Taubman Centers: Are All Retail REITs Overvalued?

I have been looking at regional centers and malls for sale on the open market to aid in the valuation of retail REITs. I have listed 3 as examples. Occupancy varies from 80% to 95% and net operating income [NOI] from 7% to 11%.

These prices are real - no discounts, no negotiations - just prices listed by the brokers.

1) Salisbury Mall, NC
GLA....... 319,659
Price..... $ 24.5 M
NOI....... $ 1.93 M

2) Wyoming Village, MI
GLA....... 176,671
Price..... $ 9.25 M
NOI....... $ 0.88 M

3) Columbus Portfolio, OH
GLA....... 1,749,160
Price..... $ 96.53 M
NOI....... $ 10.67 M

TOTALS
GLA....... 2,245,490
Price..... $ 130.25 M
NOI....... $ 13.48 M

If we are more cautious and assume an NOI on average of 8%, a portfolio could be purchased for $1 Billion with an NOI of $80 million.

As an example of a retail REIT, I have chosen Taubman Centers (TCO). Its revenue is roughly the same, but its price is around $2.7 Billion.

On this basis, Taubman does look overvalued. If you factor in variances in tenant default rates, length of leases and such, it still looks to be twice the price of open market retail centers.

On the negative side for Taubman Centers and other REITs is that this (newly constructed ) portfolio would have no debt for the same revenue.

Other points to bear in mind are that if the retail environment gets really bad, it could use its unencumbered assets to take it through the bad times.

Many REITs also have poison pill defenses to avoid takeovers, such as dual tier voting/ownership rights.

REITs are required to give 90% of their revenues to investors, hindering their ability to bolster their balance sheets.

Bearing all of these negative issues in mind, I believe that REITs should have an automatic discount of 10%, against comparable equity companies. This discount would be on top of an adjustment towards current “Real Estate Broker Prices”.

To sum up my view, I would value Taubman Centers at approximately $1.35 billion, which is around half its current level.

For general information purposes, all of the listed properties are on Loopnet.com.

I am hoping for feedback from other contributors. Your views and analysis are always welcome.

Comments

[stc1:]

Chris -

Taubman has a relatively complex structure for a REIT and it's clear you do not understand very much about this company or this sector. Two TCO properties, Stamford Town Center and Beverly Center, alone are worth in excess of $1.35 billion. I'm hoping (for your sake) that these posts are some sort of April Fool's joke played by Seeking Alpha. If not, I heartily encourage you to short this stock (and REITs in general). I'm always happy to have more idiots in the market. Easy money. Thanks and best of luck.

P.S. You should get in touch with Reggie Middleton. The two of you would make a great team.

2008 Apr 01 04:31 PM

[HaroldL:]

Ok, Mr. Marshall, I agree. If someone wanted to enter the mall operating business, now would be a good time. At least as far as purchasing the assets. But the new buyer would still have to run the mall for the long-run, or at least until they could resell the mall at a profit.

You are assigning no value to this skill and knowledge for which Taubman Centers is renowned. There is a reason that new entrants don't come into the shopping mall business every year. The well established names tend to stay through the business cycles that come and go.

Mall operators aren't required to use mark-to-market accounting, where the moment the market value of a property declines, they have to recognize a loss. Do you think the debt holders would want to immediately foreclose on TCO's malls, and dump them on the market?

Business cycles are nothing new. If some good properties come on the market, I would bet that TCO shareholders would be happy to see Taubman acquire them now at great prices.

2008 Apr 01 06:47 PM

[Chris Marshall:]

To HaroldL:

I was interested in your response, do you value their knowledge and goodwill at $1.35 Billion. I still prefer companies with strong balance sheets in a downturn, Reits owing to their set up can only use the 10% of profits to boost their balance sheets, this can be a very slow process if no capital injections are possible due to the credit crunch.

Chris Marshall

What current value would you place on TCO and GGP?

Awaiting your response with genuine interest.

2008 Apr 02 04:26 AM

[HaroldL:]

Chris, from my perspective an investor really shouldn't look at the equation the way you are trying to. There's no reason to look at the asking prices of assorted malls that are up for sale at this moment in time. Your concern about the balance sheets of REITs is considerably misplaced. You seem to be applying to REITs rules that are applicable to Wall Street banks, i.e. Bear Stearns, and saying their balance sheets are temporarily weakened and it is imperative that they shore them up quickly.

Banks have capital levels that they are required to maintain. Trading firms can see their customers abandon them overnight if there is uncertainty about their credit risk. That is not the case with mall REITS. Mall REITS own bricks and mortar. As I've read others explain it, a mall is like the shopping district of a small town where one person (entity) owns every store in town. So what if there's an economic slowdown? Those stores will still be standing there when the economy recovers and the customers return.

C corporations are not used to hold real estate because of the double taxation that would occur. REITs are primarily vehicles to distribute earnings to the shareholders in the most tax efficient manner.

I really don't understand the market pricing of the common stock of TCO or other REITs. I try to keep a diversified portfolio of preferred stocks for income. I've owned TCO preferreds for over 10 years, and I own them for the income. When I look at TCO, I see more than just a credit rating score.

As for the common stock, that's not my focus.

