The COVID-19 outbreak has had an outsized impact on a handful of commercial real estate subsectors. Among the hardest-hit groups have been retail properties. Many physical stores had to close earlier this year to help slow the spread, which has impacted their ability to generate sales and pay rent.
That's had a trickle-down effect on retail real estate investment trusts (REITs) as it hit their income, occupancy levels, and rental rates. It could take years for some of them to recover, which is why investors might want to consider selling the sector's weakest links. Three in that category are RPT Realty (NYSE: RPT), Kite Realty Group (NYSE: KRG), and Whitestone REIT (NYSE: WSR).
A long road to recovery
Shares of RPT Realty have lost more than 60% of their value this year due to concerns about the impact of COVID-19 on its operations. Only 41% of its tenants were open in April, which has affected rent collection. While both tenant openings and rental collection rates have improved, the company remains well short of 100% in both categories due in part to its exposure to bankrupt tenants. Because of that, its NOI is under pressure.
That's a concern given the company's weak balance sheet. It has an elevated leverage ratio of 7.0 times net debt-to-EBITDA (most REITs target leverage of less than 6.0 times) and a substantial amount of debt coming due over the next two years (8.4% of its total debt outstanding). While the company does have $250 million in cash -- more than enough to cover those maturities -- that's because it tapped its credit facility earlier in the year out of an abundance of caution. Combine the deterioration in the retail sector with this REIT's weak credit profile, and it could struggle to create shareholder value in the coming years.
Same story, different REIT
Kite Realty Group has many of the same issues as RPT Realty. While the REIT does have an investment-grade credit rating, it's at the very bottom rung due to its elevated leverage ratio of 7.1 times net debt-to-EBITDA. On a more positive note, it has no debt maturities until 2022 and enough liquidity to meet those coming due through 2025.
However, that high leverage ratio will likely keep the weight on Kite's stock, which has lost almost 40% of its value this year. Another issue that will keep the pressure on the company is low rental collection rates. The REIT received 80% of the rent it billed during the second quarter and signed agreements to collect another 11%. Unfortunately, it wrote off 7% as bad debt. While those numbers should improve, the company has lots of exposure to financially troubled tenants like restaurants, fitness centers, and nonessential retailers. More of those companies will likely declare bankruptcy in the future due to the fallout of COVID-19, which will affect Kite's occupancy, rental rates, and NOI. Combine those two issues, and it's hard to see this REIT creating outsized shareholder returns from here.
Slowly digging out of debt
Whitestone REIT is even deeper in debt as it began this year with an 8.6 times debt-to-EBITDA ratio. That's a long way from its target to get leverage down to between 6.0 and 7.0 times EBITDA, which it doesn't expect to hit until 2023.
It's taking a three-pronged approach to addressing its balance sheet issues:
- Grow cash flow by leasing up vacant space and increasing rental rates.
- Selectively sell debt-laden properties.
- Fund future acquisitions with less debt.
Unfortunately, there are some holes in that strategy. First of all, it will be tougher to lease space at higher rates in the current environment, given the flood of retail bankruptcies this year. Second, it will be hard to sell highly levered properties at a decent value in the current market. Finally, it won't be easy to finance acquisitions with less debt unless it issues more stock, which would be highly dilutive following the nearly 55% decline in its share price this year.
That potential for dilution is a concern given the company's plan to ramp up its acquisition volume from an average of less than $50 million in recent years to more than $200 million post-pandemic, which is a lot for a company with a roughly $250 million market cap. If it does use its beaten-down stock as currency to go on a buying binge, shares might never recover their lost ground from this year.
Not exactly high-quality merchandise
Physical retail was already in trouble before the COVID-19 outbreak levied a crushing blow to even more retailers. Because of that, retail REITs will struggle with even lower occupancy levels and rental rates. That will have a greater effect on those with weaker balance sheets, which will hold back their ability to recover. That's why investors might want to think about selling more vulnerable retail REITs like RPT Realty, Kite Realty Group, and Whitestone REIT and redeploying that capital into companies better positioned to withstand the apocalyptic conditions in the retail sector.