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BEHIND THE NEWS: Simon's Arizona flop highlights perils of housing sector

December 17, 2007

No wonder investors are jittery. The housing slump is stinging companies of all stripes these days, even those that would seem to be safe havens.

A case in point: mall developer Simon Property Group Inc., which surprised investors this month by announcing it was taking a $26 million charge to write off its entire investment in what was to become a huge Arizona housing development.

"Frankly, we had forgotten they had this Arizona thing," said Lou Taylor, an analyst with Deutsche Bank in New York City.

Indeed, Taylor had been focused-understandably-on Simon's multibillion-dollar shopping center development and redevelopment pipeline, which he and other analysts believe will power the company's stock higher.

And that's the problem for investors these days. Everyone knows that home builders are ailing and that subprimemortgage losses have staggered the big Wall Street firms. Just this month, the Swiss financial giant UBS wrote down the value of its subprime investments by $10 billion and lined up an $11.5 billion capital infusion.

But it doesn't stop there. Few companies are escaping the housing woes free and clear. Even The Steak n Shake Co., which has no direct connection to residential real estate, said the downturn is crimping customers' disposable income, depressing restaurant revenue.

Some of its customers have adjustablerate mortgages, which saddle them with higher payments. Others have lost their homes through foreclosures or feel poorer because of declining home prices.

Companies with vast investment holdings are vulnerable to more direct blows. Conseco Inc. this year has scaled back its subprime holdings, and they now represent only half a percent of the company's $26 billion investment portfolio.

Even though Conseco has adeptly maneuvered the subprime minefield so far, Chief Investment Officer Eric Johnson isn't resting on laurels.

"Recognizing this is, and will remain, a most volatile market, we'll continue to maintain great analytic vigor," Johnson said on an analyst conference call last month.

A couple of years ago, such handwringing over investments tied to residential mortgages would have been unthinkable. Investors figured home prices would continue to march higher, and people would almost always make their mortgage payments.

That was the climate back in January 2006, when Simon and two home-building heavyweights-Horsham, Pa.-based Toll Brothers Inc. and Scottsdale, Ariz.-based Meritage Homes Corp.-agreed to buy 5,485 acres in Phoenix's Northwest Valley from DaimlerChrysler Corp.

Chrysler was using the site for vehicle endurance testing. The Arizona Republic called the $312 million purchase the largest dollar-value land transaction in the state's history. The partners said the site could accommodate up to 31,000 homes, with Simon lending its expertise to develop retail components.

"We believe we can add value to this joint venture, and, most importantly, that we can make excellent returns for our shareholders," Simon President Richard Sokolov said on an analyst conference call the next month.

But while Phoenix once was among the nation's hottest housing markets, it's now in a deep freeze, with a glut of undeveloped land. Residential building permits have slipped to their lowest level in 15 years, according to the Phoenix Housing Market Letter, published by RL Brown Housing Reports of Sun City, Ariz.

Sokolov said on the conference call that Simon came across the opportunity as it began developing relationships with builders that might want to develop housing as part of existing or new retail projects.

Simon in 2005 began what it called its "asset intensification" effort, which is intended to bring non-retail uses-such as hotels, condos and homes-to excess land adjacent to its shopping centers.

Though the company since has launched residential components to retail projects elsewhere-including Texas and North Carolina-it's not likely to announce other major problems in the sector, analysts say. It has joint venture partners for some residential projects, and sold the land outright in others.

"They just don't own very much," said Rich Moore, an analyst with RBC Capital Markets in Cleveland.

Perhaps not, but the hit Simon already is taking is a doozy. The company had expected to earn 68 cents per share in the fourth quarter. The $26 million charge will cut the expected results by 11 cents-or 16 percent.
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