This is not your grandmother's mall
- Joe Coradino, CEO of Pennsylvania Real Estate Investment Trust (PEI).
He was referring to Fashion District, a ~$420M redevelopment of The Gallery in downtown Philadelphia project - 50/50 JV between PEI and Macerich (MAC) - which opened on 19 September 2019. PEI is a Philly-based company and Fashion District is in their own backyard. It is their biggest project, with sentimental value as PEI acquired the first piece of what is now Fashion District sixteen years ago.
Crowds were building. Officials gathered. The ribbon was cut. Cannons popped confetti into the sky. The Temple University marching band played. After almost 4 years of construction, Fashion District is finally open.
Spanning three city blocks in the heart of downtown Philadelphia, Fashion District will be an immersive, metropolitan shopping experience that combines style, dining, entertainment, and arts. PEI and MAC envisioned a space that would be accessible and inviting for people to come in and explore retail, dining, and entertainment opportunities. As Heather Crowell PEI's Executive VP of Strategy & Communications explains:
For the longest time, you went from the historic district to City Hall without any invitation in, and now we're wide open, we have over 20 new entrances - we used to have three... it's much more inviting.
It is important to note that Fashion District is connected to Reading Terminal, the Pennsylvania Convention Center and SEPTA's Jefferson Station - a convenient, transit-oriented location offering accessibility for millions of Philadelphia residents, commuters and visitors. Fashion District provides direct, weather-protected access to PATCO and the Market-Frankford line as well.
Fashion District aims to truly redefine the national consumer experience and the future of retail. The breakthrough mix of uses differentiates Fashion District. As Tom O'Hern, CEO of MAC notes:
This experience-forward project is a model for what the best retail properties all over the country are becoming: more things for more people, and all in an unbeatable, heart-of-everything location
Fashion District is a major milestone, marquee project for PEI, both in terms of capital invested ($200-210M capital invested, at PEI's share) and anticipated NOI ($15M+ NOI, at PEI's share upon stabilization). PEI's Management anticipates a return to earnings growth following a multi-year aggressive portfolio re-positioning (value-enhancing redevelopments, remerchandising, and anchor replacement program), by reiterating the following assumptions, including Fashion District's annual-NOI contribution of $11-$15M.
Source: September 2019 Investor Update Presentation, slide 18
MAC provides a higher and tighter range ($14-$15.8M) for Fashion District's NOI:
Source: June Presentation, slide 29
In the Q2 2019 earnings release, PEI revealed that Fashion District is anticipated to stabilize at over $18M of NOI (at PEI's share) and also highlighted some key milestones and upcoming densification initiatives:
We are seven weeks away from opening our marquee project, Fashion District, which we anticipate will stabilize at over $18 million of NOI, at our share, representing almost 10% of incremental Same Store NOI. We have taken bold action to create a quality portfolio designed to deliver results over the long term, are on track for a strong 2020 and, while not reflected in our results today, have laid the foundation for growth into the future," said Joseph F. Coradino, Chairman and Chief Executive Officer of PREIT. "We have no unleased department stores in our core portfolio, commitments for 84% of the core mall space impacted by bankruptcy, traffic growing at an average of 5% at our redeveloped properties, a diverse tenant mix comprised of 45% open air, dining and entertainment tenants and sales growing at over 5% to a historic high of $531 per square foot. Our efforts culminate this Fall as we add two trophy assets to our collection, executing on our strategic objective to create a quality platform. Despite a temporary setback, we are on course to execute on the opportunity that we have laid out, including monetizing our multifamily and hotel opportunities to recapitalize the Company.
So far, over 90% of Fashion District's leasable area is committed. The first wave of tenants opened on September 19, 2019, with opening occupancy ~60%. Anticipated year-end 2019 occupancy is ~70% and will scale up to well over 90% in 2021, the year of stabilization.
PEI's Top 6 properties are producing sales of $633 PSF and constitute almost 50% of existing NOI (48.8%).
Source: PEI Supplemental Q2 2019, pg 24
Fashion District is anticipated to generate sales PSF in excess of $700 and form part of PEI's 'Top 7 Malls' list. On a pro forma basis, the Top 7 malls are expected to produce ~2/3 of company-wide NOI. In other words, PEI's Top 7 properties are well into A-Mall territory and deliver ~2/3 of company-wide NOI.
It is important to note that the remaining assets are also of high quality, many of which are also anticipated to reach A-Mall territory once planned redevelopments come online. For example, the table below depicts the status of malls ranked 7 to 12.
Source: PEI Supplemental Q2 2019, pg 24
For example, Dartmouth Mall is already in A-Mall category (i.e. above the $500 PSF mark), Jacksonville Mall and Magnolia Mall are getting there, etc.
Many believe that when PEI commenced with the construction of Fashion District around 4 years ago, the bricks-and-mortar retail sector was a lot healthier. The past few years, there is a widespread misconception that everything in the mall, and brick-and-mortar space in general, is in free fall. However, this is not supported by the data. I recently wrote an article entitled Misleading Headlines In The Mall Space - Things Are Actually Much Better which highlights that the mall sector is actually in much better shape than what the mainstream media suggests. In fact:
In addition, malls are morphing into mixed-use/lifestyle-oriented centers (with less focus on legacy/apparel retail), becoming everything for everybody, catering for the next generation that wants it all in one place. Mall companies no longer focus on just traditional retailers, as the headlines suggest. Now it's all about uses and categories.
