Mall REITs: Get Busy Livin' Or Get Busy Dyin'

Aug. 21, 2019 1:26 AM ETCBL, MAC, PEI, RTL-OLD1, SKT, SPG, TCO, WPGGQ, XRT, SCHH, FRI, FREL, ROOF, KBWY, SRET, PSR, TGT, WMT, GPS, BBWI, KKSNF, TJX, BURL, JWN, XLRE, REET, ICF88 Comments44 Likes

Summary

  • Mall REITs have been conspicuously absent from the ‘REIT Rejuvenation.’ The lone sector in negative territory this year, mall REITs are on pace to underperform for the fourth straight year.
  • Retail apocalypse 2.0? Store closings have unexpectedly surged in 2019 as the combination of higher minimum wages, tariff-related cost pressures, and heavy discounting have pressured margins at softline retailers.
  • The casualties continued to mount last quarter as more than 7,500 store closings have been announced this year with mall-based retailers being hit especially hard.
  • Retail sales data – and mall sales productivity - has actually been solid this year. Accelerating since 2016, sales per foot grew 4.4% in the second quarter.
  • The bifurcation between top-tier and lower-tier mall REITs continues to widen. While some malls are thriving, we believe that dozens of low-productivity malls are a recession away from extinction.
  • This idea was discussed in more depth with members of my private investing community, iREIT on Alpha. Get started today »

REIT Rankings: Mall REITs

In our REIT Rankings series, we introduce and update readers to each of the commercial and residential real estate sectors. We rank REITs within the sectors based on both common and unique valuation metrics, presenting investors with numerous options that fit their own investing style and risk/return objectives. We update these rankings every quarter with new developments for existing readers.

REIT rankings malls

Before we begin, we’re excited to announce that we’re teaming up with iREIT to cultivate the premier institutional-quality real estate research service on Seeking Alpha. More information is provided at the end of the article.

Mall REIT Sector Overview

In the Hoya Capital Mall REIT Index, we track the seven mall REITs, which account for roughly $50 billion in market value. Simon Property Group (SPG), Macerich (MAC), Taubman Centers (TCO), Tanger Factory Outlets (SKT), Washington Prime Group (WPG), Pennsylvania REIT (PEI), and CBL & Associates (CBL). Having once represented as much as 15% of the REIT broad-based real estate ETFs (VNQ and IYR), mall REITs now comprise just 6% of the major indexes. Investors seeking direct exposure to retail real estate can do so through the Benchmark Retail Real Estate ETF (RTL).

mall reit overview

Together with their REIT sector brethren, the open-air Shopping Center and Net Lease REITs, retail REITs are one of the four “major’ real estate sectors along with residential, office, and industrial REITs. Once heralded as a perennial outperformer, mall REITs have had a tough decade, to say the least, as the rapid growth of e-commerce has sent shockwaves through the broader retail industry. While nearly 90% of total retail sales are still completed through the traditional brick and mortar channels, e-commerce sales account for roughly a fifth of “at-risk” retail categories, which exclude food, auto, and gasoline sales and brick and mortar retailers have been losing share at a rate of roughly 1% per year. The market share loss has been even more significant for the traditionally mall-based retail categories including department stores, clothing, sporting goods/books, and electronics retailers.e-commere retail sales

A theme that we’ll discuss throughout this report, store closings have unexpectedly surged in 2019 as the combination of higher minimum wages, tariff-related cost pressures, and heavy discounting have pressured margins at softline and specialty retailers. Coresight Research has tracked more than 7,500 closings so far this year, already outpacing the full-year count for 2018, and estimates that up to 12,000 could announce closings by year-end. A potential saving-grace for a retail sector, following a development boom during the 1990s and early 2000s, very little new retail space has been created since the recession. Despite that, the US still has more retail square footage than any other country in the world. Elevated levels of store closings in recent years, spurred by the rise of e-commerce, have created ample "shadow supply" of recently vacated space which has negatively impacted retail REIT fundamentals.

