Inland Sees Mervyns Upside

Michelle Napoli is the editor of Net Lease forum. It’s new issue comes out tomorrow.

OAK BROOK, IL—A portfolio of 25 operating Mervyns department stores was purchased by Oak Brook, IL-based Inland Western Retail Real Estate Trust Inc. for $221.8 million. Similar to another Mervyns portfolio deal closed in September by Developers Diversified Realty Corp. and Macquarie DDR Trust, the Inland acquisition functions somewhat like a sale-leaseback though technically is not, since the Mervyns real estate and operating companies are separate entities.

Properties being purchased by Inland Western total almost 1.8 million sf; 23 are in California and two are in Texas, and the purchase price represents a 7.72% cap rate. The properties are now subject to bond type triple-net leases and the average annual rent is $9.03 a sf, with 1.2% annual rent increases over their 20-year terms; the leases are cross-defaulted and backed by security deposits totaling $50 million. The agreement between buyer and seller also “allows for the sale and development of certain outlots on these 25 properties,” according to an Inland announcement. “Inland Western would share in the profits from those outlot deals.”

Joe Cosenza, chairman of Inland Real Estate Acquisitions Inc., negotiated the deal on behalf of Inland Western and tells NET LEASE forum he’s been working on it since shortly after the September 2004 sale of the Mervyns chain. “I had the opportunity to do the entire transaction, which would have been about $700 million or $800 million, but I didn’t feel comfortable with that—too much money with Mervyns,” he says. From there he says viewed all the properties before narrowing his selections, particularly honing in on California properties and the ones with the highest sales. “I got the chunk I wanted, and I feel good about it.”

“My prices are $116 to $117 per sf,” notes Consenza. “For California—-and 23 of the 25 are in California—-you just can not find bricks and mortar for $116 a foot.” Also appealing is potential upside, he says: Should a store close and the space be re-let, rents would likely be significantly higher than what Mervyns is paying. And last but not least, “Mervyns is doing better now than it was a year and a half ago, and they were doing okay then,” Cosenza adds.

With the closing of the Mervyn’s acquisition, the slightly less than 2-year-old Inland Western has $6.5 billion of assets, and Cosenza says the portfolio could grow to $8 billion by the end of the year. While the vast majority of the non-listed REIT’s initial capital raise has been invested, it continues to bring in millions a month through its dividend reinvestment program, he adds.

Mervyns was sold by Target Corp. to a consortium of investors encompassing New York City-headquartered Cerberus Capital Management LP; Chicago-based Klaff Realty LP; Philadelphia-based Lubert-Adler Partners LP and Sun Capital Partners Inc. of Boca Raton, FL.

In the September deal, a joint venture between US REIT Developers Diversified and Australia Stock Exchange-listed Macquarie DDR Trust bought a 2.74 million-sf portfolio of Mervyns stores. They paid $396.2 million for 36 assets at an initial cap rate of 7.7%. The properties are occupied under individual 15-year triple-net leases with a weighted average annual rent beginning at $11.12 per sf and increasing 2% a year; they generally include four five-year renewal options as well. Those leases are cross-defaulted and the purchase agreement included a contingent purchase price adjustment secured by a $25-million letter of credit that is payable by the seller in certain circumstances, including a termination of the Mervyns leases.

In other news, Developers Diversified announced it is part of a consortium interested in buying ShopKo Stores Inc. for $26.50 a share, an attempt to outdo another buyer that has agreed to pay $25.50 a share for the retailer. The other members of the consortium are Elliott Management Corp. of New York City, Lubert-Adler and Sun Capital. DDR said in an announcement that its involvement “would be limited to either the direct or joint venture ownership of ShopKo’s real estate assets,” which it estimates being worth $700 million to $900 million.