Feature Article, December 2004

Pushing Potential
Coventry and Developers Diversified Realty have formed a partnership to invest more than $1 billion in value-added retail properties.
Jaime Lackey

Scott Wolstein, CEO and chairman of the board, Developers Diversified Realty.

Coventry recently established the Coventry Real Estate Fund II, which has a 2-year investment period. Surpassing its original target of $250 million, the company raised $330 million of equity capital commitments from 12 institutional investors. DDR has committed to a 20 percent equity co-investment in each fund transaction. “Including DDR’s co-investment, we have roughly $400 million of equity capital to invest, which will allow us to buy more than $1 billion in assets,” according to Peter Henkel, president and CEO of Coventry.

The fund targets value-added retail opportunities — buying properties that aren’t operating at their full potential, repositioning or redeveloping them, and selling them in 3 to 5 years.

Dan Hurwitz, executive vice president of Developers Diversified Realty.

The Coventry entity is owned by its principals and is independent of DDR, but the partnership is structured in such a way that DDR will serve as an operating partner and as a co-investor for all of the fund’s deals. The partnership allows Coventry’s investors access to value-added retail deal flow and enables DDR to diversify its access to capital.

Peter Henkel, president and CEO of Coventry Real Estate Advisors.

According to Scott Wolstein, DDR’s CEO and chairman of the board, participating in the fund with Coventry “is a means of isolating one aspect of our investment strategy that we can execute with private capital as a primary source.”

Maintaining diverse investment vehicles is important to DDR’s growth strategy. “In order to be effective in all types of investment environments,” Wolstein says, “we need to have a variety of capital sources to execute our strategy. Today, we have very good access to public capital, both on the debt and equity sides; we could probably execute all of our investment strategies that way if we chose to, but markets change very rapidly. From 1998 to 2002 we didn’t have that opportunity. REITs couldn’t access equity capital in the public markets. While many of our peers hunkered down and waited out the storm, we continued to execute our investment strategy through the Coventry fund. We were able to execute about $800 million of investments.”

DDR also develops its own centers with its own capital and invests in core acquisitions primarily through its Macquarie DDR Trust (MDT), which was established last year and is listed on the Australian Stock Exchange. Wolstein emphasizes that MDT and the Coventry II Fund do not compete. He says, “We do the [MDT] core acquisitions with a different type of capital, which is looking for secure returns rather than high yield. MDT is exclusively to fund core acquisitions so that fund does not compete with Coventry because it does not look at any value-added opportunities.”

Complementing Strengths

DDR and Coventry have created a program that builds on each company’s strengths. Coventry possesses expertise in the real estate investment sector and also in investor relations. DDR brings its management, leasing and development experience to the partnership as well as its connections. “We bring deep-seated tenant relationships to the table,” says Wolstein.

He explains, “DDR is the largest landlord for virtually every major tenant that we deal with. We meet with these people several times a year and review every opportunity within our portfolio, within the Coventry portfolio and new development opportunities. In order to effectively execute a value-added strategy, you really have to know in advance where the tenants want to be. You need to be able to get into the minds of the tenants and be able to communicate with them in real time — often in advance of making an investment to know that the properties you’re looking at are going to be acceptable to them.”

Dan Hurwitz, executive vice president of DDR, adds that tenant relationships also generate leads on potential acquisitions. He explains, “Very often we’ll have tenants express interest in a particular piece of real estate but not under its current structure or format. We then inquire about acquiring that property, change the format into something more acceptable to the tenant and we know in advance of the acquisition that there is tenant interest.”

“We get an awful lot of deal flow through DDR’s tenant relationships,” Henkel says. On the other hand, Coventry has a number of people who look for deals through what Henkel calls “rather traditional means.” The company establishes relationships with owners, capital sources like banks and brokers across the country.

When it comes to the fund’s properties, Coventry tends to handle due diligence and underwriting for the acquisitions of the fund and also leads the disposition process. DDR handles leasing, day-to-day operations and repositioning for the centers acquired by the fund.

