DDR to Sell Malls at 30% Discount...to 2004 Prices

Finally a market test valuation of Commercial Real Estate, which is not just hype and Merrill Lynch speculations. The Buffalo News reports that REIT Developers Diversified Realty (DDR) is selling back 11 upstate New York shopping malls to the entity it originally purchased them from, Benderson Development Co., at a 30% discount to their 2004 purchase price.

In 2004 DDR acquired 110 properties from Benderson for $2.3 billion, an average price of $21 million, and is now selling back 11 of these for a total price of $160-$175 million, of roughly a $15 million average price, and a 30% discount. Not bad for Benderson which is buying back what it sold 5 years ago at 70 cents on the dollar.

And for all intents and purposes, this transaction was very opportunistic for DDR:

“It’s good that the ownership is going in the direction that it is,” said Michael C. Clark, director of retail tenant services at CB Richard Ellis in Buffalo. “There’s going to be a lot of markets in other parts of the country where they have portfolios for sale by different REITs and they don’t have someone like Benderson to step up.

“We’re pretty fortunate in terms of the market, in regard to that. How much better can you get than the folks that developed them and are intimately familiar with them and live and breathe here? They certainly know what they’re doing,” Clark said.

As Retail Traffic points out, this is very surprising as current estimates have been that retail properties would post at most a 40% decline from peak values achieved in 2007. A 30% discount from a 2004 price implies a significantly higher discount from the peak. RT calculated that the final closing discount from the peak is roughly 50%. As David Bodamer at RT points out:

There are a lot of things we don’t know about these assets. Are they healthy assets or do they need work? What do the current tenant rosters look like? Are the rents at market rates or lower? When do the leases come up for renewal? Did Developers Diversified sell these assets at a deeper discount than is truly reflective of market conditions out of a need to raise cash? Without this information it is hard to draw a full conclusion on what it means for the market. But the fact remains that this represents a massive drop in values from just more than two years ago. And the drop in value is larger than even the most pessimistic estimates have been for the peak-to-trough change in prices for retail real estate.

Notable is that DDR is raising cash in a non-equity offering form. Maybe Merrill has gotten to the saturation point where there is just not enough reverse inquiry into the phenomenally overpriced REITs.

Also, thanks to this market test, one will be able to recalculate what fair Debt-to-Market Value of Assets ratio is for the majority of mall REITs. The result will likely be a dramatic rise from previously consensual ratios, presenting yet another data point indicative of the REITs bloated overvaluations due exclusively to short squeezes.

Comments

[Swashbuckler:]

Benderson is getting screwed.

Jun 08 02:54 PM

[igggy:]

My theory is that people who are buying REITs now think that they are getting a cheap inflation hedge. I just can't see any other explanation.

Jun 08 04:43 PM

[Fighting Yoda:]

Property prices will continue to fall - you can only buy a over discounted property. Prevailing prices are measured by index and averages - so if something is below that - you analyze and look into it.

Residential builder Lennar also recently bought back land it sold to Calpers in 2005 at 50% (I think that was the number) of the value. It was originally a levered buy for Calpers they lost more than 100% of their investment.

Jun 08 04:59 PM

[mikebrah:]

Tyler, I'm a big fan of you and your blog, ZH. But this isn't a very legitimate comparison is it? You are comparing the average price for a 110 piece portfolio to the average price of 11 pieces within that portfolio. Unless we know the specific prices of the 11 pieces today vs. their 2004 price this is inaccurate to assume a blanket discount.

MM

Jun 09 12:30 AM

[2houndz:]

If these eleven assets represent FMV for the industry as a whole, then we are clearly screwed, but it would be impossible to jump to that assertion. Real Estate is lumpy and illiquid, and it changes hands for all sorts of reasons. A seller who has his back against the wall will do some semingly stupid things, but one transaction does not usually tell a clear story. I'm not saying we are not screwed, but we can't divine that opinion from this deal alone.

The story that seems to be coming into focus is that many of the public REITs are getting hammered, while the smart, patient private investor is finding golden opportunities. The fact is that real estate, being lumpy and illiquid, is a terrible platform when chasing quarterly profits to report to Wall Street. Time and time again I see the REITs fall into one trap after another and spin stories on the quarterly call that don't make long term sense, while many of the private companies have a long term horizon and do what is expedient looking out for the next five years or for the life of the asset. Kimco once had the long term approach, and it was a good, steady income generator that promised less than it could deliver. Then they started promoting people who knew little to nothing about actual real estate, but knew (or thought they knew) how to grow the business exponentially because they possessed financial genius.

Some of the analysts I have spoken to over the years don't understand the business well enough to really get it, so they can't help watch the henhouse - they are part of the problem. Maybe this industry should get back to the basics of understanding real estate and having a long term plan and objective for a portfolio BEFORE they close the deal. Highly leveraging cash flowing assets just because they can borrow the money is not a solid reason to risk stockholder equity. My fear is that most of the people who understand this are either retired or working for private capital.

As an aside, I heard about a guy last night (investor, not a real estate guy) who bought quite a few centers from a company where I once worked. He bought his portfolio at a 6% cap average, levered with a personally guaranteed mezz loan to 95%. A good offhand guess at the current value would be a 10% cap. Obviously this guy is about to lose everything he has. Even the private money is getting crushed if they didn't go into this for the right reasons, with solid plans, sensible leverage and realistic purchase prices.

CRE is going to get a lot uglier before it gets better. When this is over, my hope is that the industry can winnow away the people who don't know what they are doing. Also, I hope the investors buying the new offerings know what they are doing, because it seems like folly to me.

Jun 09 08:09 AM

[conceptwizard:]

This is a smart sale on behalf of the seller, The people who sell off fist before the bubble burst will make the most recovery percentage. This will allow them to recapitalize and weather the storm, possibly buy back in at the low, the same as you would in stock transactions. (perhaps the same properties at 10 cents on the dollar!) Now for you to buy this theory you would have to believe that a commercial real estate bubble was a pending explosion. They may in fact see this coming. I would contend that the discounts will deepen as we go further along and their become less buyers and Banks willing to finance. I believe that Tyler has this on the watchlist. that is why he is watching overall percentages.

Jun 09 08:38 AM

[nova:]

Nowadays, the timing is everything.

PS
IMHO, DDR is smart.

Jun 09 10:58 AM

[Choad Mangler:]

Wow, and I can drown in a lake with an average depth of 3 inches. Averages can be deceiving you know. Who is to say that these were not the worst 11 properties in the original package?

Jun 09 04:10 PM

[Rhino Realty:]

Indeed this is all speculation; however, the facts are clear:
1. DDR is in trouble and near drowning
2. DDR must shed non core assets to stay in the game
3. The Buyer took huge risk as we are just entering the CRE storm
and certain there are tenants in the portfolio that will file BK
or move out overnight.
So it seems clear, DDR has another day to live and the new buyer may soon choke on its own self indulged stupdity.....once again, good info from Tyler !

Jun 09 10:29 PM