From Vacancies to Viability: How Top Retail REITs are Leveraging the Return to Malls

In the past decade, many experts have agreed that most brick-and-mortar stores will eventually close, and consumers will do the bulk of all their shopping online. Asset manager ProShares even launched an ETF, Long Online/Short Stores (CLIX), in 2017, enabling investors to invest in online retailers and short traditional companies. The fund’s top long bets are Amazon.com (AMZN) , Alibaba Group Holdings LTD.-sponsored ADR (BABA) , eBay (EBAY) , Wayfair (W) and Overstock.com (OSTK). The short positions include Designer Brands (DBI) , Genesco (GCO), Big Lots (BIG) and Sherwin-Williams (SHW). 

On its website, ProShares writes that "Physical retailers are under immense pressure. In general, profit margins and return on assets have been declining for years, currently approaching the lows of the Great Recession. Over 80 major retailers have declared bankruptcy since 2015, and longstanding names like The Gap (GPS) and Macy's (M) are struggling to remain viable." As of July 31, the total return is 30.7% year to date, -1.98% for one year, and -23.03% for the three-year period.

Sobering Statistics

According to CapitalOne Shopping Research, as few as 700 large shopping malls remained in the U.S. in 2022. Malls had an 8.7% vacancy rate at year-end 2022, and an average of 1,170 shopping malls closed each year between 2017 and 2022. Malls face another headwind because more than 12 U.S. major retailers have announced plans to close 2,373 stores in 2023, according to Business Insider. The reasons for the closures varied from bankruptcy, efforts to reduce costs, and an attempt to reconfigure store formats to cope with changing shopping trends. The companies with the most store closings included Bed Bath & Beyond (BBBYQ), with 896 stores, and Foot Locker (FL), with 545 stores, most in shopping malls.

Silver Lining Among the Clouds

Despite the doom and gloom, Coresight Research reports significant growth for brick-and-mortar stores in 2022, as more stores opened than closed, a first since 2016. According to Coresight’s The State of the American Mall report, malls’ revenues climbed more than 11% in 2022 to about $819 billion. The firm reports several good yardsticks of robust mall performance. At year-end 2022, mall occupancy was 95.1%, compared to 92% in 2020. Foot traffic increased as well. Traffic at top-tier malls (featuring luxury brands and more affluent shoppers) rose 12% in 2022 over 2019, while traffic at non-top-tier malls (centers with a missing anchor tenant) climbed 10% in the same period.

Retail REITs

Real estate investment trusts (REITs) are significant owners and operators of regional malls, shopping centers and brick-and-mortar stores that retailers require to operate their businesses. Many REITs own properties that are leased to retailers. However, the National Association of Real Estate Trusts (NAREIT) reports that 32 publicly traded REITs concentrate on portfolios of retail properties. There are also private REITs, who invest in several sectors. While it’s true that a growing number of consumers rely on online shopping for their needs, numerous retailers still rely on physical stores for consumers who prefer to select merchandise in person.

Retail REITs generally specialize in a property type and tenant base. Retail REITs’ main income comes from leasing space to retailers, service providers and other tenants. Most retail REITs use gross leases and charge tenants a set monthly rent. The REIT calculates rent by adding the store's square footage and a pro-rated portion of the common area. 

REITs that own freestanding stores use triple net leases. In these leases, the tenant pays the core rental rate, building insurance, taxes and building maintenance. Triple net lease contracts allow REITs to achieve stable cash flows. The top REITs have endeavored to protect their portfolios from harsh economic headwinds, and these equities can be a safer way to invest in the overall expansion of retail sales.

A Top Retail REIT

Simon Property Group (SPG)’s holdings include upscale shopping, restaurants, entertainment and mixed-use destinations. It owns properties in North America, Europe and Asia. The company owns interests in 231 properties that feature malls and premium outlets with 185 million square feet of space. The total market value of its portfolio is more than $80 billion.

Like many retail REITs, Simon's mall holdings coped with many challenges in the past three years because of the rise of e-commerce and store closures due to COVID-19. These factors have negatively impacted occupancy, rental rates and the rental collection rate. The company is well positioned to profit from robust growth of traffic at its high-end malls.

Nevertheless, Simon has proactively invested in its malls and created mixed-use developments, such as office buildings and hotels. These investments have helped to develop new revenue streams and boosted mall traffic.

For example, at Simon's King of Prussia Mall, near Philadelphia, the company expanded the square footage by 155,000 feet in 2017 and, as a result, signed 50 high-end retailers such as Cartier and Jimmy Choo. 

The company’s shares are trading at 16.98 times earnings and 6.72 times sales. In the last three months, nine ranked analysts, including analysts at Goldman Sachs and Morgan Stanley, set 12-month price targets for SPG. The average price target among the analysts is $127.80, compared to its current price of $113.53. Another sign of value is that the company's enterprise value compared to earnings before interest and taxes (EV/EBIT) is 15.45.

On August 2, Simon reported second-quarter funds from operations (FFO) of $2.88 per diluted share, down from $2.91 a year earlier. The consensus number, according to analysts polled by Capital IQ was $2.92. FFO is used with REITs to compute the cash flow from their operations.

However, second-quarter revenue was $1.37 billion, compared to $1.28 billion a year earlier. Three analysts surveyed by Capital IQ expected $1.24 billion. Company executives said it expects 2023 FFO between $11.85 and $11.95 per diluted share, compared with the $11.80 to $11.95 range provided in May. Analysts polled by Capital IQ expect $11.91. In addition, the company declared a quarterly dividend of $1.90 for the third quarter. The dividend represents a robust yield of 6.58%. 

Another positive indicator was the 94.7% occupancy rate at the company’s malls and premium outlets in the second quarter, up from 94.4% in the first quarter. The base minimum rent per square foot was $56.27, compared to $55.84 last quarter.

The company also has a strong trend of insider purchases. The last SPG insider purchases happened when ten insiders purchased 2,636 shares this past June. In the previous four years, insiders have, on average, purchased 97,792 shares annually.

Ilir Salihi is the founder and senior editor of IncomeInsider.org. You can read more of his content on the IncomeInsider blog here.