A Tale of Two Retail Property Markets
Friday, December 13, 2019
Are Shopping Centers “Amazon Proof?”
- In our Income-Equity strategies, we have found compelling opportunities within the shopping center REITs group.
- Enclosed regional malls have been disrupted by online shopping and changes in consumer shopping habits, while open-air shopping centers, that provide basic necessities and services, continue to grow and adapt in the face of structural changes in US retail.
Recently, you may have heard about numerous retail bankruptcies and store closings. Over 2,000 Payless ShoeSource, 800 Gymboree, and 650 Dressbarn closures made headlines. In fact, there have been over 10,600 store closings in 2019—an eight-year high and almost twice the closures experienced in 2018. You may be wondering, why invest in retail real estate investment trusts (REITs) in this ‘apocalyptic’ environment?
But investors may be missing the tale of two retail property markets in the US: Enclosed regional malls have been disrupted by online shopping and changes in consumer shopping habits, while open-air shopping centers, that provide basic necessities and services, continue to grow and adapt in the face of structural changes in US retail.
So what explains this dispersion? Regional malls – the enclosed malls that epitomized American culture in the ‘80s and ‘90s – are anchored by large department stores. These anchor stores have experienced structural decline as shoppers are giving a larger portion of their wallet-share to online shopping, bargain hunting at off-price retailers (where shoppers can find department store brands at discounted prices), and spending on experiences over material things. Smaller regional mall tenants also felt the pressure from both the aforementioned changes in consumer habits and decreasing foot traffic. These headwinds acutely impacted mall owners’ occupancy rates and revenue generation, resulting in negative same-property net operating income growth, as depicted in the chart below. According to a 2017 report by Credit Suisse, one-in-four US malls is expected to close by 2022. Investors felt the pain with regional mall REITs experiencing a decline of 32.8% over the trailing year (as of November 30, 2019), while shopping center REITs have appreciated 23.2% over the same period.
The story is playing out very differently for shopping centers – the ubiquitous open-air strip malls that dot roadways throughout the country. Unlike regional malls, it appears that shopping centers’ business models are positioned to withstand the threat of online retail, and potentially even benefit from changing consumer habits. Over two-thirds of shopping center sales are necessity and convenience driven, such as grocery stores and pharmacies, as well as services like fitness, healthcare, and restaurants. Shopping centers are also benefiting from customer habits shifting from full-price department stores and apparel retailers, to off-price retail, where they can bargain hunt and find many of the same products at a lower price. In fact, while regional malls have seen their top anchor retailers reducing their store counts, the opposite is true for shopping center anchors that continue to expand their number of stores and grow same-store sales. For instance, Dollar General plans to open 1,000 stores in 2020, Aldi announced intentions to open over 500 stores by the end of 2022, and Planet Fitness is guiding for around 250 new locations this year. We believe these attributes may also make shopping centers more recession-resistent as shoppers are likely to continue to buy groceries, seek healthcare, and shop at off-price retail and dollar stores in a soft macro economic environment.
|Shopping Centers||Regional Malls|
|Est. 2019 Cash Flow/ Share Growth3||0.8%||-9.4%|
|Net Debt/ Forward Median EBITDA4||5.5x||7.6x|
| Source: Bloomberg; Miller/Howard Research & Analysis
Shopping Centers: BRX, FRT, KIM, REG, RPAI, SITC, WRI
Regional Malls: CBL, MAC, PEI, SKT, SPG, TCO
1. Median, 3Q 2019
2. Median cash lease spreads, 3Q 2019
3. Median Bloomberg consensus 2019/2018 FFO growth
4. Median as of 11/30/2019; Bloomberg NTM consensus estimates
The financial strength of the top tenants has allowed shopping center REITs to accelerate cash flow growth by driving higher rents and increased occupancy rates. Many of the shopping center REITs have deployed this capital to raise the dividend, buy back stock, pay down debt, and fund development projects. Redeveloping aging shopping centers has brought in new tenants, some of which are fleeing decaying regional malls for greener pastures at the shopping centers. Densification initiatives have replaced unused areas of parking lots with restaurants, hotels, offices, and even multi-family housing to drive incremental revenue while diversifying their tenant mix. Shopping centers are unique because they can accommodate many uses including retail, consumer services, medical offices, and education. With occupancy costs often only one-third that of regional malls, some shopping centers are even being used as distribution centers for online orders!
Over the last year, the market started to appreciate the attractiveness of these stocks, and shopping center REITs rallied. Despite this, they continue to trade at attractive valuations relative to other REIT sub-sectors while providing consistent and growing cash flow. Comparatively, balance sheets are strong and dividend coverage is high. In our Income-Equity strategies, we have found compelling opportunities within the shopping center REITs group, as these stocks offer high dividend yields with prospects for dividend growth.
NOTE: None of the companies mentioned in this article were held in Miller/Howard strategies as of December 13, 2019, except BRX and KIM.
Mark Phillips, CFA, Research Analyst, is responsible for fundamental stock research and reports, idea generation, and other portfolio management support. In addition, Mark leads Miller/Howard's risk management efforts and quantitative portfolio analytics. Mark started in the financial services industry in 2012 as an investment analyst at Janney Montgomery Scott's wealth management division in Philadelphia. Prior to that, he was a staff accountant at Danaher in Virginia. Mark earned a BS in Finance and a BA in Economics from Grove City College, in Pennsylvania.