A look at the Westfield platform's success in four countries

By Lorna Pappas

The commercial real estate industry has caught the globalization fever. REIT-like structures are thriving and spreading across the globe with new legislation pending in the U.K. and Germany and recently approved in Israel. Industry conferences are filled with panels related to international issues. Even this magazine dedicated an entire issue to the global impact of REITs.

While many real estate companies are thinking about going global, The Westfield Group (ASX: WDC) is already there and is perhaps the most visible worldwide commercial real estate company today. It seems like every other month, at least, this Australian-born commercial property investor, manager and developer—the world's largest retail property group by equity market capitalization (in excess of $23 billion at the end of June 2005)—announces new movement in one of the four countries it has penetrated so far: Australia, New Zealand, the U.S and U.K. In the last 12 months alone (at press time), the company purchased four super-regional and mixed-use developments in the U.K.; increased ownership in what will be the largest shopping center in greater London; further expanded in Chicago, Los Angeles and New York; bid for a dozen properties from Federated Department Stores; raised approximately $1.8 billion in the Eurobond market; achieved the largest-ever global syndicated facility in the Australian market (about $4.0 billion); priced its first debt issue into the U.S. market (about $2.6 billion, the largest issuance for a REIT in the U.S. and in Australia); sold off one U.K. asset; and in its spare time acquired three more major Australian shopping centers, while expanding another in New Zealand.

Headquartered in Sydney, and the eighth-largest entity listed on the Australian stock exchange, the internally managed, vertically integrated Westfield Group owns and operates 129 regional shopping malls worldwide, encompassing 21,200 retail outlets and 111 million square feet of space; employs 4,000 people around the globe; and has shareholders and tenants from most of the western world.

"The power of the Westfield brand itself, our specialization in redevelopment and vertical retailing, and our ability to create regional innovations help differentiate Westfield from its peers." —Frank Lowy, Chairman of Westfield Group

No wonder its name is tantamount to REIT globalization.

What is it about Westfield Group that allows it to flourish in every country it enters, and what differentiates it from some very powerful players in its category?

In the words of Frank Lowy, chairman of Westfield Group, "The power of the Westfield brand itself, our specialization in redevelopment and vertical retailing, and our ability to create regional innovations help differentiate Westfield from its peers. Also, we are adept at undertaking large, complex transactions while maintaining the financial and management discipline to generate income and capital growth from existing assets. The size and quality of our rental income stream also differentiates us. Most of the leases in our portfolio are medium or long-term, providing great earnings stability."

Westfield Repositions for Global Expansion

To better position Westfield for international growth, with a single, globally-integrated financial structure and operating platform that can leverage global opportunities, Westfield "stapled" the securities of its three entities—Westfield Trust, Westfield America Trust and Westfield Holdings—into the Westfield Group in July 2004, a substantial undertaking "that shocked the industry," states Peter Lowy, co-managing director of Westfield Group and chief executive officer of U.S. operations. The merger created the world's largest listed retail property group, combining the financial strengths and capabilities of each entity to provide Westfield Group with the scale and power necessary to command international growth.

THE WESTFIELD GROUP 11601 Wilshire Blvd., 11th Floor Los Angeles, CA 90025 310-478-4456 www.westfield.com CHAIRMAN: Frank P. Lowy DEPUTY CHAIRMEN: Frederick G. Hilmer and David H. Lowy CO-MANAGING DIRECTORS: Peter S. Lowy and Steven M. Lowy TICKER SYMBOL: WDC (Australian Stock Exchange) 52-WEEK HIGH: A$18.34 (8/2/05) 52-WEEK LOW: A$14.45 (10/26/04) CORE MARKETS: The company has investment interests in 129 shopping centers in four countries, with a total value in excess of U. S. $36 billion

Since the merger, the value of the group as a whole increased substantially and many subsequent events produced the benefits articulated at the time of the merger. The stock today is extremely liquid, trading at [as of August 2005] about A$70 million a day (about U.S. $52 million, three-month average) with over 100,000 shareholders.

