Converting a nearly 150-year-old company with multiple lines of business into a more streamlined REIT is no small feat, but Hawaii-based Alexander & Baldwin (NYSEMKT: ALEX) sees the process as key to riding the wave of the islands’ economic strength.
Alexander & Baldwin’s portfolio consists of 3.4 million square feet of primarily retail and industrial space in Hawaii. The company converted to a REIT at the beginning of 2017, mainly to attract a wider range of investors, get better access to capital, and facilitate future growth, says Christopher Benjamin, president and CEO.
While the company hasn’t set confirmed targets for when and to what extent it plans to shrink its non-REIT businesses—which include land operations on 87,000 acres throughout Hawaii as well as materials and construction operations—the focus is clearly set on commercial real estate going forward.
To better appreciate Alexander & Baldwin’s transition to where it is today, it is necessary to step back to 1869. At that time, Samuel Thomas Alexander and Henry Perrine Baldwin, both sons of pioneer missionaries in Hawaii, paid $110 for 12 acres of land on Maui that they developed into a sugar plantation. The company added water resources, a railroad and a shipping company, as well as additional sugar plantations, to its portfolio.
Benjamin says a turning point on the path toward focusing on commercial real estate came almost seven decades ago. Until then, the company had housed its plantation workers in camps that were almost like small towns with a post office, a hospital, and markets.
In the 1950s, however, the leadership of Alexander & Baldwin decided to build “Dream City,” a master-planned community where employees could “buy houses and build equity,” Benjamin says. Then in the 1970s, the company built the Wailea Resort on Maui and built more housing.
More investment in commercial real estate followed. About 20 years ago, Alexander & Baldwin executed a series of tax-deferred 1031 exchanges to invest first in five, and eventually in about 25 commercial real estate properties on the U.S. mainland. The company also built a Hawaii portfolio of about 20 commercial real estate properties through development and exchanges.
As Benjamin explains, the company considered becoming a REIT off and on for about 17 years.
“We put it off for a long time because our business model was too complex, with the shipping, agricultural, and residential development businesses.”
The first decision on Alexander & Baldwin’s path to becoming a REIT, made about six years ago, was to spin off the shipping business and focus on its land-based businesses. At the same time, the company decided to divest the mainland portfolio and focus on Hawaii, “where we know the market better,” Benjamin says.
The company opted for a new series of 1031 exchanges. “Our mainland assets were like a piggybank for our Hawaii purchases,” Benjamin says. The final mainland property was sold in April 2018. In total, the company generated $600 million from its mainland sales that were reinvested in Hawaii. “We went from nonstrategic acquisitions on the mainland to highly strategic acquisitions in Hawaii, where we have outstanding fundamentals.”
Appealing to a Broader Base
Conversion to a REIT and the development of a more focused strategy has increased Alexander & Baldwin’s appeal to a broader base of investors, says Sheila McGrath, senior managing director of Evercore ISI.
Peter Martin, managing director at JMP Securities, notes that Alexander & Baldwin has managed to demonstrate that it is a good capital allocator. “Alexander & Baldwin shut down its sugar business, which was the most volatile part of the company, and now as a REIT they focus on their highest value businesses,” Martin says.
According to McGrath, what’s essential for investors to understand about Alexander & Baldwin is the company’s deep expertise in a unique market. “There are very high barriers to entry in Hawaii, in part simply because they are islands with limited developable land for commercial purposes,” she says.
Narrowing its focus to Hawaii has brought specific advantages, such as an in-house leasing and property management business. “When we had investments on the mainland as well as Hawaii, we didn’t have the critical mass to have an in-house property management business,” Benjamin says. “Now that we’ve more than tripled our asset base in Hawaii, we can manage everything strategically and control the whole delivery of services and leasing of projects.”
Internalizing its property management business should be a positive for Alexander & Baldwin’s same store net operating income (NOI), according to Martin.
Meanwhile, Alexander & Baldwin’s decision to structure itself as an UPREIT is an underappreciated aspect of the conversion, McGrath says. She says the structure is important because of the unique landscape in Hawaii, which has lots of owners with long-term ground leases who don’t want to sell because they have a low tax basis.
“Over time, we think this tax-efficient structure and the opportunity to trade one asset in one submarket for equity in a well-diversified company within Hawaii will be attractive to sellers,” Benjamin says. “We think operating partnerships can be attractive to Hawaii families and other owners of commercial real estate.”
As it completes the strategic migration of its commercial real estate portfolio back to Hawaii, Alexander & Baldwin has sought to increase its ownership of grocery/drugstore-anchored shopping centers.
