Real estate investment trusts (REITs) that own malls have been hit particularly hard by the impact of the coronavirus. There's a good reason for that, but long-term investors shouldn't count this REIT niche out. Yes, you need to be careful about which mall REITs you buy, but it is way too soon to suggest that people are no longer going to the mall. Here's the evidence.
Leading into 2020, the big story for mall REITs was the so-called retail apocalypse. That was the slow-moving trend in which retail stores that weren't keeping up with customer buying habits were closing stores and, in some cases, going bankrupt. However, this was never as simple as a shift toward online shopping. Yes, that's part of the issue, but also playing important roles were stores not providing customers the products they wanted and retailers that had overleveraged themselves. All three pieces were key parts of the puzzle.
In hindsight, the word apocalypse was probably hyperbole, given the slow-moving process that was taking place. However, in 2020, the coronavirus sped things up and "apocalypse" no longer looks like an exaggeration. Helping that along have been the government-mandated economic shutdowns used to slow the spread of COVID-19. Malls, deemed nonessential businesses, have been shuttered. It was particularly bad early in the pandemic, with struggling retailers withholding rent payments and an uptick in retailer bankruptcies.
In fact, the shakeout probably isn't over yet. With the all-important holiday selling season upon us, retailers are going to find out if their businesses have legs or not. There's a very real risk that struggling retailers that don't have good end-of-year results will fall by the wayside in early 2021. In other words, get ready for a bankruptcy spike in the retail sector as the new year gets underway.
While all of that sounds terrible, investors willing to think long term shouldn't panic. Tanger Factory Outlet Centers (NYSE: SKT) owns largely outdoor shopping centers. This is a benefit today since being outdoors helps airflow and reduces the chance of a person catching the coronavirus. Here's the key stat -- September traffic at the company's portfolio was 98% of year- ago levels. And that was achieved despite reduced operating hours. Put simply, people are still willing to go to the mall even in the face of a global pandemic. They're just being picky about the type of mall they go to, favoring the safest (outdoor) facilities until the coronavirus is tamed.
Retailers have noticed, too, according to industry giant Simon Property Group (NYSE: SPG). During Simon's third-quarter 2020 earnings conference call, management noted, "Demand for space in our premium outlet portfolio has been really strong." That said, the company explained that there's an important distinction: Outlet centers that cater to tourists aren't doing as well as those that cater to nearby residents. But that just highlights the key point here: While people may not be traveling because of COVID-19, they are still willing to shop in malls they view as safe.
This information has to be overlaid on the bigger-picture trend in the retail sector to be helpful. The industry is dealing with material headwinds, and weaker malls are likely to get hit very hard. Those malls could go away, noting that CBL & Associates, which generally owns malls in less wealthy and dense regions, was forced to declare bankruptcy not too long ago. So, too, was Pennsylvania REIT (NYSE: PEI), which owns better-located malls but was carrying a heavy debt load.
Essentially, investors willing to look past the current headwinds should consider mall REITs with solid finances and well-located properties. Simon and Tanger both fit that mold. In fact, in the long run, malls closing down will make strong mall REITs even stronger in a reverse network effect. With fewer malls, the ones that survive will become more valuable for retailers and more desirable for shoppers.
Investing when others are fearful
Going against the grain is hard on Wall Street, and investing in mall REITs is definitely not for the faint of heart today. However, the on-the-ground trends at Tanger and Simon suggest that the big story about online shopping isn't killing malls. It's just separating the strong from the weak. No doubt it will be a difficult transition process to a new normal in the retail sector, but financially strong names with well located assets, like Tanger and Simon, are not only likely to survive, but they could very well come out the other side even better positioned than they are today.