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Retail REITs slip on Toys R Us planned liquidation

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Retail REITs slip on Toys R Us planned liquidation

Some already heavily discounted retail real estate investment trusts traded down after Toys R Us said it would shutter or sell its remaining 735 U.S. stores, but a liquidation scenario for the retailer is likely already priced into landlords' guidance, analysts said.

Toys R Us said March 15 that its cash-weak position and debt load would force it to liquidate, a move widely interpreted as a death knell for the specialty toy retailer's U.S. operations. Toys R Us, which filed for Chapter 11 bankruptcy protection in September 2017, had hoped to keep several hundred stores open. It is said to be exploring a deal to keep as many as 200 U.S. stores in operation by packaging them with its Canadian business.

DDR Corp., the retail REIT with the second-highest exposure to the ailing retailer by percentage of annualized rent revenue, suffered a steep drop in March 15 trading, falling 3.50%. The rent Toys R Us pays the REIT amounts to roughly 1.2% of its annualized rent revenue, according to S&P Global Market Intelligence data. Kimco Realty Corp. was down more than 1% on the day.

REITs on the whole have underperformed in recent quarters as investor sentiment has soured around the prospect of rising interest rates. But retail REIT stocks, and in particular landlords with lower-quality portfolios, have suffered disproportionately. The SNL U.S. REIT Equity index has returned negative 6.74% year-to-date through March 15, while the SNL U.S. REIT Retail Enclosed Mall index has returned negative 8.34% and the SNL U.S. REIT Retail Shopping Center index has returned negative 15.80%.

RBC Capital Markets' Wes Golladay and Michael Carroll said a Toys R Us liquidation was likely already baked into retail REITs' guidance. "Assuming a liquidation and stores remaining open for 1-2 months during the process, the guidance appears to mostly cover a worst-case scenario," the analysts said.

Golladay and Carroll noted that rents from the big-box space formerly occupied by The Sports Authority, which moved to liquidate in 2016, will offset the Toys R Us-related disruption as that reconfigured and re-tenanted space comes back online in 2018. Moreover, successful re-tenanting of the Toys R Us space may be a less painful process, because of the low rent hurdle landlords have to clear to make the repositioning accretive.

"We believe some of the [Toys R Us] space will need to be split, which will add costs," the two said. "Ideally, the landlords will look to re-tenant with retailers such as off-price retailers, which would require less reconfiguration."

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