Benjamin points out that while “retail cycles will come and go, Hawaii is unique in terms of grocery-anchored retail. Not only does Alexander & Baldwin have little exposure to the big-box space, but we have lower e-commerce penetration in Hawaii.”
While studies show that internet expenditures rise along with personal income, Alaska and Hawaii are outliers because of the extra travel time and shipping costs. Even though Amazon Prime offers free delivery to Hawaii, packages often take a week or more to arrive, Benjamin says. That lag time reduces the appeal of ordering groceries and other basic items online.
Getting the Message Out
Given its long and diverse history, Alexander & Baldwin’s biggest challenge is to make it simpler for the investment community to analyze its business and growth opportunities, McGrath says.
“Alexander & Baldwin continues to make strides in enhancing its disclosures to make it easier to understand the company, which still has a hand in agriculture,” McGrath says. She points out that the company brought on Jim Mead, who previously worked for REITs SL Green Realty Corp. (NYSE: SLG) and Strategic Hotels and Resorts, as its CFO in 2017. It also named Tom Lewis, the retired CEO of Realty Income Corp. (NYSE: O), to its board. “They’re very conscious in terms of getting REIT expertise to guide them.”
The company also recently rebranded with the tagline “Partners for Hawaii,” which is an homage to the founding partners as well as a reflection of the company’s partnerships with Hawaii and with its investors.
Benjamin recognizes how hard it can be to get investors to understand the intrinsic value of the company. “It’s relatively easy to value most REITs, but it might be harder to understand the value of our assets,” Benjamin says. “The onus is on us to explain that and to migrate our assets from the harder-to-value side of our ledger to the easier-to-value side.”
At the same time, Alexander & Baldwin’s Hawaii-centric portfolio is both an asset and a liability. “One of the best ways to get excited about real estate is to see it, but we’re 5,000 miles away from some of the most important investors in the REIT space,” Benjamin says. “That makes it hard to kick the tires, which is why we get on the road to convey what we have to them.”
Looking ahead, Benjamin anticipates growing Alexander & Baldwin’s portfolio through acquisitions in Hawaii, ground-up development on the land it already owns, and redevelopment of some of the older assets in its portfolio. “A big factor in Hawaii is that there is such limited supply and high barriers to entry,” Benjamin says. “It’s a challenging environment for development, so our assets will continue to be highly valued, regardless of what happens with cap rates more broadly.”
Mark Brugger, President & CEO, DiamondRock Hospitality Co. (NYSE: DRH)
“We are currently undertaking our biggest ESG-related project to date—retrofitting our entire portfolio with low-energy LED lighting. This project is estimated to save more than 11 million kilowatt-hours of electricity annually across the portfolio and prevent more than 13 million pounds of carbon dioxide from entering the environment. In addition to the important environmental benefits, LED systems present a very compelling return on investment, reducing lighting electricity consumption up to 79 percent per property.
We have set aggressive environmental targets to do our part in combating climate change. By 2025, we expect to reduce the overall carbon emissions of our existing hotels by 30 percent, energy consumption by 15 percent, and water usage by 18 percent.”
John Kilroy, Chairman, President & CEO, Kilroy Realty Corporation (NYSE: KRC)
“We have been recognized as the North American leader in sustainable commercial offices for four straight years. Achieving this kind of continuous excellence requires that every single member of our team believes deeply in our commitment to sustainability. Company-wide commitment enables us to keep finding energy and water reductions year after year in our stabilized portfolios while also leading the market in other areas like governance, health, biodiversity, green leasing, energy storage, and transparency.
This strong performance also extends to our development portfolio. All of our development projects are built to LEED Platinum or Gold standards, and we have LEED certified every development project since 2010.”
David LaRue, President & CEO, Forest City Realty Trust (NYSE: FCE.A)
“From an environmental perspective, in addition to being named a 2018 ENERGY STAR Partner of the Year, we just announced our biggest accomplishment to date. Forest City is the second U.S. REIT to set greenhouse gas reduction targets approved by the Science Based Targets initiative. Our ESG leadership reflects our strategic alignment with our core markets, who all have similar goals of their own, and our core values, which our associates bring to life every day.
As a focused urban placemaker, Forest City has a well-rounded ESG program that helps us proactively address the issues that matter most to our stakeholders. It starts with good governance—ESG issues have formal oversight from our board and are integrated into our enterprise risk management.”
American Homes 4 Rent (NYSEMKT: AMH) named Christopher Lau, executive vice president– finance, to succeed Diana Laing as CFO. Laing said she would leave the company to pursue other interests.
