The Bull Case for Simon Property Group

Among the battered real estate industry there are a few REITs that are situated to take advantage of the carnage and profit in the long run. Simon Property Group (SPG) is going to be poised to snatch up properties at rock bottom prices from sellers who simply want to pay down their enormous debt loads.

With a market cap of $7.59 billion, SPG is the largest public real estate company in the United States. As of December 31, 2008, SPG owned or held an interest in 324 income-producing properties in the U.S. It owns, operates and develops its portfolio of properties with an emphasis on high quality retail real estate. SPG operates from five retail platforms: Regional malls, Premium Outlet Centers, The Mills, community/lifestyle centers, and international properties.

As of December 31, 2008, the breakdown of percentage of owned property was: Regional Malls- 58.3%, Premium Outlet Centers- 10.7%, The Mills- 19.6%, Community/lifestyle centers- 9.2%, and other properties- 2.2%. SPG reported for the full year 2008 that diluted earnings per share decreased $0.08 or 4.1% to $1.87 from $1.95 in 2007. However, it also reported that consolidated total revenues increased $132.4 million or 3.6%. This increase in total revenues was mainly due to the full year effects of its 2007 openings and expansions.

The three main reasons why I think Simon will prevail are its consistently high occupancy rates, the poor conditions of competitors such as General Growth Properties (GGP), and strong growth in Funds From Operations (FFO).

Even in the midst of a tough retail environment, SPG has been able to maintain fairly steady occupancy rates. As you can see, even though all but The Mills are down year-over-year, they are not down nearly as much as some may have thought given the harsh economic climate for over a year now. Strong occupancy rates were accompanied in 2008 by stable rental rates which helped SPG to generate growth in operating results even with the pressures of the souring economy.

• Regional Malls: 92.4%, down 1.10%
• Premium Outlet Centers: 98.9%, down 0.80%
• The Mills: 94.5%, up 0.40%
• Mills Regional Malls: 87.4%, down 2.10%
• Community/Lifestyle Centers: 90.7%, down 3.40%
• European Shopping Centers: 98.4%, down 0.03%
• International Premium Outlet Centers: 99.9%, down 0.01%

Lots-O-Cash

SPG has a strong balance sheet with a lot of cash. As of December 31, 2008, it had approximately $774 million in cash. Going forward, SPG has specifically said it wants to expand within the US and more importantly, grow its international presence. In 2008, SPG opened three Premium Outlet centers internationally; one each in China, Japan and Italy.

REITs such as General Growth became so highly leveraged that it now cannot afford to make its debt payments and has no cash on hand to do so. Because of this extreme leveraging, it is unable to get financing for more than a few weeks since the risk of not just default, but bankruptcy, is so large.

If negotiations with bondholders and lenders to alter the terms of their bonds and loans does not work, the next best thing for these companies to do is sell assets. Simon has played it safe over the past forty-eight years and has ample cash to acquire assets at depressed prices from companies in dire need of cash. In addition to cash, it also has approximately $2.4 billion left on a $3.5 billion credit facility. (A note on the credit facility: Simon has closed a deal and issued 17.25 million shares at $31.50 and issued $650 million in senior notes due in 2019. It will use some of the proceeds to pay down part of this credit facility.) With the highest S&P credit rating among regional mall operators of A-, the company has easy access to capital.

Steady FFO Growth

Funds From Operations, or FFO, is a figure used specifically by REITs to define their cash flows from operations. It takes Net Income, adds back in Depreciation and Amortization and subtracts Gains or Losses from the Sale of Property. Since GAAP accounting requires Depreciation and Amortization be subtracted out it may reduce true earnings for REITs because the properties that the REIT owns may actually appreciate over time. It also subtracts out gains or losses on the sale of properties because these are one time charges that are not recurring and do not contribute to the REIT’s ongoing dividend paying capacity. SPG has averaged 10% growth in FFO since 2005.

Going forward, this growth has the risk of decreasing due to the crisis spreading to commercial real estate. However, since SPG’s specializes in retail I think that the risk is lower. This may sound crazy, but if it has been able to weather the past twelve months of poor consumer confidence and spending, I think that the future is a bit brighter.

I don’t necessarily need a ratio or a metric to tell me that maybe the light can be seen at the end of the tunnel. Rather, I need only go to my local mall (coincidentally owned by General Growth) and drive around for ten minutes trying to find a parking spot or visit any Simon owned mall in south Florida and do the same thing. Now, I realize that not everyone is purchasing items, but it is still traffic in the mall and in the stores. My high school soccer coach always said, “you can’t score unless you shoot the ball.” Well, you can’t buy things unless you go to the store. Consumers are out looking for bargains, and by the looks of the things, stores are giving them what they want.

