Taubman: The China Syndrome

| About: Taubman Centers, (TCO)


Taubman is a highly focused U.S. mall REIT.

But it is starting to expand into Asia, specifically China and South Korea.

This is both an opportunity and a risk for Taubman.

Image Source: Taubman Centers

When it comes to mall real estate investment trusts, or REITs, I have a preference for smaller, more focused operators. Taubman Centers (NYSE:TCO) with around 20 or so malls is a mall REIT I highlight often. But the company is making a big, and potentially risky, bet right now: Asia.

What's to like?

One of the main reasons to like Taubman is its highly focused portfolio. With just 20 or so malls, it has to ensure that its facilities are operating at a top notch level and that they continue to evolve with the market. With sales per square foot that lead the industry, Taubman has clearly proven it can do a good job of running its malls.

Then there's Taubman's history. Taubman has not only been in the mall space for a long time, but the company has also been a leader in introducing new products to market. Food courts are a great example. So not only does Taubman run great malls, but it's also an innovator.

This is all great information in the U.S. market. But Taubman's innovation, if you will, has taken it to China and South Korea. To be fair, Taubman isn't alone in its Asian drive. Simon Property Group (NYSE:SPG) is also in the region, with operations in Japan and South Korea. But Simon has over 200 malls. If it makes a mistake, the impact isn't going to be as big a deal. With just 20 or so malls, a misstep in Asia could be a very big deal for Taubman.

Image Source: Taubman Centers

This is the year

Both Simon and Taubman are using joint ventures to gain exposure to the Asian markets of their choice. That helps offset some of the risks, but clearly not all. For example, they have a partner with boots on the ground and, more important, they aren't on the hook for the entire cost of the project. Taubman's ownership stake in its two projects in China and the one it's helping build in South Korea range from 30% to a touch under 35%. Simon's ownership of one project each in Japan and South Korea ranges between 40% and 50%.

Another interesting fact here, however, is that Taubman isn't exactly new to either of these markets. It manages a mall in China and another in South Korea. It doesn't have ownership interests in these properties, but it does provide the company with its own knowledge base about these markets. So it isn't as if Taubman is going in blind; it has some idea of what to expect.

But there are two important issues to keep in mind right now. First, the three development projects Taubman is working on are slated to open in 2016. The rubber is hitting the road as you read this... The second is that the mall market in China, just like every other property market, has been built up more quickly than it appears the local economy can support. So Taubman will have to work hard to make its Chinese malls a success.

For example, The Wall Street Journal recently ran an article highlighting that two-thirds of the world's shopping center construction is taking place in China. And that malls in the country are already having trouble getting stores and customers into their malls. Malls are working overtime to get bodies in the doors, including adding such things as giant slides, animal farms, and, in one case, a beach.

So Taubman is entering into a market that's already crowded, and looks like it will only get more so. And competition is fierce. There's no way around it, this is a risky move and a misstep in Asia could easily overshadow the REIT's success in the U.S. market. If Simon makes a similar mistake in the region, the problem would get diluted away by hundreds of other malls. So if you own Taubman or are considering buying it, you'll want to keep a close eye on Asia.

Image Source: Taubman Centers

One man's rubbish

The old saying that one man's garbage is another man's gold isn't exactly perfect here, but it gets the idea across. Although Taubman is taking on a lot of risk with what is a pretty bold step into Asia, particularly China, if these malls succeed, Taubman will wind up with a strong toehold in what is expected to be one of the largest retail markets in the world. And, as with every mall Taubman owns, its small size is a big reason to make those Asian malls work. That doesn't mean they will turn out to be successful, but it's a bit different from a REIT like Simon where the relatively small impact of a single mall makes it easier to "cut and run" and, just as important, dilute the benefit of a success.

Kin Powell, a frequent reader and commentator on my articles, prodded me to write this article. From day one, he's pushed the risks Taubman faces in Asia, and he's correct. Taubman isn't a REIT for the risk-averse right now, even though it has a long and successful history in the United States. And the reason is a mixture of its small size, which is a big part of its success, and its Asian ventures, which are an outsized risk because of its small size.

Now, having said all of this, I still think the best-positioned mall REITs are too expensive right now. I would wait for a pullback before considering either Taubman or Simon. The contrarian in me, however, wonders if an Asian misstep might be just what's needed to make Taubman cheap enough to buy. But only time will tell. The last word, however, is what Kin's been saying for some time: Taubman's Asia ventures are a big risk and you'll want to pay attention to these developments if you own or are looking at the REIT.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.