Malls have been particularly hard-hit by the coronavirus pandemic. In the face of this headwind, two prominent mall real estate investment trusts (REITs), CBL & Associates (NYSE: CBL) and Pennsylvania Real Estate Investment Trust (NYSE: PEI), or PREIT, have already declared bankruptcy. If you’re looking at the mall REIT sector for bargains, tread carefully. Here’s a look at one name likely to survive and one that might end up following CBL and PREIT.
Two key factors to watch
Right now, most investors in the REIT space are monitoring rent collections. That makes total sense given that rent is, effectively, the lifeblood of every REIT. In the mall REIT space, the numbers are improving but still pretty weak. That’s likely to continue for a while and, in the grand scheme of things, isn’t the most important story for this niche long term. The bigger issue is really leverage and asset quality.
Rent collection is obviously tied to both issues, but it’s a short-term headwind that should ease as the world moves beyond COVID-19. The problem for mall REITs is really trying to cover all of their operating costs while the world adjusts to a new normal. That gets much harder with the addition of a heavy debt load.
For example, CBL and PREIT had debt-to-equity ratios of around 42 times and 68 times, respectively, as they spiraled into bankruptcy. Sure, not being able to collect rent was an issue, but the problem wouldn’t have been quite as material with less leverage.
Meanwhile, you can’t forget the old real estate saying that the industry is about location, location, location. If you have a lot of debt backing malls that just aren’t that desirable, you’ve layered up the issues you face. Struggling retailers are far more likely to shut stores in low-traffic malls with lagging sales-per-square-foot metrics. CBL is the poster child here, with a portfolio of relatively less-desirable assets weighed down by debt. PREIT’s malls were better-located, but its debts were just too much to bear.
This brings us to the comparison of Simon Property Group (NYSE: SPG) and Washington Prime Group (NYSE: WPG). These two REITs sit at different ends of the spectrum when it comes to leverage and asset quality. And the business outcomes from here are likely to be vastly different as well.
Simon’s portfolio of around 200 enclosed malls and outlet centers is fairly well-located, with around 75% of its assets in top 50 markets. Only around half of Washington Prime’s portfolio of around 100 malls and shopping centers are in top 50 markets. For reference, PREIT’s figure here is around 60%, and CBL sits at roughly 25%. In summary: Washington Prime, PREIT, and CBL are at the low end of the industry.
Meanwhile, Simon offers up a nice mix of population and income. The company’s portfolio boasts an average of around 1.5 million residents in a 15-mile radius of its properties. And the median income in the area is the second-highest in the mall sector. Washington Prime has roughly half as many people living around its malls, and the median income in the areas it serves are next to last in the industry. For context, CBL is in the bottom rung on population and median income. PREIT serves areas about as dense as Simon, with incomes that are roughly similar.
This shifts the story here to leverage. Simon’s financial debt-to-equity ratio is 1.4 times today. That’s way better than the 42 times figure at PREIT. In other words, it was excessive leverage that ultimately brought PREIT low. This demonstrates just how important balance sheet strength is during tough times. CBL had the unfortunate mixture of too much leverage and low-quality assets, which pretty much doomed it to its eventual fate. But that’s roughly the same story Washington Prime Group finds itself in — its financial debt-to-equity ratio is around 8 times.
While Washington Prime’s leverage is nowhere near as concerning as the leverage at CBL and PREIT, it’s still a substantial number. More importantly, it’s way higher than what you’ll find at Simon. In other words, the mall REIT more likely to follow CBL and PREIT into bankruptcy court is Washington Prime Group. If you’re looking for bargains in the mall REIT sector, you probably shouldn’t bet on the name with less-desirable assets and heavier leverage.
To put a capper on this comparison, Washington Prime has eliminated its common stock dividend, while Simon has “merely” cut its distribution by 40% or so, speaking to its inherently stronger financial position. Meanwhile, Washington Prime’s third-quarter funds from operations (FFO), which is like earnings for an industrial company, fell 85% year over year in the third quarter. Simon’s FFO fell by roughly a third. Both are clearly struggling, but Simon is handling the hit better. Add in Simon’s better-situated portfolio and stronger balance sheet, and it’s the clear winner of this matchup. Indeed, now is a time for caution in the mall REIT space, not going out on a limb.