The COVID-19 outbreak has had a devastating impact on the retail sector. With physical stores forced to close, many retailers couldn't generate sales. That made it hard for them to pay their bills, including rent, which impacted their landlords.
While rental collection rates have improved now that most retailers have reopened their stores, that doesn't necessarily mean that retail-focused real estate investment trusts (REITs) are out of the woods. Here's a look at whether the sector is too risky for investors these days.
Sinking cash flow and disappearing dividends
The second quarter was a challenging one for retail REITs. Many experienced big shortfalls in rent collection. For example, Kimco Realty (NYSE: KIM) -- one of the largest owners of open-air, grocery-anchored shopping centers in North America -- only collected 70% of the rent it billed during the second quarter. Meanwhile, West Coast-focused grocery-anchored shopping center REIT Retail Opportunity Investment Trust (NASDAQ: ROIC) received 81.9% of what it billed during the second quarter.
Collections were even worse for REITs that don't focus on owning properties leased to essential retailers like grocery stores. For example, outlet shopping center owner Tanger Factory Outlet Centers (NYSE: SKT) only collected 46% of its second-quarter rent. Meanwhile, mall owner Macerich's (NYSE: MAC) collection rate was 58% and 66% in June and July.
Because of those low collection rates, most retail REITs suspended their quarterly dividend to preserve cash and their balance sheets. They also took several other steps to shore up their financial situations, including pausing development projects, cutting operating expenses, and securing new credit.
On a more positive note, many retail REITs signed rent deferral agreements with their tenants, enabling them to collect those second-quarter payments eventually. Kimco granted deferrals for 18% of the rent it didn't receive and continued negotiating with the remaining tenants. Meanwhile, Tanger agreed to defer 26% of its second-quarter rent, and it's still in discussions with tenants on another 6%. Because of that, these REITs should recoup a large portion of this rent. However, they won't get it all because many retailers have filed for bankruptcy this year. As a result, Tanger already wrote off 9% of its second-quarter rents.
The haves and the have nots
While the COVID-19 outbreak hasn't spared any retail REITs, some have certainly fared better than others. That's due to two notable characteristics: portfolio makeup and credit quality.
As noted, REITs focused on owning shopping centers anchored by grocery stores (and other retailers deemed essential by governments like home improvement and pharmacies) have collected a much higher percentage of their rent. That's because nonessential retailers weren't open and couldn't generate sales to pay their bills.
Meanwhile, having a top-tier credit rating has also helped some REITs navigate the current sector turmoil better than others. For example, Federal Realty Investment Trust (NYSE: FRT) and Realty Income (NYSE: O) have some of the highest credit ratings in the REIT sector. Those strong financial profiles, as well as the fact that they primarily own properties leased to essential tenants, gave them the cushion and the confidence to maintain their dividends this year (both recently raised their payouts, continuing long-term growth streaks).
Conversely, retail REITs that have weaker credit profiles or own properties primarily leased to nonessential retailers haven't fared quite as well this year. Some have had to reduce or suspend their dividends so that their balance sheets don't deteriorate. Meanwhile, others were already in such bad shape that they're struggling to survive.
Some retail REITs are riskier than others
COVID-19 exposed the riskiness of some retail-focused REITs compared to their peers. Those that owned properties primarily leased to essential retailers have collected a much larger portion of the rent they billed than peers that own shopping malls or outlet centers. Meanwhile, having a top-notch financial profile has also proved to be vitally important as it helped cushion the blow of a lower rental collection rate. Because of that, not all retail REITs are risky right now as companies like Federal Realty Investment Trust and Realty Income have stood out for their safety amid this year's storm in the retail real estate market.