Will Retail REITs Struggle or Thrive in 2021?

Retail real estate has been one of the hardest-hit subsectors in 2020. The industry was already in the midst of a transition due to the growth of e-commerce before a pandemic brutalized the economy, and proved the final nail in the coffin for many retailers. While the S&P 500 has bounced back and delivered 13% in total returns since the beginning of the year, on strong gains by the tech sector, the S&P 1500 Retail REITs Index is still down more than 30%. 

But the question many investors want answered is this: Is the worst behind us, or will retail REITs continue to struggle? On the Nov. 2 edition of "The Wrap" on Motley Fool Live, host Jason Hall engaged Motley Fool contributor Brian Feroldi and Motley Fool analyst Tim Beyers to answer this exact question. And while all three think the worst is, broadly speaking, probably over, they have some differences in their expectations going forward. 

Transcript: 

Jason Hall: Pennsylvania Real Estate Trust (PEI). I have to confess, this is one that I bought some of before, this was back in January or February. This is the largest mall owner in Philadelphia. It just filed for bankruptcy. Brian Feroldi, I'm going to get you to go first here. I want you to tell me, will retail REIT stocks, so these are the companies that own the property, will they finish 2021 higher or lower?

Brian Feroldi: Than they are right now, I assume.

Jason Hall: Than they are right now, and why.

Brian Feroldi: Higher, they're higher. They will finish higher because by the end of 2021, we will have a vaccine, good malls will attract back people, bad malls will die, as they should, or be converted into other usable space, but I think the devaluations are so compressed on these things. I'm going to pull it up while Tim's talking, but I'm pretty sure that REITs make up 2% of the S&P 500 right now, it's somewhere around there, two percent. Apple, 6.5%, so Apple is three times bigger than all the REITs in the S&P 500. I'm not saying that's wrong, but I think there's room for REITs to go higher from here, especially over the next year plus.

Jason Hall: Tim Beyers, what do you say?

Tim Beyers: I agree with that for a different reason. I'm just going to slightly modify what Brian said because he's right in that I believe it's a small portion of the market right now, and what you said about things being repurposed, I think that's the key. I don't think the malls come back in the same way, but I believe that there's so much movement in e-commerce and movement toward logistics and flexible workspace and things like that that there's a lot of repurposed property, these fixed malls [...] reimagined as distribution centers, as all sorts of stuff that I think we can creatively reengage that space, and I think we will.

So I expect it to be higher once we start reimagining. For example, I'll just say that I would find it fascinating but also not at all surprising if Amazon goes shopping in the mall space and starts figuring out like, we're going to have a distribution center here, here, here. They got a lot of cash, they have a lot of cash flow, I could absolutely see them doing that and maybe even just tying it close to where they have all those Kohl's. You go and you drop off your return at Kohl's, get that near an Amazon distribution center, you're just optimizing, optimizing, optimizing and, man, there's nobody better than Amazon at that. So I'm going to say higher for the repurposing.

Jason Hall: I agree. I think at this point the baby's been thrown out with the bathwater. I think the idea that the mall is going to completely go away is just as false as every piece of commercial real estate in Manhattan is going to be useless. I think that there's a lot of really extreme assumptions that are getting factored into a lot of things, so I tend to agree. I think, to both Tim and Brian's point, whether it's still serving the same purpose, that's definitely up for discussion. I think, in general, a lot of it is going to get repurposed.

I think the best companies out there that are owning large malls are in the best positions to negotiate with an Amazon. If you're Amazon, you want to talk to somebody that owns 300, 500 malls because then you can pick the 50 or 100 that best fit your need versus Pennsylvania Real Estate Trust that just owns malls in a very small geographically located area that don't give them access to the markets that they need. So it's going to be really interesting to see how it plays, but I tend to agree. I'll go so far as to say not only will they be higher, I think they're going to outperform the S&P 500 over the next two years, five years, maybe even the next 10 years. I think there's a lot of opportunity.