class A mall REITs

[saltybit]

What do folks think of Class A mall REITs? seems like they've gone down a bit as a class the past year (due to pessimism about e-commerce and big-box retailer troubles like Sears), but given the prime location of some of their properties, it might be a short-term headwind.

Here's an example of a mall space being converted to office space in LA https://la.curbed.com/2019/1/8/18173979/westside-pavilion-google-office-space

 

writeup of one of the REITs on seeking alpha (Macerich)

https://seekingalpha.com/article/4235594-macerich-favorite-mall-operator

[saltybit]

other relevant articles, more on the pessimistic side:

https://www.wsj.com/articles/slowing-mall-rent-growth-poised-for-a-challenging-2019-11546606800

 

https://www.bloomberg.com/news/articles/2018-06-12/owners-of-fading-malls-on-their-knees-as-buyer-pool-evaporates

[saltybit]

A funny mall game from Bloomberg :)

https://www.bloomberg.com/features/american-mall-game/

[johnny]

I'm not sure how much you would be able to generalize the example of the Westside Pavillion to the entire portfolio of these companies, and even if you could, I don't think it would obviously present a favorable investment.

 

1. West LA is in a sort of unique situation, with a lot of price-insensitive techCos deciding there's a strategic need to lock down oversized campus territory. I don't think there's a general shortage of office space, even in LA, otherwise those guys buying DTLA Prefs would be billionaires by now.

 

2. That mall has been a ghost-town for at least a decade. Once you add those ten years (and cash bleed) to the overall analysis, I suspect the office conversion is probably close to zero IRR.

 

3. After eating the losses on it for a decade, Macerich had to sell part (75%!!!!) of its interest in the property to get the ball rolling on the re-development. So they ate losses for all those years only to split the salvage value 1-to-3 with somebody else. Looks like a good outcome year-over-year, but seems like a loser to me.

[shhughes1116]

I’ve been thinking about this topic for a few months now, trying to figure out whether any of these Class A mall REITs may warrant a place in my portfolio.  Every industry is different, and the comparison is not apples-to-apples, but the situation facing Class A mall REITs reminds me a little bit of the situation facing electric utilities a few years ago.  SolarCity and similar companies were installing all sorts of rooftop solar, and every expert was shouting from the roof tops that rooftop solar was going to be the death of electric utilities.  Turned out that there was a place for electric utilities and solar (utility scale solar, roof top solar, peaker plants, utility scale battery storage, and so on).  Utilities have since done very well and added pretty substantial portfolios of utility scale solar facilities, rooftop solar continues to be installed, although I’m not sure the companies have been stellar equity investments.  Even in light of this tailwind for utility companies, utilities that have been poorly run or that have allocated capital poorly have not done well (SCANA, PG&E, AltaGas).

 

Thinking about retail, experts have been saying that physical retailers are going to be squashed by “Amazon-ification”.  And certainly companies that have weak/absent Omni-channel businesses are not doing well, companies that are poorly run (I.e Sears, ShopKo) are also not doing well, and companies that are poorly run with a weak Omni-channel presence are getting crushed.  But, companies with strong omni-channel businesses and/or strong brands are doing just fine, if not well.  These companies are doing lots of business online, but their customers still expect a physical presence.  I see this anecdotally with spending by my wife and family.  Many, but not all, purchases are online.  Most purchases are directed towards companies with nearby physical locations, to facilitate  quick returns, exchanges, fittings, price adjustments and so on. 

 

Additionally, malls are starting to become populated by tenants focused on “experiences” (I.e. movie theaters, dog parks, fitness centers and gyms, bars and breweries, ice rinks, outdoor movies, concerts, office space).  The well-run malls in my area (Northern Virginia) made this transition a number of years ago, in my opinion.  People go for dinner/movie/etc, and stay to shop.  Add full-on redevelopment for the older mall properiteS, often into town centers with a mix of residential, office, and retail, and the optionality is pretty good for the well-located mall properties. 

 

For class A malls, the two points above lead me to below that they will do just fine as more retail spending shifts online.  There will certainly need to be adjustments to tenant mix, but the location of many of these properties (such as those held by Macerich) are generally in urban areas serving a substantial population, with a lot of optionality.  Even as physical spending decreases, there is still a large enough population to warrant having physical retail space.  In other words, location-location-location. 

 

I am not as sanguine about Class C and Class B malls.  There are a lot of malls out there that serve small population centers.  As the amount of online retail spending increases, there is no longer a large enough population to support the amount of physical retail spending necessary to keep these malls going, and there isn’t as much optionality for their real estate.  I think this is where a lot of the pain will be in mall real estate.  The exception may be those companies that started early  to transition to experience- focused mall  properties, and started handing the keys back to lenders for malls where the prospects are bleak at best.

 

I took a position in Macerich (Class a malls) recently, at around 2% of my portfolio.  Generally high-end and well-located  portfolio, and I think it will ultimately sell itself to SPG or one of the other larger international mall operators. 

