Canada’s First Capital Realty Makes Life’s Necessities a Billion-Dollar Business

For First Capital Realty (TSX: FCR), one of Canada’s largest owners, developers and operators of supermarket and drugstore-anchored shopping centers, the common creature comforts of day-to-day life are what drives its business.

“We’ve always focused on necessity-based retail centers,” says Dori Segal, First Capital’s president and CEO since 2000. “In fact, our motto is ‘shopping for everyday life,’ because the services and goods provided in those centers are less sensitive to economic cycles and to competition from online retail.”

Segal says he modeled his real estate operating company’s strategy on top-quality U.S. retail REITs in order to build long-term value for investors.

“We’ve consistently followed our business plan to acquire and redevelop community shopping centers in good locations,” Segal says. By “good,” he means Canada’s major urban markets with a high-income population. For about the last six years, First Capital has concentrated solely on those target markets.

Heather Kirk, managing director of equity research with BMO Nesbitt Burns in Toronto, notes that First Capital is the only real estate company in Canada to focus on the role and function of grocery-anchored strip centers in urban areas, which adds to its strength. The effect of that strategy in some markets has been dramatic, according to Kirk.

“First Capital has transformed neighborhoods with their redevelopment of shopping centers in urban areas,” Kirk says. “They’ve taken a long-term view and developed a high-quality portfolio, rather than focusing on short-term accretion.”

Urban Focus

More than 90 percent of First Capital’s annual rental income comes from neighborhood shopping centers in the largest seven cities in Canada: Toronto, Montreal, Ottawa, Quebec City, Edmonton, Calgary and Vancouver.

“For the past decade, we’ve seen a shift among families as well as young people and retirees to live downtown so they can walk to services and not own a car or perhaps have only one car,” Segal says. “We’ve aggressively focused on cities because of this demographic change. Our sister company Equity One (NYSE: EQY) has a similar focus in the U.S. in supply-constrained markets.”

First Capital started as a private company in the 1980s and went public in 1994. The company, formerly Centrefund Realty Corp., was acquired in August 2000 by Gazit-Globe Ltd. (NYSE: GZT), a multinational real estate company that also has a significant interest in Equity One.

“An advantage of being part of this larger global enterprise is access to information on a comparative basis in development projects in Europe and [the United States],” Segal says.  “Asset management practices within the group promote excellence and best practices in each company.”

First Capital owns 164 properties with 24 million square feet of gross leasable area, along with 4 million square feet of active and potential future development sites with a total enterprise value of $7.6 billion.

“First Capital’s strategy is a little different from its retail peers,” says Mark Rothschild, managing director and real estate analyst with Canaccord Genuity in Toronto. “The company focuses on adding value by concentrating on higher-quality locations in high-barrier markets.”

Rothschild says First Capital attracts good tenants, but its success is tied to locating its shopping centers in areas where the rents can be higher.

Giving Credit Where Due

First Capital’s credit rating was upgraded in November 2012 to BBB (high) with a stable trend by DBRS , a global credit rating agency headquartered in Toronto and to Baa2 with a stable outlook by Moody’s, making it the one of highest-rated real estate entities in Canada.

“Over the last three years, we’ve taken steps to support our rating,” Segal says. “We did some major capital recycling last year, selling assets in markets that aren’t aligned with our strategy and acquiring new properties. We also did a $515 million equity offering, so all of our 2012 acquisitions were supported by equity rather than debt. In 2013, we continued to fund investment activity predominantly by recycling capital from non-core assets to redevelopment activity.” The company also refinanced $3.2 billion of debt into longer-term notes.

Segal says First Capital has acquired older shopping centers to redevelop, expand or reposition.

“We’ve diligently acquired assets adjacent to or across the street from our existing centers, so we expand them and make them more competitive with other retail sites,” Segal says. “We’ve picked up free-standing sites and end-cap sites because it’s a natural development to have tenants like banks, fitness centers and medical offices, all family-centered services near the supermarket.”

First Capital is the largest landlord for Shoppers Drug Mart in Canada, which Segal describes as “Canada’s Walgreens.” It is also the largest landlord for Starbucks in Canada.

“We’re building in complementary services in our shopping centers, things like liquor stores, casual dining restaurants and sports bars,” Segal says. “In some locations we’re adding small amounts of rental apartments when it makes sense. We’re slowly building our residential skills so that in maybe five years or so, mixed-used developments with a residential component could be 5 percent or so of our business.”

Segal says getting the tenant mix right is a crucial element to First Capital’s success.

“We try to have a sushi restaurant at every location for healthy food, a day care center when the demographics merit it, and we also really want a cool tenant like a yoga center or a trendy furniture store,” Segal says. “We like to put in a patio or a roof terrace when we can so that families can enjoy spending time outside and, therefore, will spend more time at the shopping center. It just makes for a nicer environment.”

Economic Challenges

Ciro DeCiantis, a partner and national real estate leader with Deloitte in Toronto, says grocery-store anchored retail can be essentially recession-proof, especially when the center has the right assortment of tenants. However, Canada’s retail sector will continue to face challenges from many of the factors that have impacted the global economy. Rothschild says Canada didn’t experience the same economic weakness as the U.S. during the financial crisis and was resilient compared to most of the rest of the world during the recession. However, he points out that the national economy hasn’t subsequently shown much growth, either.

“Our motto is ‘shopping for everyday life,’ because the services and goods provided in those centers are less sensitive to economic cycles and to competition from online retail.”

—Dori Segal, President & CEO

“On the consumer demand side, the Canadian housing market has been relatively stable compared to the U.S. and has been a source of household wealth,” says Tony Cocuzzo, partner, commercial/investment property sector leader and REIT leader at Deloitte in Toronto. “Employment in Canada is largely intact as well, so consumer confidence is largely positive. At the same time, Canada doesn’t have the same supply environment as the U.S. The combination of those factors means that retailers themselves have performed well along with retail REITs.”

Cocuzzo says a large part of Canada’s economic strength comes from global demand for its resources, particularly oil.

“Depending on whether Canada continues to be viewed as a stable economy, we may see more companies coming into the country,” Cocuzzo says. “If growth prospects are muted because of higher interest rates and a decelerating global economy, then that may cool things down here as well. A large part of Canada’s economy is resource-driven, particularly tied to the price of oil, which means that global events can impact Canada, too.”

Rothschild says First Capital’s assets will outperform those of competitors if the economy softens, and they will do even better if the economy strengthens.

“If interest rates go higher, First Capital is definitely in the best position, because it doesn’t need to raise equity,” Rothschild says. “I think the most important thing about First Capital is that its management is very aligned, focused and disciplined.”

BMO’s Kirk says she also believes that First Capital is well positioned to handle the impact of rising interest rates or other economic headwinds.

“First Capital is a well-respected company with a unique vision and a great platform to execute it, including a strong balance sheet, a good cash position, well-located assets and a stable tenant base.”