Good Neighbors

Tweet

The secret to General Growth's top performance in the REIT business: John Bucksbaum knows how to make competing tenants accept one another.

Any company can put "growth" in its name, but mall owner General Growth Properties has genuinely earned its right to the word. Its growth rate, as we calculate it in our annual survey of real estate investment trusts, is five times that of the average REIT.

What separates a growth REIT from a sluggard? Attention to detail. The key to General Growth's success is easier said than accomplished: Find the right tenants and put them in the right places. On a bitterly cold January morning Spanish businessman Javier Capella sits in a warm General Growth boardroom in Chicago overlooking the river, talking about his dream to make his handbags as hot in the U.S. as they are back home. His company, Misako, drew $9 million last year from 21 accessories stores it owns in Europe (and more from its franchised stores). He wants to have 35 U.S. stores by the end of 2005. (There are 4 now.) He and some General Growth salespeople flip through shopping mall layouts, studying the high-traffic locations he wants. Next to a videogame parlor, busy with teenage boys, won't work. "Yeah," purrs Robert Wyant, head of the REIT's malls in the Midwest, "these stores will be in the thousand-dollar-a-foot sales club."

General Growth is in the right sector for making it big. Mall trusts have an advantage over other REIT subspecies. In addition to collecting rent, they can also take a slice of a store's sales, ranging from 3% to 10%. In other words, mall REITs are partners with their tenants. Office REITs, a more numerous type, treat their space more like a commodity; all they care about is that the law firm leasing three floors can make the rent.

But mall REITs, eyeing a richer bounty, take an active interest in tenants that borders on social engineering: getting the right mix and putting them in the right places to maximize sales. The shoe store near the anchor department store? The bookstore near the main door? The kids clothier near the food court? The beauty of a REIT for a prospective tenant like Misako is that it can do one-stop shopping for a nationwide expansion by visiting a single trust with 137 malls. General Growth's portfolio ranges from the 1.8-million-square-foot Ala Moana Center in Honolulu down to the 800,000-square-foot Coral Ridge Mall in Coralville, Iowa (just outside Iowa City).

The expediency of bulk-leasing negotiations may explain why, despite the theory of a few years ago that the Internet would turn malls into dustbins, mall REITs in general have scored higher total returns (stock appreciation plus dividends) than other kinds of property trusts. Over the past ten years mall REITs have turned in an annualized 17% versus 16% for office and industrial properties, 14% for strip shopping centers and 12% for apartments, according to the National Association of Real Estate Investment Trusts. And although you hear a lot about mall overbuilding, the truth is that construction has slowed lately; only 4 new regional malls opened in 2003, adding just 0.4% to the existing stock of 1,130. That gave population (up 1%) and retail sales (up 3.6%) a chance to catch up.

The stock market is only reflecting the malls' impressive operating performance and valuation. Of the 20 REITs on our list this issue, the five best performers in growth over five years are shopping mall outfits. Growth, as we see it, starts with yield and increase in earnings per share; earnings are defined here in REIT terms as "adjusted funds from operations," or AFFO. This measure, an obsession of real estate research firm Green Street Advisors (which provides us with much of our REIT data), is net income plus depreciation minus maintenance-level capital expenditures.

The story is similar for the growth in malls' real estate worth since 1999, termed "net asset value," or the liquidating value of a REIT. That's what would be left over for investors, per share, if the trust sold its properties at today's fair market value and paid off the mortgages. By this yardstick, four of the five best NAV growers on our roster were shopping mall REITs.

The bad news for prospective REIT shareholders is that the sector's shares have already been bid up. The winners on this score notably include General Growth, whose price has more than doubled since our first REIT ranking in 2002. That's why it rates only a C on the "value" scale--it's no bargain. It sells at a 21% premium to Green Street's estimate of net asset value. The only larger mall REIT, 172-mall Simon Property Group (whose $13 billion in property value also makes it the asset leader of all kinds of REITs), trades at a mere 5% over NAV and merits a B for value.

Among investment pros not everyone is in love with General Growth. Green Street analyst Gregory Andrews, though a fan, thinks its stock is fully priced. It has blown past the $20 value he said it warranted last spring. He raised his target to $30. He says the overall quality of its malls is just average. General Growth, far more likely to have a Macy's as an anchor store, generates an average $351 in retail sales per square foot; Simon and the smaller Rouse Co., more likely to sport a Saks Fifth Avenue, produce $401 and $425, respectively. When the otherwise mild-mannered John Bucksbaum, General Growth's chief executive, visited Green Street in Newport Beach, Calif., he heard that his REIT didn't fit in the research firm's "box." Bucksbaum retorted: "The box is the problem."

Bucksbaum, 47, learned about retailing at an early age. His father and uncle ran a grocery store in Cedar Rapids, Iowa, before founding General Growth in 1954. They taught him the wisdom of keeping overhead low. Bucksbaum has staunchly resisted paying himself the outsize salaries that more flamboyant REIT managers collect. The $225,000 he drew for 2002 is dwarfed by the $7.1 million collected by fellow Chicagoan Samuel Zell for chairing the Equity Residential and Equity Office trusts. General Growth's overhead costs are 3.6% of revenue, compared with tonier operations like Rouse, at 4.8%.

If General Growth's per-foot sales(and thus, presumably, rents) aren't the highest in the land, how does it keep recording these scorching earnings increases? This REIT is blessed with an uncanny leasing prowess. Bucksbaum likes to crow that General Growth gets 15% of the new leases even though it has 12% of the regional malls in the U.S.

The company has 325 staffers working full time on leasing out its space. Vacancies now run 9.3%, a bit higher than usual. General Growth, however, has a fine record of filling empty space and figuring out novel ways to squeeze more out of space that's already rented. For instance, if a Gap wants to be near the central court escalators and nothing is available there, the REIT's leasing folks might convince a record store to give up part of its space. They will muster the stats to show the music outlet that it can sell almost as many CDs in less spacious quarters. The base rent may not change much when space goes from one tenant to another, but the sales-per-square-foot will and so will the mall's take.

General Growth also excels at convincing competing specialty shops to be situated together. Some store managers obviously fear they will lose sales to rivals. General Growth has found, though, that consumers will spend more money if all the stores they want are tightly bunched. It's like packing all the New York diamond dealers into one block on 47th Street.

Where does Misako, the Spanish handbag chain, fit in? Despite Misako's fancy Spanish limestone and glass decor, its bags cost $32, a tenth the price of bags at Coach and Louis Vuitton, established denizens of General Growth malls. Misako also offers a wider selection than those exalted brands: Women get to see 1,200 new designs a year, much more than from the swankier rivals. So the delicate challenge for General Growth is talking the likes of Coach and Louis Vuitton into accepting this Iberian upstart into their midst. "You can bet Coach sees it differently," says General Growth's president, Robert Michaels. "It's going to take negotiation." That is what the REIT is good at.