This is also exactly what PEI is doing:
Source: September 2019 Investor Update Presentation, slide 11
PEI has no unleased department stores in the core portfolio (perhaps the only mall company to be able to claim such a milestone) and, importantly, redevelopments are working both in terms of traffic and sales. For example:
As a result of a multi-year transformation strategy, PEI's portfolio now consists of a diverse tenant mix comprised of 45% open air, dining and entertainment tenants and sales growing at over 5% to a historic high of $531 PSF. Also, average renewal spreads registered 6.1% for Q2 2019 and small format renewal spreads were up almost 10%.
Be wary of generalizations and extreme negative news in the media. The reality is quite different than what the doom and gloom stories suggest.
Offering a diverse range of flagship, fast-fashion, off-price, branded outlet stores, and first-to-market retail concepts, Fashion District offers mass appeal to a diverse customer base. But it's not just about retail.
There is a dedicated third-floor entertainment zone delivering a destination for engaging and social experiences, featuring Round 1, AMC Theaters, Wonderspaces, and Candytopia. There is also a collection of unique dining concepts, ranging from fast-casual, to sit down, to quick bites and cross-over live entertainment. This includes Market Eats, a collection of restaurants and eateries in partnership with Aramark, offering a modern grab-n-go food market with access to SEPTA's Jefferson Station, as well as City Winery, the brand's seventh location in the country.
There are also co-working spaces including a state-of-the-art 47,000 SF Industrious facility and a 10,000 SF REC Philly, first-of-its-kind co-working space facility for creatives featuring recording studios, visual labs, a podcast studio, rehearsal space, production rooms, meditation rooms, and private conference rooms.
In addition, Fashion District also focuses on Arts & Culture, supporting local talent with mural exhibitions and art installations by local, national and international artists, and initiatives like Uniquely Philly that seeks to better position high-potential, minority and female entrepreneurs with a curated collection of local small businesses with authentic Philadelphia offerings. Also, Fashion District has partnered with various nonprofits including Career Wardrobe, The Food Trust, Philadelphia Music Alliance for Youth (PMAY), and Mural Arts Philadelphia.
All of the above make Fashion District a truly unique mixed-use destination within an amenities-rich environment in the heart of Philadelphia city center, offering fun for everyone and supporting local demand for accessible social experiences.
Source: September 2019 Investor Update Presentation, slide 15
Retail and Specialty offerings include: Aeropostale, A|X Armani Exchange, American Eagle/Aerie, American Shaman, Asics, As Seen on TV, Bella Shoes, Boost Mobile, Burlington, Century 21, Clair de Lune, Columbia, Creative Silver, CXI Currency Exchange, DSW, Eddie Bauer, Express Factory, Forever 21, Francesca's, Gamestop, Guess Factory, H&M, Hollister, Journeys, Justice, Levi's, Nike, Pandora, Perfect Foto, Safe Talk, Samsonite, Skechers, Spencer's, Sunglass Hut, T-Mobile, Talk 'N Fix, Torrid, ULTA, The Vision, Wills Eye Wear, Windsor, YOYOSO, Zales, Zumiez
Dining options include: Starbucks, Market Eats by Aramark, Burger Fi, Chickie's and Pete's, Chick-fil-A, Freshii, La Madeleine, Oath Pizza, Pei Wei, Haagen Dasz, Jamba Juice, Tiffany's Bakery, Auntie Anne's, Beef Jerky Outlet, Big Gay Ice Cream, Dunkin' Donuts, Philly Pretzel Factory, Poke World, Potato Corner, Rolling Cow, Utepia
Entertainment options include:
Arts & Culture & Coworking options include: Art Installations, Streets Dept Walls, Nero One, Uniquely Philly (incl. American Hats LLC, Dolly's Boutique, The Sable Collective, and South Fellini), REC Philly, Industrious
In an SEC filing dated 12 September 2019, PEI revealed that several of the Company's trustees and executive officers, including the Company's CEO, "entered into separate stock purchase commitments...pursuant to which each of them agreed to purchase common shares of the Company in market transactions on the New York Stock Exchange during the period commencing September 17, 2019, and ending September 20, 2019... the aggregate number of shares the Trustees and Officers severally agreed to purchase pursuant to the Commitment Letters is 115,000."
This is already occurring as shown below. It is important to note that these are cash purchases in the open market, unlike previous filings whereby shares were awarded ("grant of restricted shares for no consideration").
PASQUERILLA MARK E purchased 10,000 shares at a price of $5.46 (transaction date: 9/17/2019)
PIZZI CHARLES P purchased 10,000 shares at an average price of $5.3399 (transaction date: 9/18/2019)
Most Lisa M. purchased 1,500 shares at an average price of $5.317 (transaction date: 9/17/2019)
KORMAN LEONARD I purchased 30,000 shares at an average price of $5.2924 (transaction date: 9/17/2019). In addition, at an earlier date, KORMAN LEONARD I purchased an additional 30,000 shares at an average price of $4.7738 (transaction date: 8/26/2019).
