We knew the third quarter would be bad for retail REITs. The question was, how bad would it be? Given the current environment of retailers filing for bankruptcy, shuttering doors, pulling back on expansion and openly announcing intentions to renegotiate leases with landlords, most retail REITs reported a declines in occupancy, a slower leasing environment, and issues with tenant default in their third quarter reports.

In this issue of CoStar Advisor, we summarize the significant trends and opinions shared by retail REIT executives in the most recent round of quarterly conference calls, including those by Simon Property Group (NYSE:SPG), General Growth Properties (NYSE: GGP), Macerich (NYSE:MAC), Pennsylvania Real Estate Investment Trust ("PREIT", NYSE:PEI), Tanger Factory Outlet Centers (NYSE:SKT), CBL & Associates Properties (NYSE:CBL), Glimcher Realty Trust (NYSE:GRT), Developers Diversified Realty (NYSE: DDR), Ramco-Gershenson Properties Trust (NYSE:RPT), Kimco Realty Corp. (NYSE:KIM), Cedar Shopping Centers (NYSE:CDR), and Weingarten Realty Investors (NYSE:WRI).

Next week, we'll follow up with a report on trends addressed by these REITs in the areas of development, investment, asset sales, and liquidity.

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OCCUPANCY

Ed Glickman, president and COO at PREIT said, "retailer concerns have resulted in a higher-than-anticipated level of store closures and a number of delayed openings," and as a result, it has brought the REIT's overall occupancy down, an effect felt across many REITs.

Tanger beat the odds, reporting a 50bps increase in occupancy during third quarter to 96.7%, outperforming most of its peers. "Outlet centers are defensive and offer growth opportunity in an economic slowdown," explained president and COO Steven Tanger.

While GGP reported a 50bps decline, both CBL and Glimcher reported a 90bps decline in mall occupancy rates over third quarter 2007. Glimcher expects this is temporary, reporting its pace of new and renewal leasing as up over last year; this expectation, however, is barring any additional significant tenant bankruptcies or store closures. CBL, however, said it expects to end 2008 with occupancy close to 100bps below the end of 2007.

At neighborhood and community center REITs, Weingarten said "strong leasing velocity" at its centers resulted in a 30bps increase in occupancy to 94.5% over second quarter. However, the REIT is planning for a decline in occupancy in January and February 2009. Cedar reported flat occupancy at 96%, while Kimco reported a 30bps decline in occupancy over second quarter. All of these REITs tout their grocery and drugstore-anchored portfolios as stable in a down economy due to a tenant mix weighed towards necessity-based tenants.

DDR is planning for occupancy to bottom out in mid-2009 due to down time regarding re-leasing efforts for additional bankruptcies it expects will occur; the REIT doesn't expect to "regain ground" until the second half of 2009.

David Simon, chairman and CEO at Simon, expects occupancy to bottom out "sometime in 2009", with new store openings during the year "at a reduced level." He added that some retailers are limited in new store openings simply because of the lack of new developments.

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LEASING ACTIVITY

DDR reported breaking an "all time company record in terms of the number of new leases executed" during third quarter. To achieve this, the company has changed its leasing strategy in response to the challenging environment. "We’re staying in front of tenants by conducting full portfolio reviews and traveling to their headquarters in record numbers," said president and COO, Daniel Hurwitz, adding that the company is renewing tenants earlier than normal. Further, DDR is pressuring its attorneys to accelerate the time it takes to process leases and is also "revisiting deals that had previously been declined."

Glimcher CEO, Michael Glimcher, said the lack of new retail product coming online has increased the probability of securing new leases, "even with less new stores opening." However, he also reported "increasing cautiousness from tenants, especially over the past several weeks" and said he doesn't expect tenants to start "aggressively expanding again" until 2010.

Mark Yale, Glimcher's CFO, said no property class is immune to a slowdown in leasing. "Everything is difficult. Everything is slower, whether it is your most premium property or your most moderate asset."

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STORE CLOSURES / TENANT BANKRUPTCIES

The major retailer closures and bankruptcies retail REITs addressed as having the biggest impact include Mervyn's, Boscov's, Steve & Barry's, Linens 'n Things, Goody's; now Circuit City is the latest.

