An Interview With: Don Wood
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Wood, from northern New Jersey, joined Federal Realty in 1998 as CFO, becoming President and COO in 2000, and CEO in 2003. He won the 2005 Ernst & Young Entrepreneur of the Year Award in Greater Washington in the real estate category and currently serves as the chair of the Metro DC Chapter of the Cystic Fibrosis Foundation. Among Federal Realty’s 17 million square feet of space are six million square feet in the Washington, DC market, including Congressional Plaza, Bethesda Row, Federal Plaza, Rockville Town Square, Sam’s Park & Shop, DC’s Friendship Heights Center, Falls Plaza, Mt. Vernon Plaza, Pentagon Row, the Village at Shirlington, and others. Founded in 1962, Federal Realty is headquartered in Rockville and has over 400 employees.
Bisnow: What’s the future hold for REITS?
REIT Laws were passed in 1960. Federal Realty was founded in 1962. And so the public has had the ability to buy real estate in the form of stock since 1960. But the reality is, it was such a small industry for so very long that I really view our industry, the public real estate industry, as new. In a real sense, it started only in the early 90’s. And the reason it started then was simple: the last real estate depression of 1989, 1990, and 1991 meant that a lot of individuals who owned shopping centers and office complexes were in trouble, and they used the public market to bail them out. If you look at the number of REITs that were formed in ‘92, ‘93, ‘94, and ‘95, it’s enormous. And it was the first time there was enough supply in the investment world for investors to start figuring out what a REIT is. When I came to Federal in 1998, I myself had no idea what a REIT was. What’s happened, particularly over the past five years, is people started to understand what public real estate is. The equity market capitalization of REITs today is over $300 billion. Just five years ago, it was barely $100 billion.
Why did ordinary people discover REITS?
A number of reasons. First of all, the tech bust. In 2000 to 2001, when the tech market crashed, many investors were looking for a safe haven, and they found real estate. Secondly, there were changes to the dividend laws that made dividends tax deductible. It didn’t change how dividends worked for REITs, because we were already tax deductible, but it did create a lot of focus on REITs and the fact that we pay pretty darn good dividends. So, when you think about the safety and the growth, all of a sudden Wall Street started looking a lot closer at public real estate. Today, there are a number of REITs in the S&P 500. That wasn’t the case five years ago. As I look at the next ten years, I think we’re currently just scratching the surface in terms of the investment community’s understanding and desire to own public real estate.
What’s Federal’s future growth story?
What I think is going to happen as people get smarter about their investment decisions and more comfortable with real estate companies, is that a differentiation among REITs will become more and more important. And I think the more people understand the Federal Realty business plan—a plan of the highest internal growth, less dependent on acquisitions, less dependent on things that we don’t control because we already have a great portfolio—the more they will believe in the value we are creating. That doesn’t mean that real estate is not partly a cyclical business. Absolutely, there will be ups and downs as interest rates change, as certain retailers go bankrupt. It’s been happening forever and will continue to happen. But for the long-term for public real estate in this country, the future has never been better.
You’re headquartered behind Congressional Plaza, so let’s take that shopping center as an example of your many properties. Everyone in Washington knows it. What does Federal do with it?
We’ve had an amazing history there. We purchased an interest in the property in 1965. It’s 41 years later and people think, “Okay, you’ve redeveloped the center. It’s done.” But that’s a fallacy you have with really good real estate. Congressional Plaza was redeveloped in the 70’s. It was redeveloped in the 80’s. It was redeveloped in the 90’s. It’s 340,000 square feet, and every year, there’s continued growth and maturity there. We continue to bring great new concepts and retailers to give a broad choice to consumers. It has 45 stores now. The latest thing that we’ve done is replace a restaurant, “That’s Amore,” with something called the “PGA Tour Restaurant.” It’s the first dining establishment of the PGA outside of a club. If it’s successful, they may add 70 or 80 other locations over the next 15 years. They’re starting in Congressional Plaza, opening scheduled for Valentine’s Day.
Why did they choose to locate in little ol’ Congressional Plaza?
We own one of the best pieces of real estate located on Rockville Pike in suburban Washington, DC. We’ve been able to put together a collection of stores that this community likes to shop at, providing us the foundation to bring in unique tenants. Their assessment is that they have the best chance for success right here. The previous restaurant was under a long-term lease but decided to close and began to find someone to sublease the space. We try to be proactive in our leasing efforts and so our leasing team, in conjunction with the tenant, found a group of investors who were working with the PGA Tour Restaurant.
