The term "retail REIT" refers to any real estate investment trust whose primary tenants operate retail businesses. And for the purposes of commercial real estate, restaurants, bars, entertainment businesses, and service-based businesses are also typically considered to be part of the retail category.
Most retail REITs specialize in a certain subtype of property. While there are many different retail REITs, each with a somewhat different investment strategy, the vast majority of retail REITs can be classified into one of three categories:
- Mall REITs: As the name implies, mall REITs own and operate shopping malls. These can be indoor or outdoor malls, and some own a combination of both.
- Shopping center REITs: Some REITs exclusively own and operate shopping centers, which typically consist of an anchor store or two (grocery stores are extremely common) and several attached smaller retail spaces.
- Net lease retail REITs: A net lease is a type of lease structure that requires tenants to pay the building's property taxes, insurance, and most maintenance expenses, and is most common in freestanding (single-tenant) commercial real estate. So, when you hear a retail REIT referred to as a net lease REIT, it essentially means that it owns single-tenant retail properties.
Why were many retail REITs so beaten down in 2020?
Real estate was one of the worst-performing parts of the stock market after the COVID-19 pandemic hit, and retail REITs were one of the worst-performing subsectors.
This shouldn't come as a major surprise. After all, retail real estate is occupied by tenants that mostly depend on people being able and willing to go out and spend money. When the pandemic worsened last March, most nonessential retail businesses in the United States were forced to shut down, and many of those that were deemed essential continued to operate on a limited basis (such as curbside service only).
While the profitability of the underlying retail businesses doesn't directly affect the retail REITs that own them, the disruption caused by the pandemic made many retail tenants unable or unwilling to pay rent. Just to name a couple of notable examples, restaurant chain Cheesecake Factory (NASDAQ: CAKE) and apparel retailer Gap (NYSE: GPS) both refused to pay rent during the shutdown. And they weren't the only ones. In fact, Commercial Observer reported that just 46% of retail tenants paid rent in May 2020.
Should investors worry about the threat of e-commerce disruption?
The short answer is yes, but there's more to the story.
First, it's important to note that retail REITs were dramatically underperforming the market before the COVID-19 pandemic set in, and e-commerce was the primary reason. Since 2010, the percentage of retail sales that can be attributed to e-commerce has steadily risen from 4% to 11.5%, and this trend doesn't show any signs of slowing down.
However, not all retail is particularly vulnerable to e-commerce disruption. Service-based retail like restaurants and hair salons are an obvious example, as are convenience stores (especially if they sell gasoline), fitness centers, and auto repair businesses. These businesses sell things that can't be sold online. Discount-oriented retail is another type that isn't particularly vulnerable, as businesses like warehouse clubs and dollar stores tend to offer bargains that even Amazon (NASDAQ: AMZN) can't match.
Furthermore, there's a big difference in e-commerce vulnerability when it comes to the quality of the properties and the tenants. As a simplified example, a national big-box retail chain has more resources to compete with e-commerce giants than a local retail establishment. And retail properties with modern dining establishments, entertainment venues, and other attractions are in a better position to keep foot traffic coming in than retail properties that are somewhat run down and depend mainly on the strength of their anchor tenants. In short, quality is very important when it comes to the ability to compete against e-commerce.
Retail REITs to buy now
Many investors are hesitant to put their money into any retail-focused investments, and that's certainly understandable. Physical retail was struggling a bit before the pandemic, and no fewer than three mall REITs have gone bankrupt in 2021 alone.
However, not all retail REITs are the same, and some could end up being big winners as the world gradually returns to normal over the next few years. Here are two in particular that look like smart buys as we head into the fourth quarter of 2021.
Retail that can thrive in an e-commerce world
STORE Capital (NYSE: STOR) owns a portfolio of more than 2,700 single-tenant properties, most of which are operated by tenants in service or retail businesses. Restaurants are a big part of the portfolio, as are convenience stores, automotive service centers, and car washes.
The key point is that most of STORE Capital's tenants aren't susceptible to e-commerce disruption. And even those that are sell products people tend to want to buy in person. For example, Camping World (NYSE: CWH) is one of STORE's major tenants, as is Bass Pro Shops.
STORE Capital has grown significantly in just over seven years as a public company, but it could be just getting warmed up. STORE estimates that $3.9 trillion of real estate exists that could fall within its investment criteria -- and with a market cap of less than $9 billion, STORE could multiply in size several times over in the years ahead.
For REIT dividend investors, STORE Capital not only pays a dividend yield of about 4.8% but has also increased the payout every year since going public in 2014 -- including in 2020. In fact, STORE Capital just announced a 6.9% increase in its dividend starting in October. And with shares down more than 10% over the past month and no company-specific news behind the move, now could be a great time to add STORE to your portfolio.
Top-quality malls will be just fine
As mentioned earlier, three mall REITs have already gone bankrupt in 2021. But it's important to realize that these REITs owned lower-quality malls, had excessive debt, or both.
Simon Property Group (NYSE: SPG) is another story. The company owns some of the busiest, most valuable mall properties in the entire world and, with its Premium Outlets brand, has a dominant lead in the outlet mall market. Over the years, Simon has done an excellent job of making destinations out of its malls by adding nonretail elements like entertainment venues, hotels, trendy dining options, office spaces, and much more.
The strategy has certainly paid off.In fact, Simon is one of the few retail REITs that didn't suspend its dividend in 2020, and the company recently raised its full-year guidance due to strong shopper traffic and retail sales. And with nearly $9 billion in liquidity, the company has the financial flexibility to keep up with changing consumer tastes going forward.
And with shares trading for just 12x the full-year funds from operations (FFO) estimates -- and for roughly half of their pre-pandemic high -- Simon could be worth a closer look now.
The Millionacres bottom line: Buy for the long term
To be perfectly clear, I'm suggesting these two retail REITs as long-term investments. I have absolutely no idea what their stock prices will do over the coming weeks or months. However, these are well-run businesses with excellent assets and lots of room to grow, and I think there's a great chance that long-term investors who add them to their portfolios now will be glad they did.