Is It Time To Jump On The High-Yield, Hated Mall REITs?

It may be time to make a high-risk bet on the loathed and downtrodden shopping mall real estate investment trusts (REITs). A record number of retail store closings in 2019 have investors fearing a Retail Apocalypse 2.0 and running away from the mall REITs. I realize that the mall owners face serious challenges, but I also think many malls will survive and thrive. The challenges facing investors are to determine if dividends are secure and if or when share prices will reach a bottom.

The other challenge facing commercial retail real estate is that there is too much of it. According to a recent Barron’s article, there are 1,350 enclosed malls in the U.S., but less than half that number are “needed.” (my emphasis). Developers have overbuilt retail space, and in recent years have been hit by failures of large retailers like Toys-R-Us, JC Penny, and Sears. It’s easy to see why investors are leery of mall owning REITs.

However, there are facts that point to an anti-doomsday scenario for retail and mall REITs. Here are some of the things I think about.

  • Have you ever noticed how charts like the one above always show a future that continues to go up? Especially for trends that are new or relatively slow. I would not be surprised if e-commerce sales start to level off.
  • According to NAREIT, the retail REIT occupancy level at the end of September was 94.885%. Occupancy has been right around 95% since 2013. REITs appear to be doing fine with replacing lost tenants.
  • Of the 1,300 enclosed malls, there are highly profitable malls, malls getting by, and challenged malls. The commercial real estate crowd labels these as A, B, and C malls. The A malls are mostly owned by REITs.
  • Mall owners are reacting to growing e-commerce sales. Business models are changing to a combination of brick and mortar and online sales. Mall owners are diversifying their tenant mix, bringing in tenants that have little or no competition from online sellers.

With these facts, my opinion is that the share prices of mall REITs will find a bottom, and as the mall owners react to changing times, they will be again able to grow free cash flow. The challenge is timing the bottom. With the yields now on these three REITs, compared to historical levels, that bottom may be very close.

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