Real-estate investment trusts focused on regional shopping malls have returned 2.14% this year, a respectable showing against the S&P 500’s (.SPX) 0.53% gain.
“The economy has been on good footing for the last few years” and federal income “tax breaks have flowed through to retail sales,” says D.J. Busch, a managing director at Green Street Advisors, a commercial research and advisory firm based in Newport Beach, Calif.
Still, Busch warns that the quality and prospects of regional malls vary considerably. So, investors should do due diligence on properties these REITs own. Green Street’s concerns include the continuing onslaught from online retailers and “uncertainty about how the department store landscape is going to shake out,” he says.
Department stores, which are typically anchor tenants, historically have been growth drivers for malls, but their ranks have been thinned by bankruptcy filings, most recently by Sears Holdings (SHLDQ), and retrenchment by Macy’s (M), J.C. Penney (JCP), and others. “There is too much unproductive retail space in the U.S.,” Busch says. While the nation has 1,000 malls, he estimates that there’s enough demand to solidly support only 300.
REITs can be attractive income vehicles, since they are required to pay out at least 90% of their taxable income to shareholders. Investors seeking yield, however, should approach the sector cautiously, partly owing to rising interest rates that increase the trusts’ borrowing costs.
Many regional mall REITs sport dividend yields in the mid-single digits or higher, as the accompanying table shows, and have solid economic prospects. For example, Simon Property Group (SPG) raised its earnings guidance for its current fiscal year, which ends next month.
Busch says that retail REITs “in general are going through a massive change,” partly to attract younger customers who want different facilities at malls than do older ones. That includes restaurants, movie theaters, and even bowling alleys.
He describes an industry that’s becoming increasingly bifurcated between top-notch properties that have capital to invest in growth and lower-quality ones that don’t. “Lower-quality properties are not getting better,” he says. “High-quality properties are at least stable, if not improving.” Operators with deeper pockets are in a much stronger position. “The capital required to own and operate regional malls has gone up,” says Busch. It’s important to invest in REITs on the right side of that trend.
Coming out of the Great Recession of a decade ago, regional malls steadily improved their financial performance, helped by better occupancy levels. Things flattened somewhat from about 2015 to 2017, but they have improved again over the past 12 to 18 months, says Busch.
REIT-owned regional malls’ same-store net operating income for properties open for at least one year rose 2.1%, on average, in the third quarter, their best showing in 18 months, according to the Nareit, a trade group that represents REITs of all stripes.
Calvin Schnure, senior vice president, research and economic analysis at Nareit, says that malls in which REITs invest are better positioned than those held by others. “There are more potential shoppers with more money to spend in the neighborhoods around a REIT-owned mall,” he maintains. According to Nareit, the average household income within five miles of a REIT-owned mall is $66,148, compared with $60,877 for other malls.
And, Schnure adds, after anchor-store departures, REIT-owned malls “line up new tenants a lot faster than a mall that doesn’t have the population density and the higher incomes in the areas around it.”
Among retail REITs,Simon Property has returned 12% this year, a stellar performance in a group that hasn’t shined. “A lot of the value in their portfolio is in very high-quality centers,” or malls, says Busch. Simon, the largest player by market capitalization and number of malls owned among the five in the table, also benefits from a strong balance sheet, relative to its peers. And it’s a powerful player in outlet malls, a niche Green Street describes as “the most sought-after segment by consumers and retailers.”
The stock’s yield of 4.3% is much lower than those of the others in the table, thanks to stronger price appreciation, but it’s more than twice that of the S&P 500.
Two other prominent higher-end regional mall operators are Macerich (MAC) and Taubman Centers (TCO), which sport higher yields than Simon Property Group. Macerich recently was yielding 6.2%, versus 5.2% for Taubman, but their stocks are both in the red this year.
A big plus for Taubman is that it “owns the highest-quality portfolio in the mall REIT sector,” according to Green Street. One of its crown jewels is The Mall at Short Hills, which caters to a very affluent customer base in northern New Jersey.
Right now, Taubman is doing a major renovation of Beverly Center in Los Angeles “aimed to preserve its competitive positioning,” Green Street notes. Taubman’s asset portfolio extends to South Korea and China.
While the company carries higher debt than Simon Property, sales are rising at its properties. In late October, CEO Robert S. Taubman said sales per square foot were up 5.8% in the three months through September, the ninth straight quarterly gain.
Macerich owns a $17 billion portfolio of “moderate to high-quality malls,” mostly in California, New York, and Arizona, along with three outlet properties, Green Street notes. Over the past few years, the company, which also carries a higher percentage of debt than Simon Property does, has sold lower-quality assets.
In any case, investors shopping for mall REITs should look well beyond the price sticker. Here, as in other real estate endeavors, the old adage holds: What’s crucial is location, location, location.
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