What are elements of winning strategies that you are seeing across the retail REIT space today?
Tsai: The industry in which retail REITs operate is mature. Bolt-on acquisitions can inject growth into multiyear forecasts beyond initial G&A savings. We think investors want to see more strategic M&A. It provides an avenue of external growth, so a stronger, larger operator (acquirer) can deliver higher returns to shareholders vis-a-vis a lower cost of capital, deeper tenant relationships, inject a more disciplined leasing philosophy, and support institutional quality redevelopment and development, which is never devoid of risk or complication. Acquirers with these capabilities can achieve improved multiples in this current environment where accretive growth is more challenging.
Golladay: Focusing on leasing and optimizing the existing tenancy and using free cash flow to reduce leverage is a winning strategy. The balance sheet is a primary area of focus now that interest rates have moved higher, so addressing interest rate risk including floating rate debt and near-term maturities is of high importance.
Dutch: Winning strategies start with a strong balance sheet. We think REITs with the strongest balance sheets are best positioned for portfolio and rent growth.
Do you think the impact of retailer distress and bankruptcy has largely been absorbed at this point?
Dutch: I think retailer distress, bankruptcy, and store closings are manageable, based on what’s been announced so far, but not yet fully absorbed.
Golladay: The strong leasing activity over the last few years led to many companies having a large pipeline of leases that are scheduled to open over the next few years, which should help companies absorb earlier than anticipated move-outs due to bankruptcies. The key going forward is to maintain solid leasing activity and for multiple bankruptcies to not occur in a short period of time.
Tsai: The liquidation of Bed, Bath & Beyond (BBBY) and Buy Buy Baby is the largest in a long time and introduces 15 million square feet of retail into the market. That said, there is much less availability now versus when the last major bankruptcies occurred. Further, there’s about 50 million square feet of space under construction currently versus 300 million headed into the great financial crisis, according to CoStar.
The majority of the BBBY leases will be filled by new retailers quickly because landlords have been working on this for some time. That said, there’s still a decent list of tenants that may need to close stores or restructure. While a lot of these tenants represent nominal exposure for REITs on an absolute basis, they may still add up to have an impact, especially as we look towards 2024. Bigger box retail seems to be faring better and value stores like Ross, T.J. Maxx, Burlington, and dollar stores are still net openers. Net-net, it’s a little bit mixed, but we could see some impact on earnings growth in 2024 as a result of downtime.
Where do you see transaction activity heading in the months ahead–both for assets and portfolios as well as larger M&A activity?
Golladay: The cost of capital for the shopping center REITs has materially increased since the Federal Reserve moved to a restrictive monetary policy and sellers have been reluctant to adjust pricing to a level sufficient for deals to make sense. Moreover, there remains ample liquidity in the market, which is limiting distressed opportunities.
Regency Centers Corp. (Nasdaq: REG) was able to reach an agreement to acquire Urstadt Biddle Properties Inc. (NYSE: UBA and UBP) as both parties agreed on a stock for stock deal at a valuation that was accretive for Regency. Fund redemptions, expiration of interest rate swaps, or debt maturities could lead to more motivated sellers over the next year, but the timing is hard to predict.
Dutch: Although retail cap rates have risen this year, bid-ask spreads still appear wide. We think further increases may be required before M&A picks up. We think retail REITs are looking for buying opportunities and await tighter bid-ask spreads.
Tsai: Transaction volumes are down significantly, and REITs are trading at historically wider discounts to net asset value (NAV). With debt maturities coming due and the 10-year Treasury still expected to increase modestly, these seem like ripe conditions for more assets to come to the market and better-capitalized REITs to take advantage of market dislocations from both an individual asset and M&A perspective.
What are you seeing in terms of retail real estate supply?
Dutch: New retail real estate supply remains extremely limited, a trend we expect to extend into 2024.
Tsai: There is minimal supply under construction. There will be shadow supply from retailer store closures. Because of the lack of supply, you are also seeing leases being bought during bankruptcies, which hasn’t happened for several years.
Golladay: There has not been much supply in the shopping center space since the great financial crisis. However, we view the sharp rise of e-commerce as a form of supply as it offered another avenue for retailers to distribute goods. Looking forward, we don’t expect a material increase in retail supply due to higher borrowing costs for developers.