Chris Bedingfield, head of real estate research, Australia, for Deutsche Bank, says that Westfield Group still faces significant risks as it expands, including a sustainable higher global interest rate environment; the sensitivity of its portfolio to long-term retail sales growth in Australia, the U.S. and the U.K.; and access to well priced capital to fund the redevelopment program.

However, Bedingfield also sees the new Westfield as even more aggressive on redevelopment opportunities, with development expenditures as a proportion of total assets increasing over the medium term, and a likelihood that Westfield Group will retain project profits and possibly a portion of operating expenses.

"As a result, Westfield Group will be able to deliver a higher return on equity and higher sustainable earnings per security growth. This will attract greater general equity fund interest which will assist in a medium/long-term positive re-rate of the stock," Bedingfield says.

Challenges of Global Operations

As Westfield continues to grow, it faces head-on the very rigorous challenges of doing business on a global basis. Matthew Ostrower, vice president, Morgan Stanley, says that the main hurdles to global expansion by mall developers are valuation, ownership concentration and regulatory barriers, as well as taxation.

"The reduction of cash flow that arises from the payment of taxes by potential targets has significant valuation and accretion implications for potential acquirers," according to Ostrower. "In addition, foreign ownership sometimes causes the loss of a target's tax-free status. Our discussion with a variety of tax and transaction experts suggests that these issues, while often surmountable, clearly make cross-border consolidation more complex, difficult and time consuming."

Westfield Bondi Junction in Sydney Where Westfield Got Its Start In 1951, 21-year-old Frank Lowy, a Holocaust survivor who had fled Eastern Europe in the 1940s, emigrated to Australia with barely a penny in his pocket, taking his first job as a sandwich delivery boy for a Sydney delicatessen. In 1958, he and a partner opened their own deli in western Sydney, then made their first real estate profit subdividing a vacant lot and building a shopping center with two department stores, 12 specialty shops and parking for a few dozen cars. Because the property was located in the western suburbs and fronted an expansive field, they named the center "Westfield Place." In 1960, just in time for the decade's shopping mall boom, Westfield Holdings was publicly listed on the ASX, and by the 1970s had constructed or acquired 14 centers on the Australian east coast. By 1974, Lowy had become Australia's dominant mall operator. Westfield entered the U.S. market in 1977, New Zealand in 1997, and the U.K. in 2000. Today, Westfield Group is the world's largest listed retail property group, and Lowy one of Australia's richest and most successful businessmen.

Peter Lowy concurs that tax planning and local legislation is a major intricacy confronting any decision to invest in a foreign market. "If a company cannot get income back to its investors in a tax efficient manner, the rationale for investing globally is seriously tested," Lowy says.

For Westfield, operating in four countries with different economies, currencies, tax jurisdictions, political temperatures, accounting rules, interest rates and sub-market characteristics, among other factors, adds a complexity to global operations that most Westfield competitors don't often encounter.

Lowy admits that the multitude of challenges makes it both difficult and expensive for a real estate company to operate globally. "The amount of time and resources allocated to these issues are staggering, but handled correctly, are very rewarding," he says.

To avoid the pitfalls of global expansion, Westfield's model is to invest modestly in a country, typically by buying one or two properties; spend senior executive time to learn and understand the market; then expand through a series of portfolio or corporate acquisitions.

Lowy says that as more and more countries adopt REIT legislation, the challenges and issues of real estate investments are changing global markets, just as they did in the U.S.

"How this will affect the level of foreign investments in those countries will be interesting to watch," Lowy says.

Building a Brand

Just as McDonald's brands its burgers so customers expect the same quality no matter where they dine, every mall in Westfield Group's international portfolio claims the Westfield brand in its property name, associating each with the same high quality of product and services.

"In most key markets we are the largest regional mall owner, providing great efficiencies and economies of scale, and strong brand penetration." —Peter Lowy, Co-managing Director and CEO of U.S. operations

Branding is a strategy that "tells our entire customer base—including consumers, retailers, shareholders and our own employees—that we produce, develop, deliver and are committed to the best possible mall products and services," Peter Lowy says. "Branding communicates that we won't stop spending money on the asset, which gives retailers the opportunity to achieve the best volumes they can."

