Retail real estate investment trusts, or retail REITs, made up one of the worst-performing subsectors of real estate in 2020. As a group, retail REITs declined by more than 25% for the year as lockdowns and tenant bankruptcies weighed on the ability and willingness of tenants to pay rent.
However, with the pandemic (hopefully) about to start winding down as vaccine distribution ramps up, now could be a good time for risk-tolerant investors to look for bargains. Before you start looking for retail REITs to add to your portfolio, here are five things to keep in mind.
Not all retail REITs are in the same category
It's important for investors to note that while 2020 was certainly a rough year for retail REITs in general, there are several subcategories of retail REITs that were affected in different ways. Here's a look at the three main categories and how they were affected.
Mall REITs were the hardest-hit companies in the retail real estate subsector. When the pandemic hit, most malls were forced to shut their doors, even if they had some "essential" businesses operating inside. Plus, most retailers that declared bankruptcy in 2020 were mall-based like Ascena Brands (OTCMKTS: ASNAQ), JCrew, and J.C. Penney.
REITs that primarily own shopping centers generally fared better than mall REITs during the pandemic, especially if their properties are anchored by grocery stores. But shopping centers tend to contain a mix of essential businesses and discretionary retail.
Net lease REITs
Net lease REITs mainly own single-tenant (freestanding) retail properties. Drugstores, restaurants, convenience stores, and dollar stores are common net lease tenants. Top net lease retail REITs include Realty Income (NYSE: O) and National Retail Properties (NYSE: NNN). The key takeaway is that net lease REITs have portfolios composed primarily of essential businesses, so this group was certainly less affected than the others.
One look at 2020 retail REIT performance shows the difference: Mall REITs as a group declined by 37% in 2020. Meanwhile, shopping center REITs fell by 28%, and freestanding retail REITs only declined by about 10%.
Things will get worse before they get better for mall REITs
When retailers go bankrupt, they typically don't close all of their stores right away. And when a large retail chain decides to consolidate its physical footprint, it generally doesn't do it all at once. These things take time to play out.
For this reason, expect things to get worse for many retail REITs (particularly malls) in 2021 before they get better. Don't be shocked or discouraged to see mall REITs report upticks in vacancies for several quarters after the COVID-19 pandemic comes to an end.
The trend towards mixed-use properties will likely continue
One of the most prominent trends in the retail industry (and one many retailers and mall operators learned too late) is that people aren't going to leave their homes for things they can get just as easily online. But if they're already out, they'll still go to physical stores and spend money.
This is why mall operators have been actively adding nonretail elements to their properties, such as hotels, co-working spaces, entertainment venues, and trendier restaurants than you'd typically find in a mall. In other words, if you're staying at a hotel that happens to be attached to the mall, there's a good chance you'll end up shopping. The same is true if you go to see a show at a concert venue inside the mall.
The COVID-19 pandemic accelerated the shift to e-commerce, but there's also pent-up demand for consumers to get out of their homes once it's safe to do so. So I foresee mall operators doubling down on their efforts to create mixed-use destinations instead of just stores.
Invest in liquidity
Even at the height of the pandemic, when all of its malls were closed, nobody worried about whether Simon Property Group (NYSE: SPG) was going to make it through the pandemic. Why? Because with $9.7 billion in cash and available credit, Simon could survive even if the shutdowns lasted for years.
Liquidity like this gives retail REITs a nice safety net in turbulent times. And not just during a global pandemic -- it's entirely possible a deep recession could cause a wave of bankruptcies or vacancies at malls.
Equally important: Liquidity also gives retail operators cash to grow and adapt to the changing retail landscape. There's a reason Simon has been able to add modern amenities and nonretail attractions to its malls while many other mall operators have not -- because the company could afford it.
That's also how Simon was able to scoop up rival mall REIT Taubman Realty Group at a significant discount to its pre-COVID-19 valuation. Investors would be wise to buy into retail REITs with lots of cash and credit available.
There will be opportunities for patient long-term investors
As a final thought, recall that retail was one of the most beaten-down real estate subsectors last year. While this has obviously been a bad year for retail REIT investors, this also means that retail REITs have quite a bit to gain in a post-pandemic world -- especially high-quality retail REITs that are proactively adapting to the new retail landscape.
It isn't going to be a straight path upward, but long-term investors with a high risk tolerance could be handsomely rewarded for adding some of the top retail REITs to their portfolio as the COVID-19 pandemic continues.