First, malls had to deal with the retail apocalypse. Then there was the coronavirus pandemic in 2020. Investors have been downbeat on this niche of the real estate investment trust (REIT) sector for years at this point. Only malls aren't dead -- at least if you own the right ones. But it's important to understand fashion retailer Chico's FAS' (NYSE: CHS) stance on malls to really understand the value proposition in the mall sector.
A simple line
In a recent investor presentation, Chico's outlined its plans to close around 15% of its stores over the next three years. In 2021 alone, it intends to shutter as many as 45 locations. That's not good news for malls, given that Chico's and sister brands Soma and White House Black Market are staples in the sector. But you have to read more deeply into what is going on to really understand the trends taking shape.
For example, on the same slide in which it outlined its store closure plans, Chico's FAS also stated: "Stores continue to be a strategic asset. Digital sales are typically higher in markets where we have a retail presence." If stores are so beneficial, why close them at all? The answer is that retail is a complicated business.
There are around 1,000 malls in the United States, and they span from high-quality fare located in population-dense and wealthy areas to less desirable assets in rural areas that can't really support a mall, based on some mixture of low population density and low income levels.
Meanwhile, in a few desirable areas, there are multiple malls competing for customers. Usually, one is old and run down but still has legacy tenants, and one is a newer, more desirable property. Some industry watchers expect as much as a third of all U.S. mall properties to get shut down by 2030. That makes total sense, especially as online retail's share of the shopping pie grows.
But that doesn't mean the mall is dead. Chico's plan is basically to close its less productive locations so it can refocus around its best. That's just good business, and it's what every retailer is really looking to do. And, as lower-quality malls close, the remaining higher-quality malls are likely to get more attractive to retailers and consumers. In other words, good malls are set to get even better.
Stick with the best
This is why the bankruptcy of a mall REIT like CBL & Associates was not all that shocking. Its malls aren't all that great, and it had a lot of debt on its balance sheet. It's more shocking that the landlord managed to limp along as long as it did.
The same was basically true of Washington Prime Group. And while Penn REIT (NYSE: PEI) owned better properties, too much leverage was the real driving force behind its bankruptcy.
Macerich (NYSE: MAC) is in comparatively better shape. Its portfolio of properties are among the most productive in the mall space, with sales per square foot prior to the coronavirus pandemic of around $800 (that's more than twice the level that low-quality malls generate). In addition, the REIT's net operating income (NOI) growth was higher than any of its peers.
The landlord owns the type of portfolio that will survive over the long term and, likely, thrive. In fact, during Macerich's first-quarter 2021 earnings conference call, it noted that sales at its properties were 2% above levels seen in 2019. That's definitely not the sign of an untimely death, noting that spending has recovered even though foot traffic is still bouncing back and occupancy levels remain weak. However, there is a risk here on Macerich's balance sheet, with a financial debt-to-equity ratio of around 2.5 times compared to 0.75 times for peer Simon Property Group (NYSE: SPG).
Simon's mall portfolio is larger and slightly less productive, with sales per share foot prior to the pandemic of about $700. Meanwhile, it was second runner-up on the NOI growth front to Macerich. However, Simon used the downturn to its advantage, buying a competitor (the No. 3 name for NOI growth) and investing, with partners, in struggling retailers.
In other words, this financially strong name is likely to exit the downturn in better shape than it entered it. All around, it's probably the best choice in the mall REIT space. In fact, Simon increased its full-year funds from operations forecast for 2021 when it reported first-quarter earnings, and it just announced a nearly 8% dividend increase.
Fear is appropriate
It would be inappropriate to suggest that investors shouldn't be worried about malls. The retail landscape is changing, and the pandemic sped the process up greatly. However, good malls aren't likely to go away anytime soon, so there's still opportunity for well-positioned landlords like Macerich and Simon.
That said, for conservative types, financially strong Simon is probably the best option. More aggressive types, meanwhile, should dig into Macerich's balance sheet before making a final call about the long-term prospects of the company's well-situated mall portfolio.