Branding also allows promotional efficiencies in markets where Westfield properties are clustered, but the intent is much more ambitious, aimed at building a strong customer loyalty and recognition that helps distinguish a Westfield mall from all others.

At the end of last year, Westfield brand awareness in the U.S. averaged 79.5 percent and was highest in St. Louis, at 91 percent, where the company has six malls. Westfield entered the Chicago and Florida markets in 2002 and within only two years had a 68 percent and 80 percent market brand awareness, respectively.

Focus on Redevelopment

Also differentiating Westfield Group is its focus on the redevelopment of current assets. For example, only one of its 68 U.S. properties was built from the ground up (after demolishing a pre-existing center on the site).

"We are the only company in the global mall business with a major focus on the redevelopment and expansion of existing assets to maximize value," says Peter Lowy.

Westfield Eagle Centre, Derby, U.K.
Westfield's Worldwide Shopping Center Portfolio
	Australia	New Zealand	United States	United Kingdom	Total
Centers	42	11	68	8	129
Square Feet	34.0	3.0	70.3	3.8	111.1
Retailers	9,800	1,200	9,300	900	21,200

Westfield's investment philosophy emphasizes both the purchase of underutilized assets with a large scope for expansion and value, and the reinvesting of capital "every seven to 10 years to fully utilize the asset's capacity," Lowy says. He points to Westfield Garden State Plaza in New Jersey, which the company has expanded three times since its purchase in 1986, spending more than $500 million to reinvigorate the property. Over approximately the last three years in the U.S. alone, Westfield has spent about $2 billion on the redevelopment and expansion of 14 different properties.

Westfield also distinguishes itself through its success in creating downtown urban sites on constricted spaces that demand vertical retailing—multi-floor, narrower retailing centers, usually in a CBD. Westfield's expertise in vertical retailing stems from its 45 years of experience developing and expanding its assets in Australia, where sites in dense urban markets are extremely tight. (For example, Sydney's Westfield Bondi Junction encompasses 300 retailers, two supermarkets, three department stores and a cinema, totaling 1 million square feet on five levels—on only 10 acres.)

Fully integrated, Westfield also maintains its own internal designers, architects, general contractors and builders, and handles its own marketing, leasing, and day-to-day funds and asset management, unlike many developers that outsource these services, with benefits not limited to cost savings, management efficiencies and a condensed learning curve.

Further differentiating Westfield is its strategy of penetrating major markets with tight clusters of mall properties, unlike some other players in the category that spread their centers on a wide geographical basis. In total, the majority of Westfield's 68 U.S. properties are clustered in 11 market regions. For example, the company owns 12 of the approximately 30 regional malls in the greater Los Angeles area, seven (with two combined) of the 10 in San Diego, six in the Greater Chicago market, and six in St. Louis.

Clustering creates a stronger community presence, according to Peter Lowy. "In most key markets we are the largest regional mall owner, providing great efficiencies and economies of scale, and strong brand penetration," Lowy says, adding that Westfield's San Diego malls cover 100 percent of the local television market, so no leakage occurs from promotional investments such as the commercials Westfield aired during the last Winter Olympics.

Westfield San Francisco Center Westfield's Operating Strategies In its 2004 merger, Westfield Group's financial structure changed, but its operating strategies remained the same: Achieve Superior Returns For Investors Through a Combination of Capital and Income Growth Attained By: Intensive management and redevelopment of existing centers Acquisition of new centers in existing and new markets Vertical Integration Property management, marketing and leasing Property development, design and construction Funds and asset management A Global Brand Clustering strategy Value creation through differentiation Customer/retailer loyalty

Changing the Nature of the Regional Mall

Current Westfield innovations mark a change in the nature of U.S. regional malls. All but one of the company's present U.S. expansion projects feature anchors that are not department stores, while the one that does is a store unique to this country.