Good luck,

HaroldL

2008 Apr 03 06:51 PM

[User 172804:]

As an ex banker and senior officer in a number of financial service organisations, I cannot but agree with everything Chris Marshall has to say. I find no flaws in his analysis and argument and would reinforce particularly his statement regarding the 90% rule on the distribution of profits. This is probably fine in very good times, but in bad times I believe this rule to be highly dangerous. The rule hugely limits the boards ability to make provision for bad times by limiting the funds available to increase the capital base, in preparation for the unforseen lean times. One could argue that its asset base is available to borrow against should this become necessary, but this of course could only aggravate the position by having to utilise what are in effect, meagre profits for debt management. This could become a vicious circle.
I am also understand that a shareholder holding 1% of the shares has in effect a 32% voting position. This voting anomoly, apart from being illegal in the rest of the civilised world, could and probably does limit the scope of the board in some crucial decision making.
Mr Marshall values the company at about half of that shown. I would be inclined towards a slightly lesser valuation.

2008 Apr 04 06:03 AM

[Chris Marshall:]

To HaroldL:

Thank you for your response, I will try to explain why I feel that this situation is untenable in the long term.

If we image a scenario whereby a mall operator has a gross revenue of $600m, with net income of $60m, at this present time, what would happen during a down turn?

If we imagine vacancy rates increasing from 5% to 12%, the gross revenue could drop to around $550m, bringing the net income down to $10m. This is before the re-rating of their debt (which has been downgraded from BB recently), therefore you can expect the borrowing cost to rise.

If the vacancy rates reach this level, in a recession scenario, it is very likely that the Asset value of the properties will fall in excess of 10%. When a balance sheet shows negligible tangible assets, it is extremely likely that their banks will ask for further collateral on their loans, bringing the LTV down to 50%-55%, as an estimate.

In this scenario, revenues, cashflow and the balance sheet will all have negative values. How would you value a company in this situation, except Zero!!

I am just pointing out that a very weak balance sheet, that is hard to rebuild in the Reit framework, is not the best starting point from which to go into a possible recession.

The reason that I looked at the open market for pricings is, in the event of a company having to sell assets quickly, its the only price that makes sense.

Regarding the mall being a small town and immune ( in some degree) to a recession), I would like to point out that Towns/Cities have many Malls/regional/power centres to choose from, and any tenant can play one against another to obtain better lease rates, when renegotiating terms. The consumers do not lack for choice in retailing.

Best regards,

Chris Marshall

2008 Apr 04 07:50 AM

[johnthebear:]

Thank you for your analysis of the market, Chris. I agree with you. I would like to comment on your point in which you said:

"Other points to bear in mind are that if the retail environment gets really bad, it could use its unencumbered assets to take it through the bad times". The problem is there is no assurance that a potential buyer could get financing and at what rate. The interest rate would probably be comparable to "junk bond" rates. I would not count on hedge funds buying any malls at a premieum price at that stage of the market.

There have been situations in England where REIT share holders were not able to sell their shares and were asked to wait at least 6 months to cash out. Also, back when Northern Rock Bank collapsed, the Bank of England was concerned that so much commercial property was valued at a 4.5% cap rate, much less than the mortgage rate. I just have to wonder how much of the REIT property in the US is also so overvalued?

When you compare the NASDAQ at the top of the market in 2000, with IYR in 2007, you will find the bubble nearly equal height. Use a 10 year chart to make this comparison. For this reason, I believe that the bottom for the IYR- REITs will follow much the same path down as the NASDAQ through 2003.

I look forward to seeing the earnings reports that will begin the last week of April. I am expecting a big drop in May, and have invested in SRS.

2008 Apr 08 12:11 AM

[Chris Marshall:]

To John the Bear:

Thank you for your comments:

I will address your points in turn:-

Regarding the unencumbered assets of Reits, I agree that hedge funds may not buy these assets( at current prices), that is why I suggested market price, as a fair value. Obviously "market price" may well be below the current level, but eventually somebody will purchase the asset, at a level that balances risk/reward. The hedge funds in the US are just starting to purchase the debt of US banks (at a discount obviously), so purchasing properties from Reits is not out of the question, if the values are sensible.

A second point to bear in mind is that some balance sheets for the Reits, are worse than others. Some Reits may not have any unencumbered assets in the very near future.

I agree that in some Reits in the UK (NS Asset Management Etc) prevented further withdrawals from their trusts, but banks in the US tend to be more forceful with a "sell the asset and repay us, or else" mentality.

Regarding cap rates, about 10 years ago, from memory cap rates for retail property was around 9%- 10%. On this basis the Reits are significantly over-valued.

One last point to bear in mind is that historically Commercial Real Estate Prices have lagged behind Residential Real Estate, by about 18 months, this indicates that CRE has a minimum of 20% to fall at this current time, with more to follow as residential has not bottomed out yet.

I am not a great fan of Reits in general, as I believe that the initial structure was very short-sighted. To avoid tax 90% of the profits MUST be dispersed to the investors, this is a BIG headache during a downturn as rebuilding a balance sheet is nigh on impossible.

I believe that many Reits need to be recapitalised, owing to their debt levels and weak balance sheets. However, I think that it is more likely that the weakest Reits will not survive the downturn, and that the others may have to adapt to the new environment, and stop any further development, until the economy starts to recover, in about 2 years.

I am wondering how the Reits will respond to the latest FED minutes concerning the outlook for the economy. Some will undoubtedly keep their heads in the sand, Others will keep churning out the standard blurb of a recovery in the second half.

It is interesting to note that the CFO of Taubman Centers has sold in excess of $4 Mill worth of shares in the last month. CFO's are famed for having no heart, so when a CFO starts selling, you should start worrying, about the state of their company.

2008 Apr 09 06:10 AM

[johnthebear:]

Thank you for a very well thought out and full response to my questions. You have helped me understand this market and i agree with you 100%.

2008 Apr 10 03:44 PM