Broadstone Net Lease, Inc. announced the addition of Greg Lang and Sean Hostert, each as vice president, acquisitions of the company’s commercial division. Lang and Hostert will cultivate new relationships with brokers and prospective sellers, and identify, analyze, and acquire single tenant commercial real estate opportunities.
Condor Hospitality Trust, Inc. (NYSE: CDOR) announced that Jeffrey Dougan, senior vice president and COO, resigned in April and accepted a position as the CEO of a Boston-based hospitality management company.
Digital Realty (NYSE: DLR) said Scott Peterson has stepped down as CIO and will assist with the transition process on a consulting arrangement through February 2019.
Gaming and Leisure Properties, Inc. (NASDAQ: GLPI) said William Clifford, CFO, will retire after 17 years with the company and its predecessor, Penn National Gaming, Inc. Clifford’s retirement will be effective August 31.
InvenTrust Properties Corp. appointed Ivy Greaner to the newly created role of COO. She most recently served as regional vice president of FivePoint, where she oversaw all operational aspects of the company’s Northern California region, including the commercial strategy.
Mack-Cali Realty Corp. (NYSE: CLI) announced that vice chairman and former CEO Mitchell Rudin has left the company to pursue other opportunities.
OUTFRONT Media Inc. (NYSE: OUT) appointed Matthew Siegel as executive vice president and CFO. Siegel most recently served as executive vice president and CFO of CBS Radio Inc. and previously held senior finance positions at Time Warner Cable Inc. and Time Warner Inc. He replaces Donald Shassian, who has retired.
RAMCO (NYSE: RPT) selected Brian Harper as president and CEO. Harper succeeds Dennis Gershenson, who assumes the position of chairman. Harper most recently served as CEO of Rouse Properties. In addition, the company named Michael Fitzmaurice as executive vice president, CFO and secretary. Fitzmaurice was most recently senior vice president of finance with Retail Properties of America.
Retail Properties of America (NYSE: RPAI) appointed Shane Garrison as its president and COO. Garrison previously served as the company’s executive vice president, CIO and COO. Following Garrison’s appointment, Steven Grimes, who served as president and CEO, will continue to serve as CEO.
Effective Oct. 1, 2018, Brian McDade will succeed Andrew Juster, who is retiring, as executive vice president and CFO of Simon Property Group (NYSE: SPG). McDade has been with Simon for more than 14 years and has served as Simon’s senior vice president and treasurer since 2014.
Former Nareit Chair W. Edward Walter has been named the new global CEO of the Urban Land Institute. Walter was most recently the Steers Chair in Real Estate at Georgetown University’s McDonough School of Business. From 2007 through 2016, he served as president and CEO of Host Hotels and Resorts (NYSE: HST).
Lisa Morrison has been promoted to executive vice president, leasing, at Tanger Factory Outlet Centers, Inc. (NYSE: SKT), and CFO James Williams has been promoted to executive vice president.
The QuadGraphics Building (formerly Brown Printing) located at 2300 Brown Ave in Waseca, Minn. has been purchased by a group of Southern Minnesota based developers. Coldwell Banker Commercial Fisher Group (CBCFG) assisted the with the purchase of the building in late June.
CBCFG worked to find investors interested in the expansive warehouse and manufacturing space and is now the listing broker. President and Broker/Owner, David Schooff, is working alongside the new owners to find ideal mix of tenants.
“It’s not your typical warehouse, not only do you have an incredible amount of affordable space, but it has unique features like climate-controlled storage, an automated retrieval system and rail access,” Schooff said. “We knew we’d have to be innovative when finding the right buyer to make sure the building could be utilized to its full potential.”
The new owners hope to attract tenants who are looking for industrial space with a focus on returning full time jobs to the greater Waseca community. Features include: 54,000 square feet of office space, 500 feet of indoor rail and equipment to provide massive production support. The building was on the market for less than six months.
CBCFG is a leader of commercial real estate and business brokerage in Southern Minnesota and the number one Coldwell Banker Commercial office in Minnesota for the past several years.
Capitalizing on intense demand for industrial space, Duke Realty Corp. is on a development roll.
As it stands now, the Indianapolis-based industrial REIT owns and operates about 149 million rentable sq. ft. of industrial properties in 20 major U.S. markets. The portfolio is ballooning quickly, though.
This spring, Duke Realty bumped up its forecast for development starts in 2018 from a range of $500 million to $700 million to a range of $650 million to $850 million. As of early April, $337 million in development projects totaling 4.5 million sq. ft. were already underway.