"The days of bringing two to four department stores into a mall project are over, and Westfield is at the forefront of this transformation," Lowy says. "Our U.S. regional mall properties are evolving from those with traditional fashion-based anchors to a product integrating ‘unconventional' forms of mall retail, such as discount stores, entertainment, supermarkets, lifestyle concepts, big boxes, al fresco dining and other non-department store elements. That's a real change for both the U.S. regional mall market and in where this company is going."

Uniting high-end retailers with economical shopping venues is also a shift in traditional mall composition. Neiman Marcus and Target stores will be together in a regional mall for the first time in U.S. history as co-anchors of Westfield Topanga in the Los Angeles area.

Westfield Parkway in El Cajon, Calif. features the first fully integrated Wal-Mart specifically designed and built to assimilate into a regional mall format, with checkouts facing the inside of the mall. Other Westfield U.S. expansion projects integrate non-conventional anchors such as Best Buy, Dick's Sporting Goods, Bed, Bath & Beyond and Costco (currently in negotiations for two of Westfield's redevelopments).

Peter Lowy points to department store consolidations as one reason for the changing complexion of U.S. malls, as well as Westfield's philosophy to provide the widest array of goods and services within one regional mall.

"We believe that full service, upmarket and discount retailing can and will perform well together in a single U.S. property, based on shopping trend research showing, for example, that the same person who shops at Neiman Marcus also shops at Target," Lowy says. "Of any trend in the regional mall development segment, today's new combination of retailers is the one totally changing the nature of the industry."

Lowy adds that this mixed retail approach is already successful in other countries, especially in Australia, Canada and the U.K., and that only the U.S. has lagged with this strategy, until now, although Westfield "has been pushing it for 20 years," he says.

Effective Transfer of Knowledge

Westfield Oakridge in San Jose, Calif.

Westfield's familiarity and success with non-department store anchors offshore fuels its commitment to the trend in the U.S. This transfer of knowledge is one payback of running a global business—cross-pollinating the information and experience gained in sub-markets to enrich other markets and strengthen the corporation as a whole.

The branding concept was carried worldwide from Australia where, according to a case study about Westfield published by the Harvard Business School, "it has a brand name so strong that the word ‘Westfield' when used in Australia is a synonym for shopping." The idea of branding came to Frank Lowy during the 1960s, when he overheard a pedestrian say to a friend, "Let's go to the Westfield."

Another effective transfer of knowledge, from the U.S. to Australia, is the practice of longer leases. Average leases for a Westfield property in Australia were running at about three years compared to about 10 years in the U.S., where the more permanent Westfield retailers were investing more capital to enliven their stores. Westfield took this concept back to Australia where they worked with retailers on improved store designs and on amortizing the capital over a longer lease to build a better shopping experience, which ultimately "changed the whole character of the Australian storefront," Peter Lowy says.

Also moving from the U.S. to Australia was the model for a centralized, destination food court for mall shoppers, a concept Australian mall operators had not pursued.

Westfield's expertise in vertical retailing, born through building on tight Australian property sites, and further developed in New Zealand and the U.S., expanded in 2000 into the U.K., where most of Westfield's development projects "are very complex, integrating a real mix of hybrid retail venues in a vertical shopping space on compact urban land areas, with vertical parking, over subways, rail yards and bus interchanges, requiring unique skill sets and an approach in which we are very experienced," Lowy says.

U.K. Expansion

One of Westfield's current priorities is to increase its exposure in the U.K., where, according to Matt Nacard, division director of listed property research for Macquarie Securities of Australia, there is "a chronic under supply of shopping center space. The country has a similar number of centers to Australia (850) but has three times the number of people. In addition, on a per capital basis, the U.S. has around eight times the amount of shopping center gross lettable area versus the U.K."

Westfield's U.K. activities today total eight projects and about 3.8 million square feet of space, with much more to come.

"While the U.K. is just 12 percent of Westfield Group's total asset base, it clearly holds the best opportunities for the company," Nacard says. "Westfield is taking a measured approach in a difficult market, which we view as entirely appropriate. The quantum of capital expenditure to be spent in the U.K. is greater than our expectations but I believe we underestimated the difficulties inherent in the development process."

