Retail REITs (real estate investment trusts) Kite Realty Group Trust (NYSE: KRG) and Retail Properties of America (NYSE: RPAI) have agreed to join forces in an all-stock deal valuing the combined entity at $7.5 billion. The merger will create the fifth-largest shopping center REIT with 185 open-air shopping centers primarily in warmer and cheaper metro areas in the Sun Belt region and West Coast. That larger scale will enable the combined entity to reduce costs, strengthen its balance sheet, and capture future growth opportunities.
The deal marks the third sizable merger among retail REITs this year. It could spur additional consolidation in the sector to help REITs combat the continued headwinds from the accelerating adoption of e-commerce.
A closer look at the deal
Kite Realty has agreed to exchange 0.623 of its shares for each share of Retail Properties of America. That ratio values Retail Properties at a 13% premium to its closing price on the last day of trading before the announcement. Despite that premium, Kite expects the deal will be accretive to shareholders as it captures an expected $27 million to $29 million of expense savings by combining the two companies.
The deal does several things for Kite. Notably, it significantly expands its portfolio to 185 open-air shopping centers with 32 million square feet of leasable space. That's up from its current portfolio of 83 properties with 12 million square feet of leasable space. The combination also increases its presence in strategic markets by bolstering its market share in the fast-growing Sun Belt cities of Dallas, Atlanta, Houston, and Austin, Texas. It will also improve its balance sheet, reduce costs, and enhance its growth prospects by providing additional opportunities to develop and redevelop space to grow its income.
The portfolio will have a heavy concentration in faster-growing warmer and cheaper markets in the Western U.S. and Sun Belt regions. Further, 70% of the retail centers by ABR will have a grocery component. That makes those shopping centers less susceptible to disruption from e-commerce as those stores drive steady traffic, benefiting other tenants.
The urge to merge
As mentioned, the combination of Kite and Retail Properties is the third merger in the retail REIT space already this year. In one sense, the deal follows the blueprint laid out by Kimco Realty (NYSE: KIM) and Weingarten Realty Investors (NYSE: WRI). The two shopping center REITs agreed to merge in a more than $20 billion deal, creating an industry-leading open-air, grocery-anchored shopping center REIT. That transaction also bolstered Kimco's scale, which will reduce costs. Further, it increased its concentration on warmer, cheaper markets in the Sun Belt region while improving its balance sheet.
Meanwhile, the other notable transaction will see Realty Income (NYSE: O) combine with diversified REIT VEREIT (NYSE: VER) in a $50 billion deal. As part of that merger, the combined company will spin off its office portfolio to focus primarily on high-quality, single-tenant net lease retail and industrial properties in the U.S. and U.K. That deal will enhance Realty Income's size and scale, reduce costs, and improve its growth profile.
All this consolidation could spur additional deals in the retail sector, especially among shopping center REITs. Once the Kite and Kimco deals close, there will be 15 publicly traded shopping center REITs remaining worth more than $1 billion. However, as rivals like Kimco and Kite grow their scale, it's giving them a competitive advantage over their smaller competitors. This may mean more retail REITs could look for a merger partner, as they look to capture those same benefits.
Getting bigger in the hopes of getting better
Kite Realty and Retail Properties of America are joining forces to increase their scale and reduce costs. The combination also strengthens the combined company's balance sheet while maintaining its focus on owning shopping centers with a grocery component in warmer and cheaper markets. Because of that, it should put the REIT in a better position to create value for investors as the retail sector recovers from the pandemic.