mall REITs 101

As we discussed in our recent commentary, we've become quite a bit more bearish on the retail sector over the last year and a half, given the disappointing fundamental performance amid an otherwise ideal macroeconomic backdrop. In 2018, brick and mortar retail sales grew at the strongest rate since 2012 yet mall REITs have been the worst-performing REIT sector since the start of last year. With near-perfect conditions for retail outperformance, we had expected the recently underperforming mall REITs to turn a corner last year, but the particularly weak operating performance from lower-quality mall REITs dragged on the indexes.

Mall REIT Stock Performance

Mall REITs have been conspicuously absent from the ‘REIT Rejuvenation’ that has lifted the long-sputtering REIT sector in 2019. Pressured by the unexpected surge in store closings, weakening department store performance, and mounting fears of a global economic slowdown, Mall REITs are the lone sector in negative territory this year. Malls have dipped 13% so far this year, underperforming the broader REIT index by a whopping 36%. By comparison, the SPDR S&P Retail ETF (XRT) has declined by roughly 6%.mall REIT performance 2019

Mall REIT investors, unfortunately, have become all-too-accustomed to underperformance. After having outperformed the REIT average in five of six years between 2009 and 2014, the mall sector is all-but-certain to stretch it’s streak of underperformance to four straight years. Mall REITs won’t be alone in the basement of the REIT sector, as shopping center REITs look poised to match this stretch of underperformance this year. As if mall REIT investors needed any more salt rubbed into the wounds, mall REITs have returned -22% since the start of 2016 while e-commerce giant Amazon (AMZN) has gained 170% in that time.

real estate sector total returns

Simon Properties was the lone mall REIT in positive territory in 2018, but even the high-productivity mall REITs haven’t been immune from the intense pressure on the sector in 2019. Remarkably, the 36% YTD underperformance for the mall REIT sector may give the sector too much credit due to the heavy weighting applied to Simon. Taking a simple average, the sector has underperformed by a staggering 50% this year, dragged down by perennial “yield-chaser” favorites, CBL and Washington Prime, which are off by more than 30% in the last quarter alone.

mall reits

Mall REIT Fundamental Performance

You wouldn’t know it from the share price performance, but 2Q19 earnings were actually - dare we say - pretty decent for the mall REIT sector. On a weighted average basis, same-store NOI growth rose 1.7% while tenant sales per square foot rose 4.4%, each continuing a reacceleration after bottoming at the depths of the “retail apocalypse 1.0” in 2016. Led by the 32% surge from Simon, leasing spreads surged 28% last quarter, by far the best spread of the post-recession period. As expected given the rash of store closings in 2019, occupancy declined but has generally hung tough, dipping a modest 30 basis points from last year. Occupancy costs continued to trend in a positive direction as well with three of the six REITs that report the metric seeing improvement.mall REIT

A theme that we’ve discussed for many years, there has been a significant and widening divergence in fundamentals and stock performance between higher-productivity mall REITs and lower-productivity mall REITs since the end of the recession. While we cited the cap-weighted performance of the mall REIT sector above, investors choosing single-names in the sector – apart from Simon Properties - probably didn’t fare nearly as well. Low-quality mall REITs saw a 6.3% dip in same-store NOI growth and a 5.3% decline in leasing spreads. Outlet and average-productivity centers have struggled as well, but have better long-term prospects than the lowest-tier REITs.

mall REIT

While we’re still waiting on the final official tallies from NAREIT’s T-Tracker data on the second quarter, retail REITs were the lone major real estate sector to see negative occupancy in the first quarter, dipping 40 basis points on a year-over-year basis, and given the store closings outlook for the rest of 2019, there may be more pain ahead, particularly in the mall segment. The sector has seen generally declining same-store occupancy since peaking in 2015 at above 96.5%. The decline in occupancy is likely understated, however, as retail REITs have actively "recycled" underperforming properties and held low-occupancy properties for sale, outside of the same-store metrics.

mall real estate

While mall REITs have also been net sellers since 2015, there has been limited transaction activity across the mall sector over the last half-decade. A relatively less liquid market than the shopping center sector, REITs own more than half of all malls across the United States, and individual assets rarely change hands. Over the last twelve months through 1Q19, mall REITs sold a net $500 million in assets after having sold a combined net $300 million in full-year 2018.