Difficulties in the U.K. market include development approvals controlled by the central government, which has an urban policy against building malls on suburban land, with a commitment to regenerating the town center in downtown areas, where sites are extremely tight and complex. "The out-of-town regional shopping center development that is commonplace in the U.S. market is virtually non-existent in the U.K.," Nacard says.

Nacard adds that since major U.K. developments can only occur in town centers, generally there are several third-party land parcels to acquire, which slows the process and limits the number of available development sites. In addition, the U.K. market has been accustomed to fairly conservative development schemes in the past.

"Since Westfield is a more aggressive developer, it takes time to convince interested parties that its approach is appropriate," Nacard says. "While Westfield is undoubtedly working through the process faster than anyone else, the total development process in the U.K. is still anywhere from about seven to 10 years."

Once established, U.K. malls tend to be even more productive than those in the U.S., generating very good returns, according to Peter Lowy.

"The fact that it is hard to build retail centers in the U.K. means companies need a very specific skill set to develop those assets, and Westfield has them," Lowy adds. Westfield now has the fourth-largest portfolio in the U.K., behind The Prudential, Capital Shopping Centers and Hermes.

A Bifurcated Market

While Westfield and other real estate conglomerates expand around the globe, they still face tough competition from strong local operators. Markets like the U.K., which strongly supports local operators, the Netherlands, which limits foreign REIT ownership, and other regions with tough regulatory barriers to expansion are home to some extremely competitive local owners, presenting investors with an interesting array of choices.

UPSIDE-DOWNSIDE Samplings of what analysts are saying about The Westfield Group Merrill Lynch RATING: NEUTRAL (8/31/05) "With a $40 billion asset base, it is hard for small deals to drive earnings surprise for investors. With the operating environment slowing a little and developments taking two to three years to bring to the income line, big deals on the acquisition front are the most likely short-term driver of earnings surprise. On the negative side, the market has come to expect flawless execution on the operating side, including the delivery of big developments on time and budget. With Westfield being the owner, head contractor and leasing agent on its projects, this is a complicated task. With the U.K. the newest market for the group, this will be the one to monitor more closely." UBS Securities RATING: NEUTRAL 1 (8/31/05) "The operational performance of the group remains strong. Sales growth remains buoyant in the U.S., slowing in Australia and New Zealand, with weakness in the U.K., where Westfield's assets contribute only 7 percent of total income. Looking forward, management expressed caution on the slowing Australian retail environment, a theme consistent with other domestic trusts with retail exposure. We have already factored a slowing into our numbers, and recognize the occupancy costs and sales productivity suggest rental growth of 2 percent to 3 percent per year should still be achievable. Occupancy has been maintained at very high levels in Australia, New Zealand and the U.K., while a 100 basis point improvement lifted U.S. occupancy." Moody's Investors Service RATING: A2 (8/31/05) "Moody's notes that key financial metrics—namely EBITDA interest coverage and gross debt/assets—were in line with Moody's expectation and remain within the ranges appropriate for Westfield's ratings. Westfield's substantial property portfolio has performed well overall, with the key Australasian and U.S. operations showing positive momentum, while the United Kingdom properties are exhibiting flat performance in line with Moody's expectation. Overall, occupancy rates remained very high, providing continued operating benefits for Westfield." UBS Securities RATING: ADD (8/31/05) "Westfield's development pipeline remains a key driver of growth for the company. Westfield has A$6.7 billion of development projects under way (the highest in the company's history) and a further A$430 million to commence before the end of 2005. Development yields (8 percent to 10 percent) for the most part remain well above those available on acquisitions indicating, in our view, prudent allocation of capital."

Lowy says that this scenario is creating a bifurcated market in which investors have a choice between not just asset classes and operators but between companies that invest only locally and those that invest globally. Lowy asserts that this bifurcation is good for investors as well as the industry, creating a wider, more efficient market and a greater ability for global companies like Westfield to raise capital. He says it will be for investors to decide which is a better model with a better return.