The Scott Letter: Closed-End Fund Report©
Published by Closed-End Fund Advisors, Inc.

October 2002, Volume II, Issue 9
George Cole Scott, Editor

Pan Pacific Retail Properties

Pan Pacific Retail Properties is an equity real estate investment trust (REIT) traded on the New York Stock Exchange under the symbol PNP. The company focuses on creating long-term stockholder value by specializing in the acquisition, ownership and management of community and  neighborhood centers for everyday essentials. Pan Pacific’s strategy is aimed at providing stockholders with long-term stable cash flow through maintaining a diverse portfolio and tenant base, balanced with consistent growth through implementing its acquisition and property management programs.

Pan Pacific is the largest neighborhood shopping center REIT on the West Coast. The Company’s 108 property portfolio, encompassing 16 million square feet, is diversified across five Western U.S. markets: Northern California, Southern California, Washington, Oregon and Nevada. As of June 30, 2002, the portfolio was 96.9% leased to 2,467 tenants.

Pan Pacific is a full service real estate company with in-house expertise in acquisitions, leasing, property management, accounting, marketing and development. The Company is headquartered in Vista, CALIFORNIA, and has regional offices located in Sacramento, California; Kent, Washington; Portland, Oregon and Las Vegas, Nevada.

Financial Summary

Year Ending December 31 2001 2000 1999 1998 1997
Total Assets* $ 1,339,618 $ 1,297,690    $ 784,537 $ 705,541 $ 487,220   
Total Revenue* 188,994 120,493    101,062 79,253 46,710   
Net Income* 64,222 37,004(a) 32,576 26,634 8,313   
Funds From Operation* 91,452 59,327(a) 50,798 41,134 18,288   
Dividends per Share 1.82 1.66(b) 1.58 1.50 1.45(c)
*In thousands.
(a) Excludes a one-time merger related expense of $3.2 million.
(b) Excludes 4Q’00 special dividend paid in connection with the acquisition of Western Properties Trust
(c) Represents annualized dividend

We interviewed Stuart Tanz, Chairman, President and CEO, in late September. He was assisted by Carol Merriman, Director for Investor Relations, whom I met with at a visit to the company’s headquarters in August.

Scott: What is the history of Pan Pacific since you went public in 1997?

Tanz: In the five years since becoming a New York Stock Exchange REIT, we have become the largest shopping center REIT on the West Coast. We started with a portfolio of 32 shopping centers in 1997 with a total market cap of $450 million. Through implementing a prudent investment strategy, involving both acquisitions of individual shopping centers and several portfolio transactions, today we own and operate 108 shopping centers with a total market cap of $1.8 billion. And while we have grown our asset base, we have been careful to always maintain a strong balance sheet.  As a result, today we are an investment grade rated company.  Perhaps most important to your readers, since going public in 1997, we have generated a total return to shareholders of approximately 146%.

Scott: You need to help me out on a good definition of FFO, or Funds From Operations which is how earnings for a real estate investment trust are computed. Many investors of REITS have difficulty understanding how it is done. The definition I have, as published in Ralph Block’s book, Investing in REITs, is that it looks at net income before deducting depreciation. As you know, this is a method for REITS and investors to correct the distortion of depreciation in real estate. According to The National Association of Real Estate Trusts, FFO “should mean net income computed in accordance with GAAP excluding gains (or losses) from debt restructuring and sales of property, plus depreciation of real property, and after adjustments for unconsolidated entities in which a REIT holds an interest.”

Doesn’t the gains from sales of property go into FFO?

Tanz: Funds from operations is the key measurement of performance for the REIT industry. In terms of gains and losses from property sales, while the majority of REITS exclude gains for property sales, there are some REITs who include it, which unfortunately makes it harder to understand the true cash flow performance of their portfolio and unfortunately causes confusion among investors. At Pan Pacific, we take a conservative approach in how we report FFO. We exclude gains and losses from the sale of assets from FFO.

Scott: Now that we have an understanding of FFO, what are your plans to continue to increase it?

Tanz: Since 1997 we have grown FFO per share by 68% in total. Based on the continued strength of the markets in which we operate and the quality of our portfolio, we expect to continue growing our FFO per share by 7% to 8% per annum over the next several years.

Scott: That is terrific. What about dividend growth?

Tanz: Similar to our FFO growth, we have increased our dividend each year since going public, for a total increase of 31% to date. Generally speaking, our policy is to increase our dividend each year at about half the rate of our FFO growth. So with our FFO growing about 7 to 8% each year, we have been increasing our dividend by about 4% each year. We would expect that to continue. By raising our dividend at about half the pace of our FFO growth, we are able to conserve more and more cash flow each year to reinvest in our business and enhance long-term shareholder value.

Scott: The theme for your 2001 annual report was “Consistency and Performance.” What is the secret of your success?

Tanz: Our success and ability to consistently perform each year is a function of three key factors. First is our property focus. Grocery-anchored shopping centers, which provide basic consumer necessities are always in demand, regardless of the economic cycle. As a result, our properties generate very stable, predictable cash flow year after year.  Second, is our West Coast focus. The markets we operate in are typically, mature, densely populated areas with strong, long-term demographic and economic fundamentals. And third, is our tenant strength and diversity. Our portfolio is leased to over 2,400 tenants with 80% of our portfolio leased to national regional retailers.In addition, our largest tenant, a very strong grocery chain, only accounts for 4.6% of our total base rent and 78% of our tenants account for less than 1% each. This diversity provides tremendous stability to our revenue stream and is the cornerstone of our success.