 

I also took a position in WPG Preferred D (class b malls and some strip malls)  at around 1.5% of my portfolio.  I think their valuation borders on rediculous.  Things are not great, but they certainly aren’t apocalyptic, which is what their valuation suggests.  And if they cut the common shares dividend, which I hope they do, they will have plenty of money for redevelopment and to continue to pay the preferreds.  Important to note that they already have the balance sheet capacity to do the redevelopment, but cutting the common shares dividend would enable a lot of this redevelopment to occur with funds from operations. 

 

Although a bit different than malls, I also took a small position in Wheeler REIT (preferred D).  They are focused on grocery-anchored strip malls.  They just got rid of their scummy/moronic CEO, Stilwell is involved so I think there is a reasonable chance of turning things around, and the Wheeler Preferred D issue has a few nice features, above and beyond a normal preferred, that make it worthwhile to take a flier on this.

 

I’d say all three are a bit hairy, especially WPG and Wheeler.  But I think that the impending death of physical retail is exaggerated - there will still be a piece of the retail spending pie for physical retail space.  And it is the hairy investments, the ones that made me feel a bit sick to pull the trigger and buy, that have worked out best for me in the past. 

 

[shhughes1116]

I should clarify that I am not suggesting utilities and malls are an apples-to-apples comparison.  Just happens that the sentiment seems similar with respect to how a certain innovation or shift will impact the incumbent industry.

[Spekulatius]

I’ve been thinking about this topic for a few months now, trying to figure out whether any of these Class A mall REITs may warrant a place in my portfolio. .

 

I took a position in Macerich (Class a malls) recently, at around 2% of my portfolio.  Generally high-end and well-located  portfolio, and I think it will ultimately sell itself to SPG or one of the other larger international mall operators. 

 

Any comment why you choose MAC vs TCO? Both seem to trade at similar valuations (7-7.5% cap rate) and TCO has even higher quality malls and a better balance sheet and way better long term track record. I think they are equally likely to be acquired.

 

What I noticed with Nc (and TCO) that both have shown shrinking FFO/share due to dispositions from property where the proceeds were invested in their higher quality properties. This is dilutive, because apparently these investment have only initial returns of about 7%, while the deposed properties have cap rates that are higher than that. Then adding the lag when the rents are kicking in from the projects and it’s clear they are dilutive to FFO , albeit hopefully accretive to NAV. The low initial returns on investment bug me a bit on project that are upgrades (low ROI’s  for green fields would be understandable, but most of these projects are just updating existing properties) and make me think they these operators have no choice but to keep their properties updates, or they quickly may become dreaded B-malls, trading for 8.5-10% cap rate and quickly losing value. So a lot of the Capex may just be maintenance Capex in the end, even if it’s capitalized.

 

Anyways, I am basically questioning if recycling the capital in higher quality properties created value.

[johnny]

Anyways, I am basically questioning if recycling the capital in higher quality properties created value.

 

This is a great specific example of something I'm generally concerned about in this area--that however high the FFO yield may be, that FFO is going to be redeployed into mallstuff by mallguys running mallreits. If I really were gungho on malls, I'd be more likely to prefer the relatively indirect 50% shot through Brookfield, since we at least know they have a plausible alternative path for cash if it ever becomes apparent it's time to cut bait. Not as cheap though, of course.

[shhughes1116]

I’ve been thinking about this topic for a few months now, trying to figure out whether any of these Class A mall REITs may warrant a place in my portfolio. .

 

I took a position in Macerich (Class a malls) recently, at around 2% of my portfolio.  Generally high-end and well-located  portfolio, and I think it will ultimately sell itself to SPG or one of the other larger international mall operators. 

 

 

Any comment why you choose MAC vs TCO? Both seem to trade at similar valuations (7-7.5% cap rate) and TCO has even higher quality malls and a better balance sheet and way better long term track record. I think they are equally likely to be acquired.

 

 

First, I agree with you that Taubman has some nice properties, and somewhat superior to Macerich's properties when measured by sales per square foot.  However, there are two somewhat related reasons that I chose Macerich over Taubman.  These reasons illustrate why I disagree with you that both of these companies are equally likely to be acquired. 

 

First, the Macerich CEO just retired.  He was at the helm of the ship when Macerich declined the SPG offer and adopted a poison pill.  In conjunction with his departure, the company is splitting the CEO and Chairman roles.  The Chairman role will now be occupied by the Lead independent director.  Generally speaking, I see both of these as positive changes for common shareholders.  More specifically, this could open the door to an acquisition. 

 

Second, Taubman has a dual-class share structure that facilitates family control.  I believe this enabled them to squash an SPG offer in the early 2000's (can't remember the year off the top of my head).  I'm not confident they are going to make decisions that put common shareholders first.         

[Spekulatius]

Shhughes1116 - thanks for the color on MAC’s managment changes. I agree it makes a change of control more likely for MAC vs family controlled TCO.

There is an interesting article from Brad Thomas (prolific writer about Reits on SA) about TCO, which also mentions MAC as a comp. The point he is making is that TCO has way less (7 stores) exposure to ailing department store retailers (Sears, JCPenney) compared to MAC (49 stores). While I think MAC can fill these cavancies when the time comes (some of it is in JV and would be a shared expense), it still means that they have a lot of work to do and capital to spent until the properties are fully productive again. It’s an opportunity, but also a risk, imo.

https://seekingalpha.com/article/4236590-taubman-centers-get-rolex-price-timex