An out of the blue multi-billion dollar acquisition, history has shown, has a tendency to kick start an otherwise dormant segment of the real estate market and provide the boost needed for a turn-around. In fact, last month, we wrote about the merger between LaSalle Hotel Properties and Blackstone which was responsible, in large part, for the 11.9% returns posted by the Lodging REIT sector in the month of May. Typically, such an acquisition inspires institutional investors or changes the collective perception of the market, but the mall REIT sector seemed largely unaffected by the closing of the largest retail real estate acquisition ever, the acquisition of Westfield Corp. by Unibail-Rodamco SE. Unibail’s portfolio is now valued at roughly $72 billion, consisting of 102 shopping malls, 13 properties and 10 convention centers in Europe and the U.S.
The agreement for Unibail to purchase Westfield for $15 billion was announced in December 2017, approved by shareholders in May 2018, and closed in June 2018. While the consideration offered to Westfield shareholders represented a slight premium over market prices, there was some doubt cast on whether the deal would be finalized. Following the deal announcement in December, Unibail shares steadily declined, reducing the original purchase price by more than $1 billion.
Capital markets seemed to disfavor the merger, largely because of the debt position that Unibail needed to pull it off. Before the acquisition, Unibail maintained a 33% loan-to-value ratio. Following the merger, Peter Papadakos of Green Street Advisors puts that number at close to 43%. In buying Westfield, Unibail’s debt will grow to 11 times EBITDA, up from 9 times, according to Green Street. The CEO of Unibail acknowledged as much, noting that the company will need to sell non-core assets from the existing Unibail portfolio and the recently acquired Westfield properties in order to shore up the company’s balance sheet.
If Unibail’s debt load wasn't enough, markets didn't ignite over the news of the Unibail-Westfield merger because of the obvious global threats faced by Mall REITs and retail centers, generally. The rise of e-commerce and digital technologies are fundamentally reshaping consumer expectations and shifting the function of stores toward useful and entertaining customer experiences. Fortunately, Westfield had been reducing its retail exposure in favor of residential and entertainment properties focused in high-income areas with strong population density. Westfield’s former CEO Peter Lowy believes that the real challenge going forward will be to “keep the mall relevant.” A nod, no doubt, to the unyielding market concerns about the health of the mall business.
As valuations for class-B and class-C properties have declined, REITs holding mainly class-A space for malls have suffered in the downdraft. One theory is that institutional investors have been too quick to lump class-A mall assets into the class-B and class-C category such that the entire asset class now suffers from the indelible mark that e-commerce has left on the broader mall and retail segment.
Amidst the doom and gloom, there may be an upside to the Unibail-Westfield merger. For months now, market commentators have been trying to parse the distinction between class-A malls and the less attractive class-B and class-C malls, which tend to be located in semi-rural or suburban areas and suffer from over-reliance on anchor tenants and exposure to box-store failure. Nora Creedon, a managing director at Goldman Sachs observes that “within various sectors, there are some opportunities emerging worth watching, such as the insufficient differentiation between high-quality [specifically naming class-A malls] and low-quality assets. We believe this is an evolution of retail, not the death of retail and that negative sentiment has made valuations very attractive for high-quality retail REITs.” Fortunately for Unibail, 85% of the assets in the Westfield portfolio are considered flagship, class-A properties.
This makes for an interesting position for Unibail. Unibail’s strategy, as both a buyer and a seller, may be difficult to achieve in the current market given the lack of appetite for lower-quality retail assets. Because of its debt-heavy balance sheet, it will be dumping its under-performing assets into a market that is buying exclusively class-A, if at all. On the other hand, if retail real estate has been overly generalized as a tainted asset class due to the specter of e-commerce, Unibail may be cashing in on Westfield’s profusion of class-A malls at an ideal time.
