Developers Diversified Realty relies on a strong foundation
By
Charles Keenan
Times might be getting tougher in the economy, but when it comes to building and maintaining shopping centers, one REIT sees a bright future.
Despite headwinds for many retailers, Developers Diversified Realty Corp. (NYSE: DDR) gives investors reason to be optimistic. Buoyed by a strong balance sheet, diverse funding sources and a defensive portfolio, the Cleveland-based REIT looks to bank on its relationships with retailers and investors to keep earnings and dividends rolling for years to come. Developers Diversified has an intangible asset: trust, derived from a consistent history of delivering on its promises.
“We try to develop a reputation among the retailers as a developer that is going to do what it says it is going to do,” says Scott Wolstein, chairman and chief executive officer. “As long as we can do that, we feel they will want to continue to do business with us. Our track record speaks very well for us.”
Solid Reputation
To be sure, the company’s solid history of completing projects could go a long way in today’s economic climate, where many developers are finding it hard to secure financing, analysts say. “The retailers know Developers Diversified is going to get it done,” says Rich Moore, an analyst at RBC Capital Markets. “In this environment, it is very important that you hitch your wagon to a developer that has enough money to finish the job.”
Developers Diversified certainly has history to back it up. The REIT has a $23 billion portfolio. Additionally, Developers Diversified has built a reputation as a company with shrewd management and the ability to extract value from developing and redeveloping shopping centers in various formats.
“What we try to do is recycle capital into higher yielding and growth opportunities,” Wolstein says. “We have sold billions of dollars of equity in our projects and taken that capital and invested it in new developments and opportunities. That is something we will continue to do.”
Portfolio Pieces
Developers Diversifed owns and manages 745 retail and development properties in 45 states, in addition to Brazil, Canada, Puerto Rico and Russia. It manages more than 163 million square feet in a variety of formats: from large shopping centers to smaller lifestyle centers, from mixed-use and urban centers to enclosed malls. Its properties tend to have a low average age—about eight years—along with consistent internal growth and market dominance. The company currently emphasizes California, Florida, the Mid-Atlantic
and New England, as well as its global locations, with development commitments totaling approximately $2 billion.
Developers Diversified focuses on geographic areas where its centers are the number one or two player in the market. The company seeks out locations within an area—not so much subject to a radius in terms of distance, but more in terms of driving time. The credit profile of tenants also plays a part, as does the merchandise mix, says Daniel Hurwitz, president and chief operating officer. “Those factors will certainly increase the chances of success,” Hurwitz says.
The format of Developers Diversified’s portfolio has led to a steady rise in funds from operations and cash dividends over the years. Funds from operations (FFO) per share rose to $3.79 per diluted share for 2007, up from $3.41 a share a year earlier. Cash dividends rose to $2.64, up from $2.36 over the same time period.
The stock suffered in 2007 and hit a 52-week low of $32.20 in January 2008, according to NAREIT data. However, it rebounded afterwards, closing at $41.88 on March 31, up 11.3 percent for the first quarter, versus 3.8 percent for its shopping center peers.
The company is still a bargain, notes David Harris, an analyst at Lehman Brothers. “The stock looks relatively inexpensive,” Harris says. “This is a well-established company that has a seasoned management team.”
Navigating Headwinds
Thanks to the credit crunch, retail REITs like Developers Diversified have been lately navigating consumer headwinds due to sluggish retail sales and consumer spending. Additionally, many retailers have scaled back their expansion plans, while chains in areas such as furniture and electronics have declared bankruptcy.
“We would expect any retail landlord is going to be faced with a tougher leasing environment where occupancies are probably going to drop and the ability to increase rent is going to be circumscribed,” Harris says.
However, it is still early in the game, says Jeffrey Spector, an analyst with UBS Securities. “This is just the beginning of this cycle, and no one knows if there will be a soft or hard landing. Time will begin to separate the better companies—with the better locations and tenants—from the weaker ones.”
Macroeconomics play in Developers Diversified’s favor, management argues. For one, U.S. retail sales have climbed steadily for decades, in part fueled by population growth. Another thing going for Developers Diversified is the defensive nature of its portfolio, which had an occupancy rate of 96 percent at year-end. Lease renewals point to another solid year, according to the company.
To be sure, analysts worry about the effects of a possible retrenchment in retail. On the good side, while most of these retailers plan to open fewer stores in 2008, the company says they still will be actively trying to expand. “Major retailers usually make decisions about locating new stores based on their sales projections three years out,” Wolstein says. “As long as they have the capital to expand and they see an opportunity to gain market share, they are not going to be dissuaded by a view that maybe over the next month they are likely to see weaker consumer demand.”
Weathering the Credit Crunch
The long-term nature of Developers Diversified’s leases with tenants also help the company’s portfolio weather any kind of economic downturn, adds David Oakes, executive vice president of finance and chief investment officer. Income is stable. “When
times are going incredibly well, we see rents consistently go up but we don’t see huge rent spikes,” he says. “When times are more challenging from an economic standpoint, we don’t really see much change in occupancy or rental levels.”
Despite the tighter credit market, Developers Diversified has been able to tap the markets for debt. It announced in March the financing of a $500 million debt package from a combination of insurance companies and commercial banks.
“We need to be concerned about companies where there is the need to raise substantial amounts of new debt capital to either replace debt that is coming due or to finance other commitments,” Harris says. “There was some concern around Developers Diversified early this year, but they have made progress with some more work to do in that regard.”
