Mall-focused real estate investment trust (REIT) Simon Property Group (NYSE: SPG) rose more than 20% on Nov. 9 when positive COVID-19 vaccine news put investors in an upbeat mood. While there’s no doubt a vaccine would be a tailwind to Simon’s business, there’s a lot more to unpack here. Here’s what you need to know before you run out and buy this retail REIT.
Prior to the pandemic
Although the coronavirus seems like it’s the most important thing impacting the world today, there was a time other issues dominated. That’s particularly true in the retail sector, which, for years, had been struggling through the so-called retail apocalypse. On the surface, this was the slow-moving consumer shift toward online shopping. But under the surface, it was really about retailers that had been unable to keep up with changing consumer tastes. Often, these retailers leveraged up their balance sheets, further limiting their ability to deal with adversity.
Indeed, stores were closing locations, facing financial difficulty, and seeking out court protections well before COVID-19. Retail REITs had been dealing with this headwind for years. It had been particularly hard on mall REITs like Simon, which were trying to deal with the long-term decline of anchor tenants while clothing sales were shifting online, hurting many of the stores that line the interior of its malls. And then, in early 2020, COVID-19 led governments around the world to effectively close their economies down.
That move was particularly difficult for malls, which suddenly found themselves shut for business. With no customers, retailers with mall locations were hit particularly hard. Some stopped paying rent, while others just threw in the towel and declared bankruptcy. Simon, in fact, has joined with partners to buy a couple of retailers, including Forever 21 and J.C. Penney (OTCMKTS: JCPNQ), in an attempt to save the businesses. All this gets at the big picture that is so important to understand at Simon Property Group.
After the dust settles
Investors shouldn’t look at a mall as a building — it’s really a carefully curated ecosystem. Yes, Simon does have to make sure the roughly 200 enclosed malls and outlet centers it owns are well-located properties. It has generally done that well, noting that roughly 75% of its portfolio is in the top-50 U.S. markets and the median household income within a 15-mile radius of its malls is near the top of its mall peer group. So, too, are its average rent and sales per square foot metrics. But owning big boxes in good locations still isn’t enough to be successful in the mall space.
Simon needs to make sure its malls look modern and desirable, which is an ongoing effort. That includes everything from ensuring they’re clean and presentable on a day-to-day basis to a constant effort to refresh and update the facility so it never gets stale. It also means Simon has to keep a close eye on the stores within its malls.
A mall REIT can’t simply lease space to anyone who wants it. There’s a dynamic to malls that requires careful oversight. As a somewhat ridiculous example, a dollar store in a high-end mall would probably be a disaster for everyone involved. Meanwhile, brands go in and out of fashion with customers. Thus, just like the facility, the actual stores in the mall have to be updated on an ongoing basis. The retail apocalypse increased the difficulty of replacing undesirable (or failed) tenants, which was already a slow process. COVID-19 sped up the pain on the front end of that equation and will likely lengthen the time needed to appropriately retenant properties on the back end. In summary: It’s not pretty for malls right now.
So far, Simon has been forced to cut its dividend by nearly 40% and, as noted above, is trying to buy some tenants out of bankruptcy to keep its malls occupied. The REIT’s third quarter funds from operations (FFO) came in at $2.05 per share, down from $3.05 in the same stanza of 2019, showing just how difficult it’s been lately. In fact, the REIT pegged the negative impact of COVID-19 at $1.10 per share, a portion of which it was able to offset with cost-cutting and other measures. It’s bad right now, but based on the way malls work, there’s still a long road ahead before its business will get back on track.
Clearly, an effective vaccine will help. But one has yet to be approved and, even then, it will have to be produced in large quantities and widely distributed to be of any benefit to Simon’s business. That’s going to take time, measured not in days or months, but quarters and, perhaps, years. Then Simon has to lure customers back to its malls at the same time it’s working to get new, desirable tenants into its facilities. There are reasons to like Simon’s prospects, but this is unlikely to be a quick turnaround.
The Millionacres bottom line
With Simon stock still down 47% for the year even after a huge stock rally, there remains material room for recovery. However, investors looking at this REIT need to understand a vaccine is only one part of a much larger turnaround effort. This is not a stock for risk-averse investors or those that expect instant gratification. In fact, it’s really more of a special situation play only appropriate for more aggressive investors willing to pay close attention to companies they own.
It will also require a strong stomach, since even after there’s a vaccine on the COVID-19 front, there’s likely to be more bad news on the business side of things before the outlook starts to materially improve. In fact, it wouldn’t be shocking to see a fresh round of retailer bankruptcies after the holiday season ends.
All in, the current 7.3% yield probably isn’t enough compensation here for more conservative investors to take on the inherent risks here. There are other REITs with similarly high yields, like W.P. Carey (NYSE: WPC), that appear to be better positioned today.