“As a general rule, we’ve got development going in most all of our markets right now—some more than others,” says Jim Connor, chairman and CEO of Duke Realty.
Connor cites Southern California, South Florida, New Jersey, Atlanta, Chicago and Dallas as some of the top-tier markets where Duke Realty is adding the most space. However, he points out that the REIT has developed more than 2 million sq. ft. of industrial space this year in one second-tier market—Columbus, Ohio.
Across the company’s 20 markets, e-commerce players drive anywhere from 25 percent to 40 percent of development and leasing activity for what Connor likes to call “modern logistics buildings.” Those buildings serve customers such as Amazon, Home Depot, Target, UPS, Walmart and Wayfair.
In a Q&A with NREI, Connor delves into his outlook for the industrial sector, including the role played by e-commerce, and discusses Duke Realty’s development and leasing forecast.
This Q&A has been edited for length, style and clarity.
NREI: How are you feeling about the industrial sector these days?
Jim Connor: I’m feeling pretty good. Business is really, really good. Some of my peers jinx us when they say, “It’s as good as it gets” or “It’s never been better” or anything like that.
NREI: What underlies that “pretty good” feeling?
Jim Connor: You’ve got 4.5 percent vacancy nationwide. It’s the lowest it’s been as long as anybody can remember, and they’ve been keeping records 25-plus years. We keep predicting every year that supply is finally going to catch up with demand, and it still hasn’t happened yet. Based on activity, I don’t see that trend changing. When you’ve got that low of a vacancy rate, it allows us to keep the occupancy rate in our portfolios ridiculously high. Our in-service portfolio is 97.5 percent leased [as of the first quarter of 2018], and with that you get great, strong rent growth numbers.
The challenge for us—and there’s always a downside with the upside—is we’re really in favor right now, so there’s a ton of capital chasing industrial. Even though interest rates have gone up 50 to 60 basis points in the last eight or nine months, we’ve seen cap rates on industrial compress 25 basis points, and maybe more in some cases. So, there’s a lot of competition out there.
NREI: The industrial sector has been really hot lately. How long is that streak going to last?
Jim Connor: Absent some global event that obviously nobody anticipates, I would tell you the market dynamics we’re seeing look really good for the next 18 to 24 months. That’s with the supply-and-demand equation staying in balance; even if we reach equilibrium with supply and demand, equilibrium is not a bad place, particularly when you reach equilibrium with 4.5 percent vacancy. That’s still a landlord’s market.
Nobody’s slowing down at all. E-commerce continues to be a big, big driver in our business. Those guys are not slowing down. Our traditional customers—retail and consumer products companies—are investing in their supply chains to get products to their customers more quickly and more efficiently. You’re seeing a tremendous amount of investment and modernization in that sector to help them compete with the e-commerce business.
NREI: How much more industrial activity can be supported by e-commerce?
Jim Connor: I believe, as do most of the industry experts, that e-commerce is in the very, very early innings—arguably the second or third inning. E-commerce today represents about 9.0 or 9.5 percent of total bricks-and-mortar retail sales. Most experts will tell you that’s heading to 20 percent.
So, if it heads to 20 percent, that would tell you there’s a lot of runway for industrial. It doesn’t mean that all of the e-commerce deals that we’ve done in the last 10 years, we’re going to double that square footage. But it means there’s a lot more demand for e-commerce facilities, whether it’s for pure e-commerce companies like Amazon or Wayfair, or whether it’s this new generation of e-commerce food companies like Blue Apron, or whether it’s existing retailers and consumer products companies that are investing in the supply chain to better support their e-commerce efforts. The logistics sector looks very, very bright for the next several years.
NREI: In light of the demand you’re foreseeing, are you leaning more toward development or acquisitions? How does that play out in terms of adding supply to meet demand?
Jim Connor: We’re kind of blessed. We can do either/or, or in some years we do both. The vast majority of our capital and our time and energy today is going toward new development, both build-to-suits and speculative, because it’s much more lucrative for us. We’re developing projects that are probably 200 to 250 basis points higher in sustained yields than on the acquisition front. We’re very, very focused on the development side.
NREI: What are you projecting for leasing?
Jim Connor: In 2017, we did about 23.7 million sq. ft. of leasing, which was a phenomenal year for us, one of our best ever. In the first quarter of 2018, we did just under 7 million sq. ft. Ours is not a perfectly linear business, but based on first-quarter activity, our expectation is to meet or exceed last year’s leasing volume, which would put us in the mid-20 million-sq.-ft. range and would be another phenomenal year. With occupancies so high across all of the markets, until you create some softening in some of the markets—either a pretty dramatic fall-off in demand or a bunch of oversupply—I think you’re going to continue to see very, very strong numbers in terms of leasing and rent growth that industrial owners are going to put up.