Every acquisition, redevelopment and disposition is subject to approval from an investment committee consisting of three DDR members and three Coventry members.

The First Investments

Coventry Real Estate Fund II has invested in four properties since closing on the fund’s capital raising. In Kansas City, Missouri, the fund has purchased Ward Parkway Center, an 811,343-square-foot power and lifestyle center. The center is currently anchored by Dillard’s, Target, AMC Theatres, 24 Hour Fitness, Dick’s Sporting Goods and TJ Maxx. The companies plan to redevelop and re-tenant the former enclosed mall.

The Coventry Fund has purchased Phoenix Spectrum Mall, a 1.1 million-square-foot enclosed mall in Phoenix. The center is currently anchored by Wal-Mart Supercenter, Costco, Dillard's Discount Store, Ross Dress For Less, PetsMart, Walgreens and Harkin Theaters.

In Phoenix, the fund has purchased Phoenix Spectrum Mall, a 1.1 million-square-foot enclosed mall. The site is 1 mile east of Interstate 17 and 3 miles west of Highway 51 and will be served by a planned light rail expansion that will be built in front of the shopping center. Phoenix Spectrum Mall was originally developed in the early 1960s and featured several traditional department stores. The center is currently anchored by Wal-Mart Supercenter, Costco, Dillard’s Discount Store, Ross Dress For Less, PetsMart, Walgreens, Harkin Theaters and a mix of specialty retailers, service providers and restaurants. Within the next several months, Dillard’s will be replaced with a yet-to-be-announced anchor tenant and portions of the shopping center will be renovated and re-tenanted.

In Kirkland, Washington, the Coventry Fund has purchased Totem Lake Malls, a 290,308-square-foot mall directly adjacent to Interstate 405. Currently, the shopping center tenant mix includes Trader Joe's, Guitar Center, Hallmark, Big 5 Sporting Goods, Famous Footwear and Ross Dress For Less.

The fund has also purchased Westover Marketplace, a new shopping center development, which will begin construction this fall. The site features approximately 63 acres at the intersection of Loop 410 and Highway 151, 10 miles northwest of San Antonio, Texas. DDR, Coventry, and local partner David Berndt Interests will build approximately 425,000 square feet of retail space anchored by Target and several mid-sized anchor tenants. Westover Marketplace is expected to open in 2005. The site is adjacent to a Lowe’s Home Improvement Warehouse.

The Value-Added Focus

Retail properties offer a lot of room for improvements, according to Henkel. He says, “Retail properties are not built vertically in a static format like a multi-story office building. Typically the assets we’re working with are built in a horizontal format on a site plan that offers opportunity to change the physical structure of the real estate. Moving buildings from point A to point B on the site, creating different access points to the site, buying adjacent land and expanding the site to meet tenant demand — there’s a lot that can be done with retail real estate in terms of creating value from a redevelopment perspective.”

Two characteristics in particular spell opportunity to the Coventry Fund II: vacancy rates and dissatisfaction with center formats. The fund looks at well located centers with significant vacancy because of bankruptcies or anchor closings. It also seeks centers in need of format changes. “We often look at de-malling a property and redeveloping it in a more modern format that is going to be successful in that marketplace,” Wolstein says. “The new wave of retailers doesn’t want to operate in the mall format.”

DDR’s connections also benefit the partnership when it comes to redeveloping centers. According to Wolstein, “Many redevelopment opportunities have existing anchor tenants in place that control any changes to the site plan. Sometimes where an opportunity might be obvious to the whole community, it may not be available to the whole community because the retailers are very particular as to whom they are going to work with to redevelop a location in which they are already operating. They want to make sure it is a company with which they have a relationship and that has the track record and the capital to execute the plan successfully. Often, we don’t have a lot of competition because companies don’t have the requisite experience to make the tenants feel comfortable.”