When it comes to the retail sector, there is one part of the year that reigns supreme: the end-of-year holiday season. For many, it is the make-or-break moment, where outsized sales make up for weaker results throughout the rest of the year. Normally, this doesn't have much to do with retail landlords, but this year could be a very different one for these two retail REITs (real estate investment trusts) and their investors. Here's why you might want to buy National Retail Properties (NYSE: NNN) and Simon Property Group (NYSE: SPG) as the holidays approach.
A little more respect
National Retail Properties is a net lease REIT, which means it owns single-tenant properties for which its tenants are responsible for most of the operating costs. It is a fairly low-risk way to invest in real estate. The company has an incredible track record of success behind it, with a streak of over 30 consecutive annual dividend increases. You don't get to Dividend Aristocrat status by accident. It is a bellwether in the net lease space.
However, something interesting happened in 2020, when the coronavirus pandemic upended the normal functioning of the world. Specifically, National Retail's dividend yield has traded in lockstep with that of peer Realty Income for many years but is currently notably higher. To put a number on that, Realty Income's dividend yield is roughly 4.1%, while National Retail's is 4.6%. While 50 basis points may seem modest on an absolute basis, it is an over 10% difference.
In the early days of the pandemic, National Retail, like most retail-focused REITs, faced material headwinds. However, it muddled through that period in relative stride and is today doing quite well, noting that it collected 99% of its second-quarter rents.
As investors get more comfortable with the strength of the company's portfolio, the discount to peer Realty Income is likely to close. And this holiday season could be the key factor that helps to finally resolve investor concerns here.
Hoping for strong sales
While National Retail is really about investors catching up to obvious business improvements, mall landlord Simon Property Group requires a bit more faith. This REIT ended up cutting its dividend in 2020 because of the impact of the coronavirus, as it had to work closely with its tenants to help them survive. That included adjusting leases so that base rents were lower.
But the key to getting that change done was normally the retailer being willing to increase the percentage rent due to Simon. Percentage rent is based on sales, with the REIT basically getting a piece of the retailer's top line. So, if the holiday season is a good one, Simon will see a big boost to fourth-quarter results. The question is, how likely is that?
There's clearly no way to tell for sure, but Simon increased its earnings guidance in both the first and second quarters. And it increased its dividend in both of those quarters as well. So the REIT is already recovering quite strongly.
Notably, during Simon's second-quarter 2021 earnings conference call, management highlighted that sales have improved dramatically over the past year. But if you remove two well-known, and troubled, tenants from the mix, second-quarter sales were actually higher than they were in 2019.
This is important because it shows that Simon's portfolio of enclosed malls and outlet centers is fundamentally strong. It wouldn't be shocking at all if the percentage rents it collects this holiday season help to push Simon's results toward the top end of its guidance.
Rewarding investors for patience
National Retail and Simon are in very different positions in the retail space. One has recovered strongly, and investors simply need to catch up to what's going on. That should lead National Retail Properties to close the yield gap with peer Realty Income and hopefully give investors a nice share price gain along the way.
Simon is still trying to prove that its business has turned the corner, even after two strong quarters. However, given the increase in the use of percentage rent during the downturn, there's likely to be a material business upside if this holiday season is a good one. Buying before this year's biggest selling season gets underway makes a lot of sense in both situations.