REITs sellers As mentioned above, the saving grace of the mall REIT sector over the past half a decade has been record-low new development. Significant amounts of "shadow supply" from recent and future store closings persist across the sector, however. New supply growth has averaged less than 0.5% of existing stock per year since the recession, helping the industry absorb this ample "shadow supply" from vacated stores. For the high-productivity mall REITs, namely Simon, Macerich, and Taubman, redevelopment remains a substantial source of untapped long-term value. Top-tier retail assets are ideal for the “live-work-play” mixed-use residential expansion and there are a handful of highly successful redevelopments from these three higher-productivity REITs.

retail reit development pipeline

Macro Retail Sales Trends & Outlook

Mall REIT investors, particularly in the average and lower-quality mall REITs, hope that this retail earnings season could be a positive catalyst to stop the bleeding. Lousy results from Macy’s (M), JC Penney (JCP), and Dillard's (DDS) last week, however, damped hope and further amplified to the selling pressure as department stores continued their downward spiral after showing signs of life last year. While higher-productivity mall REITs have had success in repurposing vacated department store space into higher-productivity uses including high-rise residential and office space, lower-tier mall REITs are generally far more dependent on the success of their department store anchor tenants.

retailer sales

After reaching the fastest rate of growth since 2012 in the middle of last year, retail sales growth has generally moderated over the past several months, but data has been relatively strong this summer despite the volatility seen in the financial markets. Retail sales beat estimates last month led by a surge in e-commerce sales, no doubt related to Amazon's Prime Day which did more sales volume on the site than Black Friday and Cyber Monday 2018 combined, according to Amazon. Brick and mortar retail sales have been decent but clearly slowing this year with the performance of individual retailers continuing to diverge, as illustrated by strong results this week from Walmart but comparative weak numbers posted by Macy's.

retail sales growth

As we’ve discussed in our weekly macroeconomic reports, for retailers, the more significant issue over the last two years has not been on the demand-side, but rather on the expense-side. Before even considering the margin hit from tariffs and excess inventory, labor costs have risen considerably over the last two years as eighteen states raised their minimum wage in 2018 and many cities (largely in already high-cost markets) have raised minimum wages over the last two years, oftentimes far above market rate, which has begun to result in retail job cuts and store closures. Hourly earnings surged to 5% in early 2019, outpacing the roughly 3% growth in retail sales, while retail job growth has been negative on a year-over-year basis for all of 2019.

retail sales 2019

While the majority of the store closings (on a square footage basis) over the last five years were concentrated in the anchor and big-box space, more than half of the store closings so far in 2019 have been in the specialty categories, suggesting that smaller businesses have been hit especially hard by minimum wage pressures. While hardline and food retailers tend to be somewhat immune from e-commerce related disruption, softline and specialty retail categories are generally more at risk. During the so-called "retail apocalypse" of 2016-2017, these categories were particularly weak. After recovering nicely throughout 2018, these softline and specialty retailers have again fallen on tough times this year.

softline retail

Mall REIT Valuations

As they have for most of the past half a decade, retail REITs screen as fairly attractive across most traditional REIT metrics. The past half-decade has been particularly challenging for “value” investors in the REIT space as lower-yielding and higher-growing REITs have substantially outperformed since 2014. Now powered by data from iREIT’s REIT Terminal, we illustrate that mall REITs are the second "cheapest" REIT sector based on Free Cash Flow (aka AFFO, FAD, CAD). Mall REITs continue to trade at a wide NAV discount, estimated at 20-30% based on consensus estimates.