CORADINO JOSEPH F purchased 11,200 shares at an average price of $5.334 (transaction date: 9/17/2019)
Crowell Heather purchased 1,500 shares at an average price of $5.33 (transaction date: 9/17/2019)
Aristone Joseph J. purchased 5,000 shares at an average price of $5.46 (transaction date: 9/17/2019)
Ioannou Andrew M. purchased 2,000 shares $5.25 at an average price of $5.25 (transaction date: 9/18/2019)
ALBURGER GEORGE J JR purchased 10,000 at an average price of $5.29 (transaction date: 9/18/2019)
Ventresca Mario C. Jr. purchased 10,000 shares at an average price of $5.2447 (transaction date: 9/18/2019)
DeMarco Michael J. purchased 10,000 shares at an average price of $5.5257 (transaction date: 9/19/2019)
It is important to note that a constant criticism was the lack of insider buys in the open market. I believe it is significant that so many trustees and executive officers are participating, in a coordinated and united manner, sending a clear message to the market that PEI is significantly undervalued. Even though I would like to see more insider buys in terms of magnitude, this is certainly a step in the right direction. Optics matter.
What's more, it is important to highlight that Steven H. Korman, via an SEC SC 13G filing on 20 March 2019 disclosed a 5%+ stake in PEI. Steven H. Korman, associated with Korman Communities, is a well-known real estate developer and philanthropist with roots from Philadelphia. I believe this action speaks for itself.
Management reiterated the dividend is "secure"
PEI's management has constantly reiterated throughout the multi-year transformation program, which started in 2013, that the common dividend is "secure" and provided guidance for the dividend coverage ratio "FFO payout ratio expected to be approximately 60% and FAD payout ratio expected to be below 90% in 2020". This was done once again just a few weeks ago during the September 2019 Investor Update Presentation.
Source: September 2019 Investor Update Presentation, slide 3
As noted above, PEI has several near-term high-impact projects anticipated to generate more than $30M of annual recurring NOI. That's substantial. Fashion District already started producing income as of 19 September 2019. This NOI jump is significant relative to PEI's size and current dividend payments and will provide a substantial boost to per share metrics and the dividend coverage ratio.
PEI currently pays an annual common dividend of $0.84/share, which equates to ~$67M per annum in absolute terms (based on the current share count) and also pays around $27.5M annually in preferred dividends. Therefore, the additional $30M+ NOI boost from growth projects more than covers the entire annual preferred dividends of $27.5M or almost 50% of the current common dividend of $67M per annum. As a result, on a pro-forma basis and based on the current dividend policy, Management's guidance for the FFO payout ratio to be ~60% and FAD payout ratio to be below 90% in 2020 seems reasonable.
Source: September 2019 Investor Update Presentation, slide 19
Due to PEI's presence in densely populated markets, the Company has identified significant opportunity to add over 5,000 multifamily units and over 2,000 hotel rooms to its properties.
Source: September 2019 Investor Update Presentation, slide 4
An extensive multifamily and hotel opportunity allow for further enhancing PEI's mixed-use platform. Also, PEI's densification program provides a clear deleveraging plan since land sales can fetch up to $300M (around 3/4 of PREIT's current market cap!). $200M in proceeds will reduce Debt/EBITDA by 1x, and lower interest payments due to reduced debt outstanding. Note these land sales are non-dilutive since the land plots in question (think excess parking lots and land adjacent to existing malls) do not produce any income.
Growth projects are finally starting to contribute to NOI. Fashion District was an almost 4 years wait whereby PEI invested $200-210M and for 4 years this capital was not generating any income. This changes now. PEI is trading at a fraction of NAV and the dividend is well-covered on a proforma basis.
A large number of insiders are buying shares in the open market using their own money (i.e. not awarded shares), which indicates that the Company's trustees and executive officers also believe the Company is undervalued. It is also a symbolic coordinated move, which coincides with the opening of Fashion District, sending a strong signal to the market. I believe that the opening of Fashion District marks the much-anticipated inflection/turning point, the first step towards NOI and FFO growth. Also, the 5%+ ownership stake disclosed by Steven Korman is also significant, something that arguably went below the radar.
Lastly, looking at historical FFO and CAPEX trends in order to extrapolate future trends for PEI is of limited value. Growth projects are finally coming online (meaning NOI/FFO growth), and consequently, growth CAPEX is set to fall substantially (unless PEI goes on an expansion spree which is not likely). The additional contracted cash flow from growth projects is something that the market has failed to take into account, hence the depressed share price. Once the additional NOI is reflected in the financial reports in the coming quarters, and the FFO trend reverses, I expect substantial dividend yield compression i.e. substantial share price increase. Also, it is important to not lose sight of PEI's densification program, which provides a clear deleveraging plan via multifamily/hotel non-dilutive land sales that could fetch up to $300M (around 3/4 of PREIT's current market cap!). Conventional wisdom dictates that market is forward-looking. Let's see.
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Disclosure: I am/we are long PEI. 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.