Scott: Would you tell us something more about your markets?

Tanz: Aside from the strong demographic and economic fundamentals, the West Coast markets we operate in are very supply constrained. In other words, there is very limited land available to develop competing centers. Furthermore, the entitlement process for new development is very difficult and can take years to complete. One other important aspect about our markets is that the ownership of shopping centers on the West Coast is highly fragmented and there is a vast inventory of existing shopping centers.  We believe the barriers-to-entry and fragmentation of ownership in our core markets will continue to provide exceptional growth opportunities for our company.

Scott: Isn’t it difficult to find the quality of properties you seek?

Tanz: Not really. Given that we are the largest owner and operator across our markets and have been consistently buying properties for a number of years, we are well known in our markets. As a result, we have a lot of strong relationships with property owners, developers, brokers and tenants. Through these relationships we are often able to source acquisition opportunities before they are widely marketed.

Scott: I take it that your acquisition of Western Properties Trust you acquired in late 2000 has worked out to your expectations?

Tanz: It has proven to be a very successful acquisition in a number of ways. First, it gave us a significant presence in three strong markets: San Francisco, Sacramento and Portland. Second, the transaction strengthened our balance sheet and our financial flexibility. We recently received a rating upgrade from Standard & Poor’s, based in-part on our success in efficiently integrating the Western portfolio. Third, given the transaction was a stock for stock merger, our public float increased significantly. As a result, our daily trading volume has increased four fold and we have expanded our investor base substantially.

Scott: Do you think you will issue any new shares going forward?

Tanz: We have no immediate need or plans to issue equity. We continue to meet our growth objectives through internally generated cash flow and our on-going disposition program of selling non-core assets. In addition, we have a $300 million unsecured credit facility.

Scott: I did notice the number of stock options increased dramatically in 2001 versus the prior year.

Tanz: It was a result of the Western Properties acquisition.

Scott: We are hearing so much now about “expensing options.” Is that a problem for your industry?

Tanz: Generally speaking, the expensing of options should only have a modest impact on the REIT industry. On average, I would expect that the impact for most REITs, as with Pan Pacific, is less than 1% of FFO.

Scott: Have the weaker economies in Washington and Oregon hurt your business?

Tanz: No. Our shopping centers in Seattle and Portland continue to perform well. Our occupancy rate in those markets continues to be in the 96% to 97% range.  Importantly, there has been very little new supply that has come onto the market in the past five years. And as I discussed, our properties focus on providing basic consumer necessities, which are always in demand, unlike luxury retailing that comes and goes with the economy.

Scott: With all this wonderful things you are telling me, there has to be a downside to your business.Would tell us the negatives?

Tanz: There is not much to point to. With the continued strength of our markets, along with the quality of our properties and diverse tenant base, our business continues to perform well. The only risk would be if we were unable to find attractive acquisition opportunities. If that were to happen, our earnings growth would slow, but it would not adversely impact our existing cash flow stream and dividend.

Scott: If there is a major bankruptcy, as in the case of K-Mart liquidating, could this be filled easily?

Tanz: The key to our company is our tenant diversification. Unlike many of our peers, we have no tenant concentration issues. As I mentioned, our largest tenant only accounts for 4.6% of our base rent. As to filling vacancies when tenants move out, we have a very strong track record of keeping our portfolio virtually full. For the past eight years running, we have maintained a portfolio occupancy rate of 95% or higher.

Scott: If an investor looks at the price/earnings ratio for a REIT, he sees a higher figure. My machine shows a P/E of 17. Would you explain to our readers how this doesn’t apply to REITs?

Tanz: As we discussed, net income, which includes real estate depreciation, can be a misleading number. A better measurement in terms of analyzing various REIT investment opportunities would be to compare REIT FFO multiples, as well as net asset value in relation to stock price.

Scott: Downside risk is something we pay great attention to. This is partly why we were attracted to quality REITs such as yours. However, we see that your stock is trading at or close to its all-time high. How can we overcome our resistance to buying it at these levels?

Tanz: When you compare our FFO multiple and projected growth rate, along with our conservative balance sheet, secure dividend payout ratio and net asset value, to other REITs, as well as other broader investment opportunities, I think we continue to be an attractive stock for investors seeking a stable current return with identifiable growth potential.

Scott: When you mention “net asset value” we can respond to this. Our closed-end and mutual fund investors pay a lot of attention to net asset value. We are always looking for a chance to invest in something selling below its net asset value. However, we prefer investing in REITs rather than in bond funds because of the growth potential, increased dividends in the stronger ones and the stability you have expressed that a strong REIT has in the volatile stock markets we have been experiencing.


The editors of The Scott Letter Online are interested in any feedback from our readers regarding how we may improve this publication. Comments concerning topics in which you agree or disagree are also of interest to us. Your opinions are valuable and will help us to be able to serve you better. Please send your questions or comments to our email address or by regular mail prior to the next edition or The Scott Letter Online. We do read your letters, but we cannot guarantee they will be published in The Scott Letter.

Note: None of the information contained herein should be construed as an offer to buy or sell securities or as recommendations. Performance results shown should under no circumstances be construed as an indication of future performance. Data, while obtained from sources we believe is reliable, cannot be guaranteed.

Use or reproduction of any of The Scott Letter Online requires written permission from Closed-End Fund Advisors, Inc. The Scott Letter is copyrighted to Closed-End Fund Advisors. All Rights Reserved.