High-Quality Retail REITs on the Clearance Rack
Despite the dour headlines, we see buying opportunities in these real estate investment trusts.
A recent article in The Wall Street Journal asserted that retail real estate investment trusts have been the focus of increased short-selling activity.
These REITs own malls and shopping centers that are homes to struggling retailers such as Macy's (M), Sears (SHLD), and J.C. Penney (JCP). According to the Journal, short sellers have been active in the mall REIT space, betting that these landlords will face higher costs to spruce up their shopping centers or struggle to replace stores that close, especially in weaker locations.
We have a differentiated take, however, especially when it comes to high-quality, so-called Class A mall REITs. Real estate equity analyst Edward Mui thinks high-quality, well located, and compelling physical retail environments will still be successful even as online shopping grows.
"A wave of negative press about store closures and retailer bankruptcies, in addition to uncertainties surrounding the effects of policies of the new administration and a rising interest-rate environment, have placed tremendous pressure on the retail REITs," said Mui. He thinks the current market is overly cautious on mall REITS and painting the industry with too broad a brush, punishing high-quality retail real estate properties that are still relevant to the communities they serve and profitable for their retail tenants' strategies.
"We expect the retail REITs under our coverage, including shopping center REITs and regional mall REITs, to maintain steady performance despite industry turbulence and think investors can currently get shares 'on sale,' " Mui said.
Not only are the three stocks we highlight below undervalued, in our view, they have economic moat ratings of narrow, which means we think they have advantages that will fend off competitors for at least 10 years. They also have fair value uncertainty ratings of medium or low, which means we think we can more tightly bound their fair value, because we can estimate the stock's future cash flows with a greater degree of confidence.
Simon Property Group (SPG)
Mui thinks mall owner and operator Simon Property Group, the largest mall REIT and the largest REIT by market capitalization, is well positioned to deliver long-term shareholder value. Although bigger is not necessarily better, Mui says, Simon has amassed and refined a portfolio of high-quality, geographically diversified, productive regional mall and outlet properties that we believe will remain an important part of retailers' increasingly omnichannel retailing strategies, earning the firm its narrow economic moat.
Mui also expects Simon to remain an exemplary steward of shareholder capital, remaining disciplined in its investment approach and reinvesting in its assets while maintaining an enviable and flexible fortress balance sheet, supporting future performance. Despite pressure from e-commerce on retailers and Simon's massive scale, Mui believes the firm still possesses several avenues for growth. Occupancy cost for Simon's tenants currently averages roughly 13%, below the midteens level we believe tenants can sustain, giving additional room for rent growth if not a buffer for potential weakness in tenant sales.
We assign GGP a narrow moat rating due to its efficient scale and the network effect benefits enjoyed by its high-quality, productive retail properties that attract both tenant and consumer demand. Since restructuring and re-emerging in late 2010, the company has made significant strides to regain investor confidence; it has transform itself back into a premier retail property operating and investment platform by shedding billions in noncore assets, deleveraging, and installing new executive leadership, Mui said.
Now primarily an owner of productive, high-quality regional mall and retail assets, GGP appears to be on the right path. But given the changing retail landscape, Mui thinks GGP will have some more work to do. The ever-increasing adoption and threat of e-commerce will continue to pressure brick-and-mortar retail performance and force landlords like GGP to constantly reinvest in their properties and deliver compelling retail environments for both consumers and tenants alike.
Like GGP, Macerich has benefited from restructuring, divesting over $1.5 billion in less productive and noncore properties since 2012. By reinvesting these proceeds into core assets, Macerich has ultimately built a stronger portfolio of primarily "Class A" regional mall and retail properties that exhibit higher tenant sales productivity, occupancy levels, and rent, said Mui. He expects Macerich to continue refining its overall portfolio through redevelopment, opportunistic acquisitions, and asset sales, altogether positioning the company well to traverse a turbulent path ahead.
Mui points out that past stewardship decisions remain a concern affecting management and shareholders, however: In early 2015, Macerich eschewed a high-profile takeover attempt by Simon Property Group and instead adopted several relatively shareholder-unfriendly antitakeover provisions, rebuffing the viable offer after engaging its consultants. Heated shareholder activism has since helped reverse the antitakeover provisions and added directors to the board. But risks remain, Mui says: Macerich may be incented to take increased risks in order to create ample value and win back investor confidence after rebuffing the takeover advances.
Karen Wallace does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.