The Mall's Not Dead
High-quality shopping centers will remain critical to retail strategies.
Retailers ultimately want to be in the distribution channels where their customers shop and where they have the best chance of financial success. Despite the effect of e-commerce on a changing retail landscape, we think physical brick-and-mortar stores will continue to have a relevant and critical role in increasingly omnichannel retail strategies. To this point, successful malls tend to be premier retail centers located in markets catering to demographically attractive customer segments that in turn drive top tenant demand and increase customer traffic and tenant sales productivity, creating competitive advantages worthy of economic moats. The natural cyclicality of retail and tenant bankruptcies are not new to the mall industry, and we think only the best-quality properties that are able to deliver the value proposition of a compelling in-store experience to both consumers and retailers will ultimately prosper. We believe real estate investment trusts Simon Property Group (SPG) and Taubman Centers (TCO) are well positioned to prosper in a transitioning retail environment.
Although bigger is not necessarily better, Simon, the largest REIT by market capitalization, has been able to effectively amass and refine a portfolio of high-quality, geographically diversified, productive properties. By actively reinvesting in its malls, repositioning its portfolio (including spinning off less productive assets in 2014 and expanding internationally and into its successful premium outlet business), and maintaining its fortress balance sheet, Simon is the standard bearer of the mall industry, in our view.
Simon should benefit from broad development and redevelopment opportunities across its large platform, providing growth levers in the medium term. Given a relatively low dividend payout ratio, we think dividends can comfortably grow in the midsingle digits or more annually; five-year dividend per share growth has been an impressive 18%. We think Simon is fairly valued currently. With a low fair value uncertainty rating for a best-in-class narrow-moat REIT that consistently achieves returns above its cost of capital, Simon may represent an attractive risk-adjusted investment opportunity for REIT investors.
Taubman has historically created significant shareholder value by focusing on improving the quality of its portfolio and actively recycling capital through strategic acquisitions, development, and asset sales. This has created a concentrated, particularly moaty portfolio that boasts the highest average tenant sales per square foot among mall REITs, enjoys strong tenant demand, and consequently achieves the highest average rents, a trend we expect to continue throughout its core portfolio to the benefit of shareholders.
The company has recently put meaningful capital to work, including significant spending on acquisitions, redevelopment of existing properties, and development of new properties. The ultimate outcome of these investments has the ability to drive major growth and outsize value creation over the next few years. While we are comfortable that Taubman can achieve its expected returns on domestic projects, we think recent large investments in China and South Korea are inherently more volatile, contributing to our high fair value uncertainty rating. While our base case allows Taubman to increase dividends at a mid- to high-single-digit if not double-digit pace in the near term, the current market price, which is slightly below our fair value estimate, may provide an interesting opportunity for investors looking for an investment with potentially considerable upside or volatility.
Edward Mui does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.