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The Mall REIT Conundrum | I am looking for alpha



Most of the time I drive past my mall every day on my way to work, and it's a constant reminder that Darwinism is alive. Charles Darwin wrote in 1882: "This preservation of varieties that have an advantage in structure, constitution or instinct, I have received during the battle for life. I have called natural selection. "

The survival of the fittest is an expression that has its origins in Darwin as a method to describe the mechanism of natural selection: in Darwinian terms, the term is best defined as" survival of the form, which leaves the most copies of itself in successive generations ".

We are all experiencing development first-hand Some shopping malls are becoming extinct and others are experiencing a "retail renaissance". This "fight for life" has taken many forms in the shopping area, from renewal to development to natural death.

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Photo Source

This picture (above) is, of course, a horrible example of a mall that has not survived, and although many suspect that the "retail apocalypse" is not a myth, there are hundreds of Examples of thriving shopping malls like the one below, owned by the Simon Property Group (SPG).



Photo Source

In a Bloomberg article last year, "These malls have not received the memo they die," the author cites "Class A Malls," which attract and retain first-class tenants well developed both in terms of fundamentals and in terms of valuation.

According to Green Street Advisors, "this discrepancy is captured by the analysis below, which reveals that the approximately 270 malls rated Class A (by Green Street Advisors) make up 72% of the total value of the mall. By contrast, the remainder of more than 700 B / C shopping centers account for only 28% of the total shopping center.



Photo Source

The most commonly used method for determining a mall classification (as A, B, C or D) is the revenue per square meter of its inline tenant. The following table (created by Korpacz) shows that revenue per square foot over $ 500 generally falls into category "A".

 Mall Classificatin

The traditional mall consists of three to four department store anchors that generate traffic, which in turn leads to pedestrian traffic inside the mall. According to Bloomberg, JC Penney, Sears and Macy, sales per square foot are almost below the main anchor tenants, which is not surprising given their declining profits and sales.

When Sears is in a death spiral, JC Penney (JCP) is also having trouble getting a foothold. CNBC said Penney plans to "close three stores by spring as part of an ongoing evaluation of its performance". At the beginning of 2018, the department store chain said it would reduce 130 jobs (at corporate headquarters) to save around $ 25 million annually.

Macy & # 39; s also having trouble when Bank of America ranked the retailer's stock of "neutral" last week after underperforming after weak holiday sales. According to CNBC, Macy's expects "a declining earnings trend in the coming years without a strong increase in comps."



Source: Yahoo Finance

Follow The Money

As readers and supporters know, I've started alarming for the B / C Mall REITs for a long time with the pounding. As mentioned above, I pass by my shopping center (owned by CBL) every day, and it is a constant reminder that death is inevitable when there is no competitive advantage.

In the US, hardly any shopping centers are built to signify that the only way for the REITs is to either (1) grow organically, (2) redevelop, (3) invest internationally, or (4) other malls or mall -REITs to acquire. Without reasonable capital costs, options 2, 3 and 4 are almost impossible. Now, I will highlight another use of the A, B, C, and D concepts …

As mentioned above, analysts and investors use revenue per square foot to rate the quality rating of a mall. Another way to leverage this concept is to examine the overall quality of the balance sheet to determine how the business can manage its growth.

I consider Simon Property ( SPG) and

Unibail-Rodamco-Westfield (OTCPK: UNBLF) becoming the only REITs of the Class A mall. This is because the company receives a similar A rating with S & P and Moody's and Fitch. While I have not yet written about Unibail, I consider this mall REIT to be a big consolidator in the years to come.

Unibail-Rodamco, Europe's largest commercial landlord, acquired Australian Westfield Corp. about a year ago. for about $ 21 A The consolidated company has the world's highest portfolio of mall malls:

Source

Although not rated, I consider Taubman Centers (TCO) a high-quality mall-REIT, which takes into account both sales per square foot and the cost of capital. Taubman has the highest sales per square foot in the mall at $ 845 PSF.