They’re going to have golf celebrities coming in and out?
That’s our understanding. One in particular will be Fred Funk, who was previously the golf coach at the University of Maryland. It’ll be a clubhouse design, a big bar, flat-screen TVs tuned to the Golf Channel. High quality food. The ultimate 19th Hole.
To the untrained eye, what’s different at Congressional Plaza today compared to 10 or 20 years ago?
It’s a family-driven shopping destination. So you’ll see many mothers with baby carriages, because it has stores such as “Buy, Buy Baby,” for children’s products, and also home accessories like you’ll find at “Plow and Hearth,” very rare for our area. And the physical aspects of a shopping center are extremely important. They’re the wrapper. They are part of the reason that a family wants to spend time at a place. It creates avsense of place, such that if you walk through and you look at the rafters, the colors, and the materials, it feels very comfortable. And the parking is terrific, so the convenience, in terms of its physical layout, is another component. When you marry that to the merchandising and the type of retailers there, it’s simply an A-plus shopping center.
What do you feel distinguishes the 17.5 million square feet of retail space in Federal Realty’s portfolio overall?
I truly believe it’s the highest quality retail space available as a group in America, and let me tell you why. High quality means meeting the needs of the surrounding community, resulting in growth in rents and cash flow for us as a landlord. Sometimes that’s Gucci, sometimes it’s Target. In the Washington, DC area specifically, we’ve found more opportunities within our portfolio to continue to re-develop, to re-merchandise, to re-tenant, and to create better retail destinations because they’re in great locations. Look at Rockville Town Square. It was a situation where we owned a 100,000 square foot strip center that was a critical component to the city’s dream, and our dream, of creating a center, a town square, for Rockville. As a result, we played a major role in designing and executing that town square. It’s under construction today and will be open and operating about 15 months from now. It’s an amazing spot.
Other examples in the region?
Take Shirlington, in Arlington, Virginia. We’ve got the same situation where we own a critical piece of real estate that we are now exploiting to create a larger, more impactful center that includes retail, condominiums, and apartments. All of which is being done in a partnership between us and key residential builders in the area: Trammell-Crow, in the case of the condos; Bozzuto, in the case of apartments. And look at Bethesda. It’s been well-documented that our success there over the past ten years has come from an incremental approach of creating Bethesda Row, the neighborhood bordered by Woodmont Avenue, Arlington Avenue, Bethesda Avenue, and Elm Street. We have another phase to go and, over the next few months, you’ll see us embark on a $65 million development with additional retail on the ground floor and about 180 luxury apartment units above, with what we call the “Festival Street” going down the middle of it, filled with shops, restaurants, and boutique retailers that finish off the experience.
Where is that new Bethesda Row phase exactly?
It’s on the old Giant Food site. If you remember, Giant had a small, 25,000 square foot supermarket that we have since knocked down, and built Giant a new, state-of-the-art prototype across the street. We’ve already started the site work, but the building will start in the next few months. We are 24 months away from completion of the project.
What’s the value of your entire real estate portfolio? Or is that the same as your market cap?
Personally, I think our value is significantly above our market cap, which is about $4.2 billion or so.
Why do you think it’s above? Why would the price not reflect that?
I simply believe that the opportunities we have to create additional value with existing real estate are numerous, but that the market won’t pay for that until it happens.
What’s an example?
The best example is Rockville Town Square. It’s under construction, it is being leased up today, but it is not creating earnings today. It will in the next two years. The same with the Bethesda Row final phase in Bethesda. The same with Shirlington. I believe that the market will pay for some of that, but not for all of that, until it happens.
Yet investors in a company like Google will pay seventy times earnings because of their believing in future growth. Why don’t your investors give you the benefit of the doubt?
First of all, when you’re talking about technology, you really are in such a different place compared to many other businesses, so I’m not sure that is an appropriate comparison. In real estate, as in many businesses, the certainty of the future stream of cash flows is what’s being paid for. And there’s always uncertainty. The uncertainty of cash flow creates a discount. What I believe about Federal, compared with any of our competitors, is that uncertainty is quite less. And that’s one of the competitive advantages of Federal. The bottom line is: we are better than 95% leased, yet we are only 92% occupied. Think about that for a minute. Of the 17.5 million square feet of space that we have or are currently building, 95.5% we have contractual agreements with retailers to pay rent. Yet, only 92% are actually in there, occupying and paying rent today. That means there’s 300 basis points, or 3%, of our portfolio, for which all we have to do is deliver the product for rent to start. That is far more certain than if I was sitting here telling you, don’t worry, we’re going to find something for that space. We actually have deals with 95.5%.