I am a huge fan of science fiction. Books, comics, movies, you name it. As a kid growing up in upstate New York, it didn’t get any better than a big bowl of Jiffy Pop and the old black-and-white Sylvania tuned to a classic space epic on the WPIX Saturday Afternoon Movie.
What always drew me to science fiction, and still does, is the notion that anything is possible in the future. Flying cars? No problem. Evil robots trying to enslave mankind? Seems likely. Signing a lease at the new AvalonMoon, shopping at Simon’s Mall of Mars, or spending the night at Park Hotels’ Hilton Venus? Let’s not get carried away.
While I won’t sign any of Nareit’s members up for intergalactic expansion just yet (what would those cross-border tax rules look like?), the concept of people living among the stars may not be as far away as we think—according to at least one futurist.
In this issue’s “4 Quick Questions,” James Canton, author, futurist, and head of the Institute for Global Futures, discusses what REITs and real estate companies should be doing right now to be “future smart.” He describes being future smart as understanding today’s disruptive technologies and adapting in order to best position a company for the future.
Most of the disruptive technologies he discusses have to do with smart buildings, climate change, artificial intelligence, and the evolution of the “internet of things”— developments most REIT executives are already dealing with or planning for.
In fact, each issue of REIT magazine this year includes an “On the Horizon” feature focused on how REITs in specific sectors are adapting to the fundamental changes in the way we utilize real estate now and into the future. This issue looks at the industrial sector and the game-changing impact e-commerce and rapid delivery have had on the sector.
At the end of the interview with Canton, we asked his thoughts on where the future might take REITs. His answer has REITs boldly going where no REIT has gone before.
Could we really see REITs among those companies pioneering new civilizations in outer space? While even my inner sci-fi fan finds that hard to believe, Canton says he believes we will see it in his lifetime.
Whether his prediction turns out to be the final frontier or just a futuristic fantasy, it sure sounds like the plot for a great Saturday Afternoon Movie.
Editor in Chief
During her 13 years with RLJ Lodging Trust (NYSE: RLJ), and its predecessor, Leslie Hale has had a front row seat at every turn of the company’s strategic evolution, including an initial public offering in 2011 and an approximately $3 billion merger in 2017.
Since joining RLJ as director of real estate and finance, Hale has served as CFO, executive vice president of real estate and finance, and, most recently, as COO since 2016. In August, she will take over as president and CEO.
“I’ve really had a great career by all standards,” Hale says, which in addition to RLJ includes a variety of positions at Goldman Sachs and GE.
Hale spoke to REIT magazine in May about her new role as CEO, RLJ’s priorities, the state of the lodging sector, diversity in the C-suite, and lessons learned along the way.
Do you anticipate any strategic changes once you take over as CEO?
We remain focused on executing our current strategy and at this time, there are no changes contemplated strategically. We believe that RLJ is on very solid ground. Our strategy and business model are supported by a high-quality and geographically-diverse portfolio. Our balance sheet is strong and is well-positioned to continue to support our long-term growth. We’re also executing well on our post-merger initiatives.
Besides strategy, what else is important to you in this new role?
Many people think of a CEO in terms of having to create or set the vision and strategy for a company, but we also have the responsibility to build a strong team and a collegial environment where we can recognize and reward our team. That’s something that’s really important to me as I take over this new role.
I think we have the right team and I feel a deep sense of responsibility to ensure that they are positioned for success.
What initially attracted you to real estate finance?
I fell in love with finance back in college, when I took my first finance class. The concept of being able to take a dollar and turn it into two was amazing. I was a skinny kid from South Central Los Angeles who went to public school, so being able to take one dollar and turn it into two was fascinating to me.
What career path did you take to get to RLJ?
I grew up in the financial management program at General Electric, which is renowned for its training program. My first permanent assignment at GE was in real estate and I loved the fact that it was so tangible. We’ve all stayed in a hotel, we’ve shopped in a mall, we’ve worked in offices. It’s an asset class that you can touch, feel, and understand—I love that.
After I finished my first assignment at GE, I then went on to do international real estate for GE in Paris and Madrid. It was also a great experience to see that real estate, whether it is in the United States or abroad, still had the same characteristics. The ability to combine both real estate and finance was the best of both worlds for me, which I was able to leverage at RLJ.
What’s the best advice you’ve received in your career?
As a young professional, my mentor told me that I needed to earn my seat at the table every day, which really instilled in me an incredible sense of not being complacent. I developed a tremendous work ethic as a result.