Macerich (MAC) has high-quality sales per square foot (was a $ 688 in Q3-18) with a portfolio of many high quality retailers including Zara, Lululemon, Victoria's Secret, Tesla, and Sephora Apple. Macerich's balance sheet is also strong with 47.3% debt / market capitalization, 3.30x interest coverage and a weighted average 5.6 years.

According to Green Street Advisors, Macerich is the "most urban" of the mall owners he measures, according to population densities within a 10-mile trading zone. "

Do not forget the newly formed Brookfield Property REIT (BPR), which was founded by Brookfield Real Estate Partners ] (BPY) to merge General Growth Properties (formerly GGP ). BPY is an LP structure and BPR is a simpler 1099 structure that pays unqualified dividends like any other REIT.

The GGP deal creates a larger public float for BPY, and the transaction is immediately an FFO / equity share. The transaction provides direct access to GGP's class A irreplaceable retail portfolio and a REIT that is sure to expand over time. I consider BPY / BPR to be a consolidator in the coming years.

PREIT (PEI) is a good choice, but I've become increasingly involved with the company's commitment to JC Penney. Although PREF per square foot is more than $ 500 ($ 510 in the third quarter of last year), I am concerned with the 14 JC Penney businesses, and if the development has improved in 2019, I fear that the split could be shortened. Therefore, we recently downgraded PREIT to a SPEC BUY.

The Mall REITs are rounded off: Washington Prime (WPG) and CBL Properties (CBL) – both Strong Sells. I have often called the B & C malls "ugly ducklings" because they are exactly what they have become.

No matter how you cut or roll the dice, these two REITs are lost over time and they are likely to fall into the "retail apocalypse" category. Keep in mind that not only the department stores are struggling, but also the in-line tenants who will continue to put pressure on development efforts.

Without scale (growth) or capital costs, it will be extremely difficult for these REITs to grow and hold their current dividend. For that reason, I think these REITs should consider considering switching from REIT status to C-Corp status to remove the ongoing pressure on the dividend distribution.

I created the following table using the "ABCD" definition for both sales per square foot and capital costs. Although I have not really addressed the definition of a "D" mall, I think "D" is "a dog worth demolishing".



Source: Rhino Real Estate Advisors

Another harbinger as we begin in 2019 : Although Sears is almost done, I reckon with further closings department store sector. This means that the B / C Mall's REITs will do their job for them if they try to patch, repair and even demolish dark department stores.

Whenever I pass by my local mall, I always see windows nearby and try to imagine what the Sears store will be like. And to be honest, I can not find a logically highest and best use. Given that the mall is about 85% staffed, the redevelopment of this asset is very difficult.

Put simply, it means "survival of the fittest" and that's why I've kept a more tactical approach. In retail, I've chosen to choose only the "best in class" names.

When I think about the future of the mall, I can not believe there will be a continuing wave of consolidation, and I predict that. The top A-Mall REITs (as valued by Rhino) will be the consolidators, and I think that the most logical M & A deal (today) is Macerich (the seller) and Unibail-Rodemco-Westfield (the buyer).

PREIT is not a needle mover for the A-Mall REITs, and this means that private equity could be the ticket (for PREIT). Always remember that this is due to the magnitude and cost of capital as the two key competitive advantages. If you are investing hard earned capital in a REIT, make sure that it is a SWAN. As my mother used to say, "the cream finally goes up."



Source: Rhino Real Estate Advisors

Westfield Century City [photo]

Author's note: Brad Thomas is a Wall Street writer and that means he's not always right with his predictions or recommendations. This also applies to his grammar. Please excuse any typing errors and be assured that he will do his best to correct mistakes if he is overlooked.

Finally, this article is free and the sole purpose of the letter is to support the research a forum for second-level thinking.

Brad Thomas is one of Seeking Alpha's most widely read authors and has developed a familiar brand in the REIT sector over the years. His articles generate significant traffic (approximately 500,000 views per month), and he has thousands of satisfied customers who rely on his expertise.

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Disclosure: I am / we are long TCO. I wrote this article myself, and it expresses my own opinion. I can not get any compensation for it (except from Seeking Alpha). I have no business relationship with a company whose shares are mentioned in this article.

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