Mall real estate investment trusts (REITs) have been in the center of two storms, and it's not been pretty for them. In fact, the coronavirus pandemic, the second storm, finally pushed some of the worst-positioned players into bankruptcy court. But one mall REIT has stood above the rest and, despite the difficulties, looks well worth owning for more aggressive investors. Here's a look at this survivor and why you should buy it now.
If you had to boil the problem for mall REITs down to one single issue, it would be the growth of online shopping. That, however, doesn't really get to the crux of the issue. Before the 2020 coronavirus pandemic, shopping over the internet was a slow-growing trend. But it was having a notable impact on the retail sector, which was spilling over into the mall REIT space because troubled retailers were going bankrupt and shutting stores.
Although often dubbed the retail apocalypse, this troubling turn of events in the retail sector involved more than just online shopping. Indeed, retailers were falling behind customer wants and needs in more ways than one, including factors like design choices, and sitting on heavily leveraged balance sheets. Weak operating results and too much debt tipped the scales in a bad way. The coronavirus pandemic basically sped up this preexisting trend.
Malls across the board were left with empty holes to fill -- too many holes. And, on top of that, malls were considered nonessential during the pandemic and got shut down, leading to further difficulties on the rent collection front. Penn REIT and CBL & Associates fell into bankruptcy in 2020. Washington Prime has managed to hold on for longer, but now looks like it will fall, too. But while Macerich (NYSE: MAC), Tanger Factory Outlets (NYSE: SKT), and Simon Property Group (NYSE: SPG) all look like they are in better shape, Simon is the best option today.
A differentiated business
Macerich owns well-located and highly productive malls, and Tanger has a solid balance sheet. Those are positives, but alone neither is exactly a slam dunk. Indeed, Macerich's leverage is high enough that investors should be concerned about its future. And Tanger's malls, while well located and desirable, don't produce the same level of sales as Macerich's malls.
Part of that is related to its focus on outlet centers, which are cheaper to operate, but it's enough of an issue that investors will probably prefer Simon, which owns a collection of well-located and productive enclosed malls and outlet centers. It's basically more diversified than either of the other names here and, on top of that, has the strongest balance sheet in the sector.
But there's more to the story here than that. During the downturn, while its peers were focusing on survival, Simon was looking for ways to improve its business. That included buying a peer with a collection of strong malls and partnering in the acquisition of retailers. Simon is actually positioned to exit this deep industry downturn a stronger company than when it entered it.
There are two important takeaways here. On the mall front, Simon is looking to own the best assets. This is because the mall space is due for a shakeout, with smaller malls in less desirable locations very likely to get shut down. The same is true of secondary malls in desirable areas. The remaining malls will become more important destinations for retailers and for customers. Simon is positioning to own those assets.
On the retailer front, Simon's play is more nuanced. It's likely hoping to ensure iconic retailers like Brooks Brothers and J.C. Penney remain in its malls. That will help with occupancy, given that full malls are far more desirable than half-empty ones. However, there's also the online angle to consider, as these retailers operate physical stores as well as digital ones. So Simon is also reaching into the digital space with this move.
It would be a mistake to read too much into this retail push, given that owning malls is still Simon's core business. However, being a part owner of retailers with online businesses will provide important insights for Simon as it moves forward in a world that's increasingly digital. Effectively, it will be able to work hand in hand with the retailers it owns with its partners to figure out the best ways to merge its physical assets with the digital future.
Already back to growth
If you need another reason to buy Simon over Macerich and Tanger, here it is: Simon is the only mall REIT projecting growth in funds from operations (FFO) this year. Macerich lowered its 2021 FFO guidance after first-quarter earnings and is now looking for a year-over-year decline. Tanger's guidance was maintained after the first quarter, but at best suggests break-even results this year. Simon increased its FFO guidance range in the first quarter and, at the midpoint of the range, is calling for 7% FFO growth in 2021.
In other words, its leading industry position is already allowing it to outperform its peers. If you are looking at the troubled mall space today, you should pick the best-positioned name -- and that's Simon.