As a woman, the most important piece of advice that I got was to stay on the revenue-generating side of the business. Sometimes, women are encouraged to take leadership roles, but leadership roles that are more often on the support side of the business. Those roles are important, and can create value inside an organization, but they’re not necessarily the ones that will lead you to being able to influence the strategic direction of a company.
One piece of advice that I believe changed my life, literally, came from Alan Braxton, a mentor of mine. He asked me a simple question, “What are your peers doing?” That one conversation changed not only the way that I view the world, but the way that I view myself in the world.
I answered his question by saying, “Well, I’ve got peers from undergrad who are doing this, and peers from business school who are doing that, and people who worked at GE who are doing this.” Alan stopped me and said, “Your peers are not the individuals who come from the same background as you, or who have the same job as you. Your peers are the individuals who are doing what you want to do.” What he was trying to get me to do was to not look left and right, but to look forward and to strive higher, and really have strong aspirations. That was a pivotal conversation in my career.
Can you talk about the progress RLJ has made on integrating FelCor Lodging Trust?
When we closed on the merger, we laid out a very clear plan and we are executing very effectively on that plan. The overall integration has gone very well. I’m excited by the progress we have made on our key initiatives that will unlock long-term value for our shareholders.
We are continuing to optimize our portfolio through the disposition of non-core assets as demonstrated by the three assets we’ve sold since the merger for $300 million, and we remain on solid footing to execute an additional $200 million to $400 million in asset sales this year. We’ve also paid down $300 million of our $500 million debt reduction goal and brought our leverage in line with our overall target. Given our disposition pipeline, we’re on track to achieve our debt reduction and leverage goals.
Furthermore, we have already realized a significant portion of the $22 million in merger synergies related to annual general and administrative expenses and have identified some incremental operational synergies that we expect to offset 25 to 50 basis points of margin pressure by the end of next year.
How would you characterize lodging industry fundamentals today?
We see some green shoots but there are also some lingering headwinds. In terms of green shoots: One, industry demand growth accelerated during the first quarter. Two, industry occupancy continues to hit new highs and is helping to absorb new supply. And finally, there have been signs recently that corporate travel may be strengthening, given the improving economic backdrop.
The headwinds are really associated with new supply growth, especially in urban markets, which is constraining rate growth and placing pressure on wages as more hotels are looking for talent. But, we are encouraged. We’re cautiously optimistic that trends in the industry are improving and we’re hopeful that the recent strength will hold.
What about the leisure travel segment? Is that an area where you want RLJ to be more involved?
Leisure has really been a strong component of lodging demand over the past couple of years and provided support at a time when corporate demand had softened. While we have a healthy leisure component in our portfolio, which helps us on shoulder days, we operate a predominantly business transient hotel portfolio which sees strong revenues during weekdays.
Having said that, with the FelCor merger we did increase our leisure exposure slightly with the addition of several Embassy Suites assets that have a healthy balance between leisure and corporate segments. So, with that addition we feel very good about the overall balance between our leisure and corporate exposure.
Do you see potential from portfolio renovations and conversions?
This year we are strategically investing in markets that are on a path to recovery. For example, approximately a quarter of our 2018 renovations are in our largest market of Northern California, which we expect to benefit from blockbuster city-wide demand next year. We try to be very thoughtful about how we allocate capital toward renovations and think it’s important to continuously invest in our assets.
When it comes to conversions, on an opportunistic basis we look for ways to potentially realize additional value by up-branding a hotel or converting to a new flag in order to capitalize on a market dynamic or location of a particular asset. This is something that is a core area of expertise for us, as we’ve executed several successful conversions in recent years.
With the FelCor transaction, we’ve identified the Mandalay Beach Resort in Oxnard, California as a potential conversion to a lifestyle brand, and we look forward to being able to execute on that conversion.
When it comes to renovations, is there a particular area within the hotel that you’re focusing on?
The most important thing that we’re doing right now is re-conceptualizing the lobby area for the Embassy Suites branded hotels. Really recapturing that space and converting it into an area that we can make very inviting to our customers, while also creating revenue-generating concepts for ourselves.
How optimistic are you about the future of diversity in the C-suite?
I definitely believe there needs to be more diversity, but when I look at lodging, I’m encouraged. I look across our space and see that, for example, there are three African-American CFOs. I will be the second African-American CEO in the lodging space and the first woman, which is significant, obviously. When I think about our other partners, whether it’s a management company or a brand, there are a number of women in CFO or COO positions.