mall reit valuations

Mall REIT Dividend Yields

Mall REITs have quietly become the highest-yield REIT sector, but not for the right reasons. Based on dividend yield, mall top the charts, paying an average yield of 6.3%. Mall REITs have significantly scaled back the pace of dividend growth over the past half-decade, choosing to retain an average of 30% of their remaining free cash flow.

mall reit dividends

Within the sector, more than other REIT sectors, investors need to be cautious not to fall into common "value traps" by assuming that high dividend yields can offset declining price returns. As we've pointed out for the past several years, despite paying double-digit dividend yields, REITs like CBL, PEI, and WPG have wiped out any yield premium many times over.

mall reit dividends

Factor Sensitivity of Mall REITs

Mall REITs tend to exhibit more growth-like qualities than other real estate sectors and respond favorably to a strong economy regardless of its impact on interest rates. Mall REITs exhibit slightly above-average sensitivity to the equity market and below-average sensitivity to the 10-year Treasury yield.

mall REITs interest rates

Bull and Bear Thesis for Retail REITs

While mall REITs get more than their fair share of negative headlines, there are a handful of reasons to be bullish on the long-term prospects for the mall REIT sector. Recognizing the challenges of the pure-play online retail strategy, more retailers have embraced the "brick and clicks" omnichannel retail strategy, including e-commerce giant Amazon through their heavy investment into Whole Foods. There's been very limited new construction of retail real estate space over the last decade and high-productivity retail REITs continue to find accretive yields in redeveloping vacated store space into higher-value mixed uses, including multifamily and experience-based retailers. Below, we outline the five reasons that investors are bullish on mall REITs.

bullish mall REITs

While the "retail apocalypse" may have been exaggerated, mall REITs continue to be challenged by broader secular headwinds, pressures that have intensified in 2019. Store closures have surged this year as retailers deal with a myriad of pressures including tariff concerns, rising minimum wages, and excess inventory. Downsizing retailers have focused their investment on higher-performing stores and have continued to close weaker-performing stores in lower-tier malls and retail centers. As we often discuss, valuations can be self-reinforcing in the REIT sector and cheap REITs tend to stay cheap as low equity valuations make it more challenging to raise the capital needed for redevelopment and external growth.

bearish mall REITs

Bottom Line: Get Busy Livin’ or Get Busy Dyin’

Mall REITs have been conspicuously absent from the ‘REIT Rejuvenation.’ The lone sector in negative territory this year, mall REITs are on pace to underperform for the fourth straight year. Retail apocalypse 2.0? Store closings have unexpectedly surged in 2019 as the combination of higher minimum wages, tariff-related cost pressures, and heavy discounting have pressured margins at softline and specialty retailers.

The casualties continued to mount last quarter as more than 7,500 store closings have been announced this year with mall-based retailers being hit especially hard. Believe it or not, retail sales data – and mall sales productivity - has actually been solid this year. Accelerating since 2016, sales per foot grew 4.4% in the second quarter.

Despite modest signs of improvement, we remain negative on the retail sector given the disappointing fundamental performance amid an otherwise ideal macroeconomic backdrop. The bifurcation between top-tier and lower-tier mall REITs continues to widen. While some malls are indeed thriving, we continue to believe that dozens of low-productivity malls are a recession away from extinction.

If you enjoyed this report, be sure to "Follow" our page to stay up-to-date on the latest developments in the housing and commercial real estate sectors. For an in-depth analysis of all real estate sectors, be sure to check out all of our quarterly reports: Apartments, Homebuilders, Student Housing, Single-Family Rentals, Manufactured Housing, Cell Towers, Healthcare, Industrial, Data Center, Malls, Net Lease, Shopping Centers, Hotels, Office, Storage, Timber, and Real Estate Crowdfunding.

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