Who is in your peer group? Who is your competition?
We very much view the companies in the Bloomberg Shopping Center Index as our competition. They include big national companies, like Regency Centers out of Jacksonville, that has a big presence here in Washington. Like Kimco, out of New Hyde Park, New York. Pan Pacific, on the West Coast; which is in our California markets. And others: Developers Diversified, Weingarten, and a few more.
Any other interesting projects you’re working on around here where you are tapping new value?
Let me tell you about one that’s finishing up now: Mount Vernon Plaza in lower Fairfax County. This was an acquisition that our company made a couple years ago of two shopping centers directly adjacent to each other, Mount Vernon Plaza and South Valley Shopping Center. They were under separate ownership and never marketed together. One had a Home Depot in it. One had a Shopper’s Food Warehouse. The parking lots were not connected. We saw the ability to buy both quietly, negotiate with each, and create a much more dominant retail destination by combining them. We saw the Mount Vernon area of Route 1 in Fairfax County as being pretty ugly on the face of it. But if you peeled back the onion a little bit and you looked at the neighborhoods behind and what was happening to them, you could see additional residential building going on and expansion at Fort Belvoir. It was pretty clear to us that if we could get a big piece of land on Route 1 in this particular area, we’d be able to create a lot of value through the re-development of those shopping centers. For the last two years, we have been doing that. We turned a vacant Ames Department Store in the back of that shopping center into a beautiful new Bed, Bath & Beyond, Michael’s, and PetSmart. We renovated the entire center. We added additional retail down the middle that connects the two pieces and has some terrific stores like Carter’s Children's Clothes and New England Custom Furniture. We’ve created a retail destination there that has brought in customers that would have never been frequenting that center.
How many strip malls do you have in this property or in this region?
In this region, we have twenty-seven. Federal Realty has 103 retail assets.
How about describing one more current project and its significance to Federal’s value?
Let’s go out west to Leesburg. This is one of my favorite stories. If you look at Loudon County, Virginia, it has been the second or third fastest growing county in the country during the past ten or fifteen years. But just building a shopping center in an area that is fast growing, particularly on the outskirts, has risks because there are very few barriers to entry. You have green fields and farms, so building a shopping center in the community around it today is subject to more competition when the next shopping center is built tomorrow. We bought this piece of property back in the mid-90s. That was in the center of Leesburg: Leesburg Shopping Center, which has a very well performing Giant Food Store in it, but had a non-performing K-Mart. We got a great opportunity to re-develop it once K-Mart decided to close the store. Rather than fill this big, 85,000 foot box with another 85,000 foot user, because K-Mart was paying very little rent, we had the ability, instead, to re-develop the shopping center and add smaller anchors there. So we’ve added Party City and PetSmart and Champion Billiards. And we’ve also been able to add room for retailers closer to the street, which creates additional value. The bottom line is that if you look at Leesburg today versus just two or three years ago, you’ll see a completely renovated shopping center. When taken along with places like Mount Vernon, the Village of Shirlington, Bethesda Row, and Rockville Town Square, this makes us a huge player in the Washington area in terms of re-development and renovations.
What is it that makes your approach and vision unique? Why would you develop these properties differently than a Regency or someone else?
Well, there’s a couple differentiators. The single biggest thing is that this portfolio has been accumulating since 1965. Most companies buy portfolios: ten, twenty, thirty, fifty assets, or more. And in any portfolio, there’s good stuff and there’s bad stuff. Federal never took that approach. Our approach has always been much more asset-by-asset. You’re going to grow slower, but only buy the asset that you think has great re-development potential. If you fast forward to 2006, the accumulation of this portfolio is irreplaceable. It can’t be recreated again today. It’s there. What has happened to the Washington area, to Philadelphia, to New York and New Jersey, and Boston over the last forty years has resulted in our owning the most valuable infill group of shopping centers. And if you think about that, that raw material is simply irreplaceable and gives us lots of opportunities to do the kind of things that we’ve been talking about.
What’s your biggest challenge? Your biggest concern out there?
Construction costs these days are through the roof. They squeeze returns. Once again, though, they impact us less, because we do more re-development work rather than new development work. And in re-development, everything I’ve just described to you, there’s no land cost. We already own the land and have owned it for years and years and years. If you think about land costs as traditionally somewhere between fifteen and twenty percent of the cost of the entire project, it’s an amazing advantage to start with.