2013 may not be the year of the mall. Large domestic shopping mall owners, including General Growth Properties (GGP), Kimco (KIM) and Simon Property Group (SPG), performed well since the market bottomed out in 2008 and 2009, even forcing GGP to seek bankruptcy protection. Nonetheless, these companies may have appreciated too quickly, especially considering the continued weakness seen in many geographic areas and the potential for high unemployment for several years to come.
In 2012, the REIT sub-group of domestic mall landlords appreciated by about 25 percent despite elevated delinquency rates within malls throughout the past few years. As a result of poor performing retailers and regions, both retailers and mall operators have been concentrating on the most profitable markets and limiting, and in some cases abandoning, endeavors in lower income areas.
This may be an indication of a need for several malls to be removed from the marketplace, and so for a variety of reasons that likely include reasons beyond a poor economy. In addition to being in lower income areas, many problematic mall properties are simply older and less appealing than newer competing properties. After all, do you want to go to that new mall where everything is so futuristic, or that old one with the funny smell?
General Growth Properties is currently the second largest U.S. shopping-mall owner behind Simon Property Group. The company filed for bankruptcy in 2009 after accumulating about $27 billion in debt that it couldn't easily refinance because of the collapse of the commercial mortgage-backed securities market that followed the subprime residential mortgage collapse. The company's shares have gained substantially since bottoming in 2009.
General Growth Properties appreciated by about one-third in 2012. The company concentrated on premium properties that generate higher sales per square foot, and which rent out at a higher rate, while attempting to divest itself of some poorer performing properties. General Growth Properties also spun off two entities since exiting bankruptcy protection: Howard Hughes (HHC) and Rouse (RSE).
Over the summer, activist investor Bill Ackman's hedge fund, Pershing Square Capital Management, pushed for a sale of GGP under Ackman's terms. Ackman noted concern that Brookfield Asset Management (BAM) might be attempting to acquire GGP on the cheap. Simon Property Group was interested in acquiring GGP, and Ackman believed that SPG might pay more than BAM for the business. Simon had previously attempted to acquire GGP, but the effort failed.
At the start of 2013, Brookfield Asset Management informed General Growth Properties that affiliates of Brookfield acquired GGP warrants held by affiliates of Pershing Square Capital Management, with the right to acquire 18,432,855 shares of GGP common stock. Much of the reason so many parties were interested in GGP, and may still continue to be interested, is that GGP's portfolio includes so many valuable and high profit properties. The company's spin-off of Rouse appears to have improved the quality profile of the GGP's remaining portfolio.
Not all malls will be spun off. Some will be sold, including those owned by GGP's competition. Macerich (MAC), a retail REIT for example, has over a dozen of its poorer performing malls in poorer performing markets up for sale. Many of thee properties may be difficult to sell. Unsuccessful malls in undesirable markets are likely in need of renovation and may also have visible issues with the condition and quality of tenant retailers.
Though most vacancies are troubling to the owner, not all new vacancies are necessarily bad things. In higher end markets, many mall landlords are now hoping for some languishing retailers to exit so that newer high-end retailers may replace them. For example, many have been anticipating that several more traditional retailers such as J.C. Penney (JCP) and Best Buy (BBY), among others, may end up exiting some malls and that newer retailers like Uniqlo and Zara would take their place. The problem is that these newer and more desirable tenants are primarily interested in expending within the top tier malls. This means some malls have waiting lists, while others have vacant wings that are anxiously awaiting retailers.
Another negative headwind for mall values in 2013 is that it is entirely possible that Sears Holdings Corporation (SHLD) will again ramp up selling some of its properties. Billionaire Eddie Lampert bought Kmart out of bankruptcy in 2003 and combined the retailer with Sears in 2005. The company owns many properties across the nation and many of them are underperforming. Lampert continues to press for a resurgence of the Sears business, as well as its many brands such as Craftsman, DieHard and Kenmore, but there is certainly room for Sears and the sale of numerous Sears and Kmart properties.
It is likely that in 2013, Sears will either sell some of its properties or otherwise revamp and reorganize them so that the company will transition in those locations from a retailer to a landlord. J.C. Penney has made strides to put stores within its own stores, and Sears may attempt a similar measure. In any form, the increased capacity that these large retailers may potentially add to the markets of for sale and for lease mall retail space should have the effect of reducing prices.
One reason why so many individuals invest in mall REITs is because they pay a substantial and often growing dividend. REITs must pay out 90% of income in order to avoid paying corporate taxes, but those dividends are taxed as income to the recipient and not at a lower qualified dividend rate like a standard corporate dividend. Many of these REITs saw dramatic reductions in their collected rents when housing bottomed, while their costs continued to increase.
For mall REITs to continue appreciating as they have for the past few years, these malls will have to continue to sign and re-sign tenants to long lease terms with escalating rent payments. Such contracts allow Wall Street and the company itself to predict future cash flow and also when to best maintain and upgrade their properties.