Rick Sokolov, president and COO at Simon, pointed out that direct impact Simon feels from anchor tenants going dark is limited, as most of those stores are owned by others, however, the REIT has identified a "number of users" to backfill these boxes. In addition, Simon may buy back some boxes to turn them into small shop space; particularly at the company's "better properties." The issue that arises in that, Simon warned, is that the REIT "probably" won't pay the price those owners would like to get.

Macerich said it has "a very robust level of interest from retailers wanting to take over" the 41 Mervyn's stores in its portfolio. CEO Art Coppola "suspects" that many Mervyn's stores will be acquired by a major retailer(s) before the stores even go to auction.

DDR has formed a division dedicated to backfilling bankrupt retailers' spaces, which it says has increased its "ability to pursue package deals or portfolio transactions" and reports "a number of potential transactions with retailers who are obviously viewing this opportunity as their means to enter new markets and win market share."

"Tenants that are actively making new deals that could potentially backfill these boxes include Bed Bath and Beyond, Christmas Tree Shops, buybuy Baby, TJ Maxx, Marshalls, AJ Wright, Kohl’s, JC Penney, Ross, JoAnn's, Dick's Sporting Goods, Sports Authority, PetSmart, Petco, HH Gregg, Staples, Fresh Market, Best Buy and several others," said DDR's Hurwitz.

Store closures at Tanger's outlet centers seem to benefit the REIT, if it can keep up its pace of leasing, that is. With six retailers pulling out of the outlet center industry during the first half of this year, Tanger was left with 38 empty spaces, and so far, has released about half of those for an average rental rate 61% higher than the prior tenant. However, Tanger already has another 32 stores scheduled to close by the end of first quarter 2009.

"We’re crossing our fingers over the next bankruptcy season, which really is next February of 2009," said Glimcher's president and COO, Marshall Loeb.

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LEASE CONCESSIONS / TENANT DEFAULT

PREIT said it has had to increase reserves for delinquent accounts for both regional and local tenants and also posted an increase in bad debt expense during third quarter as a result of tenant bankruptcy filings.

Drew Alexander, president and CEO at Weingarten, said the REIT's same property NOI was down in third quarter, "due to increases in bad debt expense and retailer fallout." He added that the REIT has seen even more "retailers experiencing difficulty in just the last few weeks."

Weingarten EVP, Johnny Hendrix, said, "One of the issues we've had is with small tenants getting behind in rent. On a historical basis, maybe 70% of those tenants have been able to come out by getting a loan from their family, bank, home equity, or sign a lease and sell the business. Those options do not appear to be available today. We are not seeing many small tenants work their way out once they fall behind in rent."

"We do all that we can to try to keep the tenants in place. Unfortunately in most cases the rent is not enough to turn a business around," added Hendrix.

Michael Sullivan, SVP of asset management at Ramco, said he sees the trend of falling tenancies moderating, as the company is "seeing a drop-off" in requests for rent relief and rent delinquency payment plans, as well as a slight increase in renewal retention.

PREIT said it has provided some relief to retailers over the last quarter, granting underperforming retailers "several short-term renewals at their current terms with the goal of maintaining occupancy in the near term while providing us the flexibility to re-lease these spaces in a more favorable economic environment."

CBL president, Stephen Lebovitz, confirmed that retailers are "being more aggressive" in asking CBL for rent relief, but said the company is "fighting back to preserve our rent streams." He said that in some cases CBL has granted tenants to pay a percent of sales in lieu of rent; or granting renewals on a short-term basis.

In handling tenants seeking rent relief, Simon said it assesses the viability of what it might get if a tenant files Chapter 11 and reorganizes, versus keeping the tenant and providing rent relief. Further, the REIT typically coordinates with other developers to see how they're handling the situation to "come up with a consistent format."

To hedge against tenant fallout or having to keep a tenant on in a rent relief situation, both Simon and PREIT said they start marketing underperforming tenants' spaces far in advance. PREIT typically negotiates "a recapture rate so to the extent we find that replacement tenant we can move the other existing tenant out unless they agree to stay on at full rent." Simon said the practice maximizes its "ability to either renew that tenant with better rent" or bring in a replacement tenant at market rent.

