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WHERE ANGELS FEAR TO TREAD

MANY INTERNATIONAL REITS HAVE SKIRTED EUROPE, BUT NOT ALL

By Ryan Chittum

In recent years REITs have been looking overseas for higher returns. Things have not been easy, though, for retail REITs trying to break into the European markets. And it does not look as if that will change anytime soon, given the freeze in big loans and the inherent difficulty of developing projects in there, though if a European mall company stumbles over the debt crisis, acquisitions are still possible.

“It's a difficult market to penetrate,” said Matthew Ostrower, a Morgan Stanley retail REIT analyst in New York City. Europe, denser than the U.S., has done much more to protect its Main Street (what the Europeans call High Street) shopping culture from the effects of the suburban shopping center than has mall-friendly

America, which saw its downtowns depleted for nearly half a century as shops and shoppers moved out of the cities.

“In Europe the High Streets are the primary spots where retail is done,” said Rich Moore, an analyst at RBC Capital Markets. “These are the downtownish areas, and it's a very different concept. It's almost like a giant lifestyle center. Doing an enclosed retail mall is probably not going to be as popular.”

European governments place heavy restrictions on out-of-town development. This has protected existing projects from competition and kept property prices sky-high, but it has also made it hard for international REITs to enter. “Companies have a hard time getting in at any kind of a yield that they could justify here in the U.S.,” Ostrower said.

Analysts say the biggest opportunities for greenfield development in Europe are in Spain and Central and Eastern Europe, where there is more open space. France, the U.K. and other more economically developed countries are largely built out. Still, Australian mall giant Westfield has done well for itself in the U.K. Its two massive mall developments in London are among the biggest retail bets in the world right now. Westfield London at White City is scheduled to open in October at an eye-popping cost of about £1.6 billion ($3 billion), making it one of the most expensive malls ever built. The 1.6 million-square-foot center will have four anchors (including Marks & Spencer) and 265 in-line shops, a portion of which will be set aside as a luxury hub (Louis Vuitton has signed up).

Westfield is building an even more expensive mixed-use project near the 2012 site of the Olympic Games in east London. Westfield's first phase of the Stratford City development is expected to cost about $8 billion and will contain about 3.4 million square feet of mixed-use space, including some 2 million square feet of retail, leisure and entertainment space. Last year Westfield opened a $700 million, 1 million-square-foot center in Derby, in the center of England.

These high prices illustrate the difficulty international developers have making a retail model work. Westfield is paying about $300 million just for transportation improvements to the White City site, according to London officials.

It has been reported that Westfield is in talks to buy Liberty International, a U.K. retail REIT that owns some $17.3 billion worth of properties, three-quarters of which are U.K. regional shopping centers. Westfield is sitting on a multibillion-dollar hoard of cash it has been stockpiling for such a time as this, when other mall companies may be finding themselves in trouble. The firm's total gross leasable area in the U.K. makes up about 4 percent of its portfolio.

Indianapolis-based mall giant Simon Property Group made its first international investment just a decade ago and has since invested in dozens of developments overseas, mostly in Italy, through a joint venture with that country's Rinascente Group. Simon owns 59 properties outside the U.S., and 51 of those are in Europe, 44 in Italy alone, plus five in France and two in Poland.

But though Simon's European properties make up about 13 percent of its 392 properties globally, they tend to be smaller in size and also have a smaller impact on its bottom line than the U.S. regional malls at the core of the portfolio. The European centers account for about 4 percent of Simon's 258 million square feet of retail space worldwide. International properties on the whole contribute about 5 percent of the firm's total earnings before interest, taxes, depreciation and amortization.

“Westfield has made a more significant investment in Europe relative to their size,” said Ostrower. “Simon has a large number of projects, and they own a large number of existing assets, but it's not as big an investment.” Simon's European footprint totals 11.3 million square feet, according to its Web site. By comparison, its two biggest U.S. malls alone — King of Prussia (Pa.) and the Galleria, in Houston — have a combined 5 million square feet of gross leasable area.

But Simon is looking to make more investments through Simon Ivanhoe in France, for example, and it wants to bring its Chelsea Premium Outlets centers to Europe too. “The one area that I'm challenging the guys to figure out is Europe,” CEO David Simon told a Merrill Lynch investor conference in September. “We have a small interest in a company there, but we've got to figure out, ultimately, how to take the product or do something in Europe with Chelsea. The outlets there are very small, though. I mean, they're 100,000 square feet, so they're not anywhere near what we do here, or even in Japan, or even in South Korea. So it's a different kind of product, but it's a very good business there, in continental [Europe] and in the U.K.”

Moore says acquisition is probably the best avenue into Europe for international REITs. “There are strong companies there with good balance sheets, and ones struggling with debt,” he said. “One of the targets [for Simon and Westfield] is going to be ex-U.S. companies. In Europe those companies are expensive as well. They've pulled back in price, but they're still expensive.”

Developers Diversified Realty Corp. entered Russia and Ukraine last May with a commitment to make a $174 million investment through a joint venture with Germany's ECE Projectmanagement. CFO William H. Shafer said in a conference call in February that by 2010 DDR's investments in Russia, Ukraine and Brazil will account for half the company's total development pipeline.

Simon has said it wants to form a joint venture in Russia but has not found the right partner.

Among U.S. REITs, General Growth Properties has done little overseas so far. In Europe the firm owns one 463,000-square-foot shopping center, in Turkey. The four-story Espark development opened on Halloween and has 150 shops and restaurants, as well as three anchors. GGP does manage several other centers in Turkey, in which it has no ownership stakes.

Other U.S. REITs are content to leave Europe to others, at least for the moment. Macerich has no overseas investments. “We are focused on our opportunities here at home,” a Macerich spokeswoman said. “We have a very deep pipeline with a lot going on.”

Meanwhile, Taubman Centers and CBL & Associates have no European investments. A spokeswoman for Taubman says the firm is focused on Asia, where it has several projects under way, including some in Macau and South Korea. CBL is making several investments in South America at the moment.

The neighborhood and community shopping center industry has done even less in Europe. Kimco Realty Corp. has no projects there, despite having big investments in Canada and Mexico, while Federal Realty Investment Trust and Regency Centers Corp. have no properties outside the U.S. at all.

Overseas development is complicated, many say, and Europe is no vacation.