in a fragmented, recovering market. Twenty- seven months after ROIC’s debut, the REIT owns 25 properties, about the number Pan Pacific owned when it came public in 1997 but on average the properties are smaller in square footage. Interestingly none of these deals was marketed publicly. Thanks to Tanz’s network of contacts and his own reputation, the deals came looking for a buyer with credibility in the credit markets, the ability to size up a deal rapidly and the cash to close quickly. ...
“With Retail Opportunity growing fast from a modest base, it’s not easy to draw a bead on its expanding revenues and thus on valuations. New properties are coming on line that add to cash flow. Acquired properties are being tenanted and in some cases repositioned. ROIC recently raised the estimate for Funds From Operations (Net income that excludes gains or losses from sales of property and debt restructuring, plus depreciation along with adjustments for joint ventures and partnerships) for this fiscal year to between 60 and 70 cents a share, which works out to a Price to FFO ratio between 15.9 and 18.5. Only Weingarten (WRI) is cheaper. Federal Realty (FRT), the best of breed at present, projects a ratio between 22.2 and 22.6.
“ROIC intends to pay out about 70% to 80% of FFO, which means, if Tanz has his FFO right, somewhere between 42 cents and 56 cents, for a yield between 3.8% and 5%, the midpoint for which would make it the best yielding of its primary strip mall competitors. We suggest an initial buy limit of $12.”
Gray Cardiff, Sound Advice, 7/15/11