Tanger said it's not seeing tenants asking for more concessions or taking longer to negotiate deals than is considered "business as usual" in the outlet center industry.

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RETAILER SALES

DDR said consumers' shift toward value-oriented retailers is benefiting its portfolio; as such tenants largely anchor it. "The market share shift to tenants that offer value and convenience is accelerating dramatically. We see that manifest itself every month in sales and margin results," said Hurwitz. Hendrix at Weingarten echoed this, saying discount retailers selling necessities are the ones seeing sales increases and as a result, remain in expansion mode.

Leo Ullman, CEO and president at Cedar, said "On the grocer side, generally, many have reported as good a result for the past quarter as they have ever have."

In evidence that sales productivity is down for retailers at many malls, most REITs reported a decline in percentage rent income; however, most also said they are phasing out structuring leases with that provision.

Glimcher reported a slight improvement in sales per square foot over the previous quarter, but said it is concerned "about the current economic situation and probable corresponding impact on consumer spending."

"In good times, people like to bargain on brand name products and in tough times like now, they need a bargain. Outlet stores remain a very profitable channel for our tenants," said Tanger. While most retailers have been consistently reporting declines in sales, Tanger reported the sales per square foot at its outlet centers as consistent over last year.

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WHAT TENANTS ARE SIGNING LEASES?

REITs named several tenants actively signing leases during third quarter.

Kohl’s, Dick's Sporting Goods, Publix, buybuy Baby, Fresh Market, Bealls Outlet, HH Gregg, Golfsmith, Hobby Lobby, Dollar Tree, Ross, Best Buy, Sunflower Markets, and 99 Ranch Markets (a Chinese supermarket retailer), were among those listed as signing on for junior or major anchor spaces.

In malls, J. Crew, Zumiez, Aerie, Coach, Forever 21, American Eagle, Limited Brands, Express, Sephora, Buckle, and Wet Seal continue to sign leases; along with Maggiano's, Seasons 52, Capital Grille, and California Pizza Kitchen on the restaurant side.

At outlet centers, Stewart Weismann, True Religion, Neiman Marcus Last Call, Restoration Hardware, Victoria’s Secret, Ann Taylor Loft, Williams Sonoma Home, Betsey Johnson, and Wolford were named.

Grocery, personal service, apparel and convenience store tenants were named as continuing to take space. Specific grocery retailers identified as continuing to grow include Stop & Shop, Shaw's, Price Chopper, Giant, Hannaford, Weis, Shop Rite, Acme, Pathmark, Supervalu, Farm Fresh, Ukrop's, and Food Lion.

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REGIONAL TRENDS

Ramco said it has been the subject of speculation that its portfolio occupancy would decline because of the number of centers it owns in Michigan and Florida, two states "viewed as economically challenged markets." However, Ramco beat the odds, reporting that while a chunk of Florida and Michigan retailers didn’t renew this year, a great chunk signed new leases.

DDR echoed Ramco's leasing results in the so-called troubled Florida market, reporting that the Southern region was its highest producing in terms of leasing space during the quarter.

At Macerich, Coppola said, "Here in the US we have not only have had impacts of that global recession, but we even find ourselves in a situation in Arizona where it actually begins to feel like a depression." The company has a high concentration of development in Arizona. However, the REIT's releasing spreads in Phoenix "have been exceeding 20% just as the United States has exceeded 20%," said Coppola.

Tanger said it dropped two projects in the pipeline in Florida and Phoenix due to a combination of weak initial tenant demand and cautiousness over those local economies.

"Geographically, Texas has done better than most of the country. Florida was probably the first to see the weakness and then it moved to California or the west. Generally, Arizona, California, and Florida today are still the hardest hit," said Weingarten's Hendrix.

Stephen Lebovitz at CBL said North Carolina has "showed relative strength," while the Midwest and South regions have had mixed results.

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Quotes for this story were pulled from conference call transcripts provided by Seeking Alpha.

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