I believe the lodging industry has many talented high-potential women and minorities who, given the opportunity, could ascend. While lodging could always have more diversity, I do think that other sectors could learn from us. I’m very proud that RLJ is a diverse company with minority representation throughout the organization, but particularly at the management and board level.
Nearly one year after Amazon’s acquisition of organic grocer Whole Foods, the grocery-anchored shopping center sector, typically viewed as more “Internet-proof” than other segments of retail, has taken greater strides to boost its omni-channel offerings.
So far, the acquisition has not been overtly disruptive to the grocery industry, experts say. However, some grocers are still working to hedge any long-term effects of the deal, particularly as smaller chains struggle to keep up with technological pressures and price competition intensifies. These factors could lead to continued consolidation of smaller grocers and increased investor scrutiny of grocer tenants, according to those in the industry.
“There’s been a limited short-term impact on existing brick-and-mortar grocers,” says Joseph McKeska, president and co-founder of Elkhorn Real Estate Partners, which provides advisory and investment services for those in the retail real estate sector.
There still could be a greater impact should Amazon look to expand its brick-and-mortar food footprint, McKeska says. That’s what’s triggered some grocers to improve now, even if it hurts their bottom lines in the near future, “in anticipation that Amazon is going to become more aggressive over time,” he says.
But to start, it appears the union of the online retail giant and Whole Foods, which has some 480 stores in North America and the U.K. and is known for its focus on organic fare and higher-than-average prices, was to improve Amazon as a retailer by giving it more of a physical foothold, says Theresa Johnson, senior vice president of retail investment sales at Avison Young, a real estate services firm. The move comes as there has been increasing competition between Amazon and Walmart. Walmart operates more than 4,100 stores in the U.S. and acquired e-retailer Jet.com in 2016 for $3.3 billion.
The acquisition of Whole Foods also allowed Amazon to tie discounts related to its Prime customer loyalty program to the grocer. “The Amazon acquisition was more of a play to get people more embedded into the Amazon model,” Johnson says.
Other grocers have taken notice. Prior to the transaction, many brick-and-mortar chains were already working on improving their omni-channel services. But the partnerships and services offered only seemed to escalate in the months since the deal’s announcement.
Kroger, for example, which operates some 2,400 stores across the U.S., introduced a partnership with online grocery service Ocado and expanded its partnership with Instacart, a customer delivery service. In its first quarter earnings release, Kroger reported it grew its digital sales by 66 percent during the quarter. Meanwhile, Walmart, which has announced partnerships with delivery companies Postmates and DoorDash, reported that its e-commerce sales grew by 33 percent in the first quarter of 2018.
Indeed, it appears there is growing consumer demand for these types of services. A report from analytics firm Nielsen found that 23 percent of shoppers in the U.S. purchased groceries online in 2016, which is 20 percent more than two years prior. The firm estimates that between 2021 and 2023 total online grocery spending in the U.S. will hit $100 billion. And according to a survey Nielsen conducted, 69 percent of households said home delivery models appeal to them.
Grocers have also started to reinvest more into their physical stores and some have pulled back on expansions. A report from real estate research firm JLL found that grocery store openings were down 28.8 percent from 2016. Investment sales in the grocery-anchored shopping sector remains strong, however, as in 2017 the sector saw sales growth of 5.3 percent, the report stated. That may be because property fundamentals are still strong. While the retail sector overall has struggled, the occupancy rate for neighborhood centers was close to 93 percent in the second quarter, up from 92.4 percent year-over-year, according to research firm CoStar. Rents for the sector grew by 1.9 percent year-over-year.
Nevertheless, the grocery market is oversaturated with stores—whether its non-traditional grocers like Walmart expanding or traditional players overtaking existing chains—and that could trigger more chains to concede market share, wrote Suzanne Mulvee, director of research at CoStar, in an email. “There is not enough room for all of these players to succeed, and chains will continue to be displaced by those with a better business model. A bigger shift to e-commerce in this sector will lead to even more consolidation,” she wrote. Most at risk from these pressures are middle-market grocers, or those that favor trade areas with $50,000 to $70,000 in median household income (think Aldi and Kroger).
“It was a warning shot across the bow, as they say, and each of the stores has reacted in their own ways,” says Joel Murphy, CEO of New Market Properties LLC, of the Amazon deal. New Market, an Atlanta-based owner and operator of 41 grocery-anchored shopping centers in seven Sun Belt states, has been working with its grocers to modify its centers’ common areas if needed to help grocers facilitate these offerings, for example with expanded refrigerated sections, Murphy says.
