It would be a vast understatement to say that 2020 was a bad year for mall-focused real estate investment trusts (REITs). Coronavirus vaccines and reduced economic and social restrictions suggest that 2021 will be a much better year for the property niche. However, "better" is a relative term. Indeed, here's why the hard work is just beginning for mall REITs.
A vital asset class
Malls were facing a crisis before coronavirus swept across the globe. There were too many of them, and people were increasingly choosing to shop online rather than in-person. When the pandemic broke out and malls were forcibly closed by the government as nonessential businesses, the trends in this property niche got even worse. For investors, there was a very real concern that mall REITs wouldn't be able to weather the hit.
The truth is that many malls and mall landlords won't. Already, CBL & Associates and Penn REIT have declared bankruptcy, with Washington Prime looking like it could go the same way soon. But the bigger concern is really what place malls will occupy in the broader retail landscape as the world emerges from the pandemic. The answer is more positive than negative.
For example, Tanger Factory Outlet Centers (NYSE: SKT) noted during its first-quarter 2021 earnings conference call that customer traffic at its largely outdoor centers was back to 2019 levels. In fact, April's foot traffic was higher than the same month in 2019.
Simon Property Group (NYSE: SPG) provided a similarly positive view on its earnings call, noting its open-air shopping centers saw higher sales volumes in March 2021 than in March 2019. Macerich (NYSE: MAC) also saw sales at its properties rebound to pre-COVID levels in the first quarter. This is very good news for these REITs, noting that they collectively own some of the best malls in the country.
However, what it says for the broader mall sector is that the death of the American mall has been greatly exaggerated. Indeed, these properties remain a vital asset class, and there's a future here. As an investor, however, you need to step back and think about what that future will look like. Here are a few things to consider.
1. Good malls and bad malls
Every mall is not created equal. Simon, Macerich, and Tanger have strong assets that are generally located near large, wealthy population centers. Malls in less-populated and poorer regions will likely continue to struggle, with many likely to close for good.
Mall quality is a big part of the problem that has dragged down CBL & Associates and Washington Prime. It's likely to take some time for the shakeout to work through the system, but a lot of the less-desirable malls in the country will, indeed, close in the coming years as retailers increasingly choose to focus their spending on better locations. Until that culling process is complete, the entire mall sector will likely be under something of a dark cloud.
With customers starting to come back to the mall, the next big issue for mall REITs is weak occupancy levels. It's not just mall landlords that have gone bankrupt -- many retailers did, too.
Many retailers that have managed to survive without a trip to bankruptcy court are closing locations (largely in lesser malls, as noted above). Occupancy across the entire mall REIT sector is under pressure. The math is pretty simple: Fewer tenants means less rent, which is bad. So investors should pay particular attention to this important metric in the months and years ahead.
3. The right tenants
As less-desirable malls shut, there's likely to be a reverse networking effect that makes the remaining malls more desirable for tenants and consumers. That's good, but there's more to the retenanting process than just finding willing retailers. A mall is an ecosystem, in which each tenant impacts every other tenant. Indeed, leases often include clauses that tie rent levels to the mall's other tenants and, in some cases, allow a tenant to break its lease if certain retailers close (usually the mall's anchor tenants).
So it's important for malls to carefully curate their list of tenants to make sure the property as a whole is desirable for consumers. Simon is the largest name in the mall space, and the REIT is projecting that it could take until 2023 to get occupancy back to pre-COVID levels. That's a long time, but rushing to fill space would risk turning a desirable mall into an undesirable one if it meant degrading the overall shopping experience. As an investor, you'll want to monitor the types of tenants that mall REITs are bringing into their centers.
A lot of work ahead
The first quarter brought a material amount of good news for mall REITs, most notably the fact that customers are coming back. However, there are still very big issues to deal with in the industry, and it will take some time for the sector to really recover. That includes the ongoing shakeout of lesser mall properties, industry-wide efforts to improve occupancy, and the always vital focus on ensuring that malls bring in the right tenants to preserve the ecosystems that draw shoppers into these properties. It's wonderful that 2020 and the pandemic hit appear to be in the rearview mirror, but there's still plenty of work ahead for mall landlords.