SPG is looking toward the future and management is focusing on being around for another forty-eight years. The company’s diversified portfolio along with the several items above will help it continue to be the strongest player in the REIT sector.

-Patrick Dougherty

Disclosures: None

Comments

[Mad Hedge F...:]

They are swimming against the tide. George Soros says that it is “inevitable” that commercial real estate falls another 30%. Rents are falling, tenant bankruptcies are rising, there is tons of debt to be refinanced for which there is no market, so cap rates are rocketing and “ghost mall” has joined the recessionary lexicon. This all adds up to lower prices. Some credit default swaps are trading at levels suggesting that a major REIT bankruptcy is imminent. I know George is sometimes prone to extreme statements, but this time he may be on to something. If you want a short play, or if you have an existing long position in commercial real estate which you can’t get out of and want to hedge, try a short position in the (IYR), although it has already dropped from $85 to $21. You can also play one of the sicker REIT names like Brookfield Properties (BPO).

Apr 02 03:05 PM

[Joe Friday:]

when it comes to malls, one always needs to keep in mind that it doesn't take many vacancies or bad debt tenants to result in negative cash flow. A typical mall lease is alwasy net net to the landlord, losing a tenant means not only losing base rent, but, in addition the contribution of that tenant towards operating costs and taxes. If you believe that either vacancies will be on the rise, or that rents will be lower on renewal for any maturing leases, then you want to avoid the mall owners. They are at risk. The effect of the retail problems is not immediate, but it is inevitable.
In the case of SPG specifically, one should be concerned about their very large exposure to Macy's. If M closes a significant number of stores, that would be very costly for SPG. In general, SPG is probably a better short than a long.

Apr 02 04:12 PM

[Amateur Hour:]

I respectfully disagree with this analysis on a number of fronts.

You are missing the issue here. What is important is not a REITs ability to cover it's interest exprense, rather it is the ability to roll-over maturing debt that matters. GGPs problem (and SPGs looming problem) is about refinancing risk -- in other words, solvency. Banks won't underwrite roll-over debt in the comming years b/c with the underlying commercial properties declining in value, the LTV won't permit it.

Recent actions by SPG show they are in the beginning of a major crisis. First, if their cash position were particularly stong, they would not have had to distribute 90% of the value of their dividend payment to shareholders in additional equity. Their need to preserve cash comes from weakness, not strength/

Second, SPG recently had to pay more than 400 bps more for senior unsecured financing than they did when they raised twice as much senior unsecured financing last May.

The commercial real estate peak was 18 - 24 months behind the residential real estate peak. The CRE bust will be similarly spaced.

Good luck to all.

Apr 02 06:02 PM

[Adam Sharp:]

$24b in debt and $774 million in cash = strong balance sheet? I disagree, and think any cash they raise/earn will go towards paying that off, not buying up properties.

Costs of borrowing rising (they paid 10%+ on most recent bond issue), property values falling, retailers going bankrupt, consumer spending still falling (YOY, MOM fluctuations are worthless). I'm short SPG still.

They have some great properties, but you have to factor in that debt. No bulls like to mention that.

Apr 02 06:18 PM

[TruthSayer:]

Looks like there are no supporters for your analysis.

I will have to agree with the commentors - SPG is in for trouble. It maybe that SPG is the prettiest horse in the glue factory - nonetheless it will feel pain. I would even venture to say if we do continue on this fake/delayed rebound, people will likely jump on things that are exploding - financials/technology/... - versus the obviously painful commericial real estate play. Real estate in general is clearly understood to be overbuilt.

Apr 02 09:54 PM

[REITBull:]

If I am reading their balance sheet correctly, SPG has $19.7 billion in liabilities and $24 billion in assets. $19 billion of the assests are real estate being depreciated from cost. A large number of their properties were built or acquired over 10 yrs ago, so I assume that there must be some appreciation of these assests. It looks like SPG has about $7 billion in debt rolling over in 09 & 10. Relative to their assets, this should not be a major concern to their solvency.

I agree that the cost of capital is rising (i.e. the 10% offering). But if cap rates are already near 10%, is it unreasonable to think that SPG can reinvest in distressed property and realize a 15% cap rate?

I know there is some pain in the short term. However, 3 years from now, I think I will be happy with my investment at these prices.


