This year hasn't gone quite according to plan for retail REIT Simon Property Group (NYSE: SPG). The leading mall owner began 2020 by making a massive contrarian bet the retail apocalypse wouldn't crush the sector by sealing a deal to buy rival Taubman Centers (NYSE: TCO) back in February at a more than 50% premium.
However, the COVID-19 outbreak dashed its bold strategy, forcing it to abandon that deal along with more than $1 billion of other growth-focused investments. It also created a much hazier near-term outlook for the REIT. Here's a look at where it seems headed over the next three years.
A rapid strategy shift
Simon Properties entered 2020 with a strategy focused on transforming many of its existing malls into marketplaces of the future. It had more than 30 projects underway across its portfolio totaling $1.8 billion of investment. These included redeveloping several former department stores into new retail, entertainment, and mixed-use centers. Simon's aim was to transform its malls from shopping centers into live, work, play, and stay destinations.
Simon wanted to extend that strategy to Taubman's mall portfolio. However, COVID-19 forced the company to alter its game plan dramatically. It abandoned the Taubman deal and suspended more than $1 billion of redevelopment and new development projects to preserve its financial strength amid the initial uncertainty. As a result, it currently only expects to spend $160 million on capital projects through next year, which will delay the transformation of many of its properties.
Instead of investing money to refresh its malls, Simon has started buying up some of its bankrupt tenants in hopes of turning them around. It previously partnered with fellow mall owner Brookfield Property (NASDAQ: BPY) (NASDAQ: BPYU) and brand manager Authentic Brands to acquire Aeropostale and Forever 21 out of bankruptcy.
The REIT accelerated that strategy this year. It paired with Authentic Brands to acquire Brooks Brothers for $325 million and Lucky Brand for $140 million, helping keep more stores open to pay rent. Meanwhile, it's partnering with Brookfield Property to buy J.C. Penney (OTC: JCPN.Q) in a deal that values J.C.Penney at around $1.75 billion. That will enable the mall owners to keep more stores open, as well as more control over redeveloping the locations they close.
Hints at what's ahead
Simon has been able to go on the offensive because it has one of the best balance sheets in the REIT sector. It ended the second quarter with $8.5 billion of liquidity, including $3.6 billion cash. It also has a top-notch credit rating. That gives it nearly unparalleled financial flexibility in the sector.
All this means when conditions are right, Simon will likely restart its development program to continue turning its malls into retail centers of the future. One feature the company will invest more money into is enhancing its tenants' ability to complement in-store shopping with fulfillment to serve as distribution, pickup, and return centers for online orders. That means improving curbside pickup options and making it easier for consumers to buy online and pick up or return in the store.
Along those same lines, Simon could convert some vacant department stores into fulfillment centers for online retailers like Amazon (NASDAQ: AMZN). These properties could help Amazon cut down on their last-mile distribution costs and speed up delivery times due to their proximity to population centers. Further, given the estimated need for another 1 billion square feet of space by 2025 to support growth in e-commerce, Simon could quickly fill up some of its vacant storefronts.
Simon's financial strength also means it can continue buying up well-known bankrupt retail brands to turn around. That's because these brands can still be successful in an e-commerce world with the right strategy, financial backing, and management team. Similarly, Simon might take another run at Taubman or purchase other high-quality mall properties it can transform into shopping, dining, and entertainment centers.
Expect Simon to leverage its financial strength and real estate portfolio
Simon Property is in a much better spot than most mall owners because it has a top-notch portfolio and a top-tier balance sheet. That gives it the flexibility -- both in space and financially -- to take advantage of opportunities resulting from the COVID-19 outbreak. As a result, it will likely continue buying bankrupt retailers and transforming its properties into destinations that meet more needs of tenants and consumers.
Similarly, its flexibility gives it the optionality to buy other high-quality properties and convert some of its vacant storefronts into new uses like fulfillment centers. Because of that, investors should expect Simon to leverage its flexibility to create long-term value over the next three years.