In the fourth quarter of 2021, strip mall landlord Brixmor (BRX 0.75%) bought four new shopping centers. Subsequent to the quarter ending, it bought again. And it's doing this despite the fact that management believes prices are on the expensive side. What's important here is that management has long-term plans that play into one of the company's core competencies. Here's what you need to know.
Paying up
During Brixmor's third-quarter 2021 earnings conference call, CEO James Taylor pointed out that, "...what's striking is the cap rate environment has compressed pretty dramatically." In plain English, that means prices for acquisitions have gone up, strikingly. That's not a good sign for shopping center real estate investment trusts (REITs) in the market to buy new assets. And yet, Brixmor hasn't shied away from acquisitions. It inked four deals in the third quarter and another one in early 2022. Based on management's own view of the market as expensive, it likely paid dear prices for these assets.
Image source: Getty Images.
The reason for the continued investment boils down to another quote from the call, when Taylor noted, "...all cap rates aren't created equal. We focus so much on that cap rate, but the real question to ask as an investor is, where is that low- to mid-5 going over time." Again, to translate that into layman's terms, Brixmor believes that it can buy strip malls at current prices, which it sees as being on the expensive side, but add value over time and improve the returns it expects to achieve from the property investment. Looking at the purchase price alone doesn't provide enough information. Notably, the REIT has been spending a great deal of time and money over the past few years redeveloping assets within its portfolio.
The results speak for themselves. Between 2016 and 2020, Brixmor invested $524 million in redevelopment projects at 166 properties. The spending went toward things like updating space for new tenants, modernizing strip malls, and adding new buildings, among other things. Management estimates that it was able to achieve an incremental net operating income yield of 11% across all of these projects, which is materially more than it could make from building new centers from the ground up. And it has another billion dollars of projects on the drawing board for the future, with a run rate of around $200 million or so a year
What can we do with it?
Thus, the question isn't what cash flows is Brixmor expecting to generate from an acquisition in year one. The question is, what cash flows does it expect to produce in the future?
Brixmor notes that the properties it is looking to add are similar in nature to what it already owns. So it isn't going outside of its comfort zone. Meanwhile, it is specifically trying to find properties that have below-market rents that can be jacked up when leases expire. Or locations where there are open stores that can be leased. Perhaps a property needs to be spruced up, which will also allow for higher rents and increased occupancy. Management could also easily get excited by a property where new space could be added, allowing the property to produce more cash flow. These are the tools that management has reliably used to take a low cap rate and turn it into a higher one over time.
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Redevelopment Case Study: Western Hills Plaza in Cincinnati, Ohio |
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Old building: 118,000-square-foot (SF) three-story Sears store |
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New building: 15,000 SF Old Navy, 11,000 SF Ulta, 4,000 SF Spectrum, and a 2,000 SF Tropical Smoothie. Additional construction: Multi-tenant outparcel building for a 3,000 SF Buff City Soap, 3,000 SF Chicken Salad Chick, and a 3,000 SF Sleep Outfitters. General upgrades: Facade renovations, new pylon signage, landscaping, and parking enhancements. |
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Total Redevelopment Cost: $13 million Increase in average rent: 20% Increase in leased square feet: 35.7 percentage points, improving occupancy to 98.3% |
Information: Brixmor
The problem is that these types of investments don't happen overnight. However, as Brixmor works through its backlog of projects, its future internal investment opportunities decline. Unless the REIT buys new assets to refill that backlog, its long-term growth prospects will diminish. That's partly what's going on with the acquisitions as Brixmor is essentially preparing for the future.
Juxtaposed against all of this, meanwhile, is the fact that Brixmor is also selling properties. In the fourth quarter, it sold eight shopping centers. Although the news release didn't specify the prices it achieved on the sales, it's fair to assume they were just as high as the properties Brixmor was buying. Basically, management is recycling capital so it can keep its growth outlook strong.
Looking past the headlines
Brixmor's history is a little complicated. It came public in 2013 with a portfolio of 522 properties, many of which were in need of updating. There was a scandal in 2016 that resulted in a leadership overhaul. Since 2016 the company has trimmed its portfolio from 518 centers to 386 at the end of the third quarter. Despite reducing the size of its portfolio by a huge 25%, the REIT posted adjusted funds from operations (FFO) of $0.48 per share in the third quarter of 2021, just slightly below the $0.52 per share it posted in the third quarter of 2016 when the portfolio was much larger. And, in between, there was the impact of the pandemic to contend with, which depressed rents.
With the pandemic becoming more normalized, and rent collection rates solidifying, Brixmor is in a position to start growing. For example, it has been able to raise rates at a faster clip than its peers, with a great deal of the rental rate improvement related to its redevelopment efforts. Now that the portfolio is down to a more manageable size, Brixmor's financial results should start to provide increasing evidence of its proven ability to add value to its properties over time. And that spells an opportunity for long-term growth, with new acquisitions keeping the pipeline filled with high-return redevelopment investments.