On Apr 02 06:18 PM Adam Sharp wrote:

> $24b in debt and $774 million in cash = strong balance sheet? I disagree,
> and think any cash they raise/earn will go towards paying that off,
> not buying up properties.
>
> Costs of borrowing rising (they paid 10%+ on most recent bond issue),
> property values falling, retailers going bankrupt, consumer spending
> still falling (YOY, MOM fluctuations are worthless). I'm short SPG
> still.
>
> They have some great properties, but you have to factor in that debt.
> No bulls like to mention that.

Apr 03 10:00 AM

[mdpath:]

I'm always amazed that when bloggers are so keen on a stock they have no disclosure. why is that?

Apr 03 10:02 AM

[REITBull:]

I am long SPG.

Apr 03 10:17 AM

[This Game i...:]

The author wrote, "The three main reasons why I think Simon will prevail are its consistently high occupancy rates, the poor conditions of competitors such as General Growth Properties (GGP), and strong growth in Funds From Operations (FFO)."

Wrong on all three accounts.

High occupancy is a temporary factor that occurred because retailers signed leases 3-5 years ago during "boom times" in retailing. That is no longer the case.

Competitors failing will result in new owners purchasing the bankrupt malls at a significant discount - thereby enabling the failed malls to offer lower pricing to attract tenants - bringing down the value of all retail properties.

Growth in FFO is a direct result of occupancy and pricing. Both will be down significantly through 2011.

Apr 03 11:08 AM

[Adam Sharp:]

As I understand it, they have $24b total debt. That is including their share of off-balance sheet joint-venture debt. Check page 83 of their 10k (or just search the page for "Contractual Obligations and Off-balance Sheet Arrangements:"):

idea.sec.gov/Archives/...

It states that Simon's "Total Pro Rata Share Of Long Term Debt" is $24.3b.

On Apr 03 10:00 AM REITBull wrote:

>
> If I am reading their balance sheet correctly, SPG has $19.7 billion
> in liabilities and $24 billion in assets.

Apr 03 11:10 AM

[Amateur Hour:]

Also, REIT bull, any assets are recorded at historical prices. CRE properties are declining in value -- don't take my word for it; take a look at the basement price SPG sold a Cinncinati property for in January.

In the short run longs may benefit from the occassional short squeeze or short cover rally, but IMHO you're playing with fire.

In any event, good luck to you and others (on both the long and short side of this).

Apr 03 11:27 AM

[Jason Tillberg:]

Am also short SPG and plan to add more as I covered most early last month.

Spending bubble peaked and will deflate as pointed out by James Quinn recently. I can tell you from living on Long Island, we have more mall space than we could ever possibly need. All the walmarts, targets, kohls, home depots.. it's a complete disaster how many retail stores there are. Couple this with amazon and ebay. Seriously, looking 3 years out, I'm with Celente, malls will be ghost towns.

Apr 03 12:27 PM

[TruthSayer:]

mdpath - your right I should disclose.

I was short SPG got out in low 30's now I am rebuilding my short position in SPG. I am long SRS - selling calls on the rise owning calls on the fall. Short VNO - okay that covers disclosure of the subject -CRE. I wont go into the rest of my port.

Apr 03 12:47 PM

[REITBull:]

Adam,

Thanks for pointing that out on the J.V. side. My apologies. Much of this debt is non-recourse but you are absolutely correct, it is still a liability.

You make a good point about the depreciation of CRE. However, I have a tough time believing that values will drop below the cost of acquisition for properties acquired or built in the 1990's or before. Cincinatti Mills was acquired by SPG as part of a larger acquisition of the Mills Corporation. According to the Wall Street Journal, it was only 60% occupied by non-anchor tenants at the time of sale and was a failed redevelopment long before SPG acquired it. I think it is a bit extreme to use the sale price as an indicator for the entire portfolio.

Apr 03 01:09 PM

[REITBull:]

I should note that the Cincinnati response was directed at Amateur Hour, not Adam.

Apr 03 03:14 PM

[Jeopardy:]

Yeap, many people don't seem to understand how assets on their book are valued.

On Apr 03 01:09 PM REITBull wrote:

> You make a good point about the depreciation of CRE. However, I have
> a tough time believing that values will drop below the cost of acquisition
> for properties acquired or built in the 1990's or before.

Apr 03 09:55 PM

[hook:]

hmmmm. you forgot to mention how bullish it is that SPG will now pay at least 90 percent of their dividends in stock. so holders of equity in a business that is slowing down get to own a larger piece of the business and be diluted in the process. real bullish...

Apr 05 11:06 PM

[Jeopardy:]

I will be very interested to see some data on the weighted average acquisition date on their real estate holdings.

Apr 06 07:42 PM