Meanwhile, some of the smaller grocers who may have already been struggling may not have the capital resources to implement the costly infrastructure needed to be competitive in the online world, Murphy says.
And pressures within the sector are already being felt. The Fresh Market Inc., a grocery chain based in North Carolina that was acquired by private equity firm Apollo Global Management for about $1.36 billion, announced recently that it is closing 15 underperforming stores across the country. Southeastern Grocers, the parent of Winn-Dixie, announced in March that it was closing 94 stores in the U.S. and filing for bankruptcy. And Tops Markets LLC, a regional player, said it to was filing for bankruptcy amid increasing price pressures from Amazon and debt, Reuters reported.
With Amazon now playing in the grocery sector, consolidation in the space, particularly as smaller, regional grocers are pushed out of some markets, may only continue. The deal not only intensified a price war that had been long felt throughout the industry, but also introduced a technology war, says Jeffrey Edison, CEO of Phillips Edison & Company, which operates hundreds of shopping centers across the country. Now investors will have to be more selective about the grocers they have in their tenant mix; the grocers who are not investing in technology will have a good chance of being left behind, Edison says. “It’s going to make it increasingly important on who you bet on for your anchors,” he notes.
Aside from watching grocers adapt to these new pressures, Edison says his firm is also avoiding tenants that are backed by private equity firms. News has abounded in recent years of retailers in other sectors that have been acquired by private equity, taken on a lot of debt and subsequently closed many stores or filed for bankruptcy—Toys ‘R’ Us being a prime example. “We don’t believe leverage in the retail business works over a long period of time,” Edison says, as it deprives retailers of the ability to reinvest in their stores. “It’s very destructive,” he adds.
Glenn Rufrano, CEO of VEREIT, Inc. (NYSE: VER), participated in a video interview at Nareit’s REITweek: 2018 Investor Conference in New York.
Rufrano said VEREIT’s portfolio diversification is moving in a positive direction after standards were set for it more than two years ago. While there is still work to do, he said, protecting the downside of the company is key.
“The cash flow is stable, the growth is stable, [and] we don’t want anything to disrupt that,” Rufrano said. In order for VEREIT to remain diversified, he said the company has two criteria it adheres to: keeping tenants at no more than five percent and office properties within 15 to 20 percent.
Rufrano agreed that a simple, straightforward approach to retail is the best method. It’s a philosophy he’s adopted over his career, beginning with his roots in the mall business in the 1980s, and then when he worked for a shopping center company in the 2000s.
“Today we’ve got simple boxes on corners. Retail has changed,” he said, noting that forms of distribution and credit profiles in particular have evolved.
Rufrano said it’s a very binary decision when VEREIT looks at buying a tenant or not. “We don’t buy a shopping center where there are 20 tenants where we’ve got to worry about credit,” he said. “Simple is better; less capital is better.”
Meanwhile, VEREIT isn’t concerned about overbuilding or supply outstripping demand in its markets. “We don’t see it yet, but could it happen—yes,” Rufrano said.
Phillips Edison & Company, Inc. (PECO), a public non-listed REIT (PNLR), said July 18 that it has agreed to merge with Phillips Edison Grocery Center REIT II, Inc., a PNLR it currently sponsors and manages, creating a $6.3 billion REIT focused exclusively on grocery-anchored shopping centers.
The stock-for-stock merger will create a national portfolio of 323 grocery-anchored shopping centers encompassing approximately 36.7 million square feet, located across 33 states.
Jeff Edison, chairman, CEO, and co-founder of PECO, said the merger is the next step on the path to liquidity for both sets of shareholders.
“The enhanced size, scale, and prominence of the combined portfolio will greatly improve our access to the capital markets, which can be used to support ongoing strategic investments, as well as to drive future growth opportunities,” Edison said.
Edison said the current operating environment and long-term fundamentals support the sector: “This merger demonstrates our unwavering confidence in the asset class.”
As a combined entity, occupancy is expected to increase 43 basis points to 94 percent. The merger will also boost the percentage of earnings from real estate from 92 percent to approximately 97 percent.
The transaction is expected to close in the fourth quarter of 2018. In exchange for each share of REIT II common stock, REIT II shareholders will receive 2.04 shares of PECO common stock, which is equivalent to $22.54 per share based on PECO’s most recent estimated net asset value per share (EVPS) of $11.05. With the merger, the advisory agreement between REIT II and PECO will be terminated, effectively eliminating $14 million in annual expenses for REIT II.
PECO moved to an internal management structure at the end of 2017 upon the acquisition of its former sponsor. At the same time, the company also discarded its former name, Phillips Edison Grocery Center REIT I, Inc.