Simon Property Group Continues Malling of America

Here in New Jersey, the spread of the strip mall has been at the heart of its traffic congestion. Along with cramming more people into a relatively small space than anywhere else in the country -- New Jersey is the most densely populated state in the union, some 13 times higher than the national average -- it also has more malls per square mile than any other state. Northern New Jersey alone has the most shopping malls in one area in the world, with seven major shopping malls in a 25 square mile radius.

All those people navigating in and out of all the curb cuts to shop at the sprawling strip malls that line its network of highways contributes mightily to the headache-inducing traffic jams we encounter on a daily basis. With the country -- let alone New Jersey -- awash in strip malls, there's not much of a market yet to build anymore, and it might help explain why the nation's largest mall operator, Simon Property Group (NYSE: SPG  ) , is spinning off its strip mall operations into a new real estate investment trust.

Room at the inn
According to the market researchers at Reis, the third quarter national vacancy rate for strip malls remains unchanged from the second quarter, at 10.5%, which is only 0.3% lower than it was a year ago. So stagnant is the market that it's down just 0.6% from its peak of 11.1% two years ago, leaving the rent situation weak as well. The Wall Street Journal points to Green Street Advisors, who show that strip mall rents fell by 2% in 2011, were flat in 2012, and are expected to increase by only 1% this year. A recovery perhaps, but not by much.

Simon has fared better, though, with Reis pointing to the REIT's 5% national average as being among the industry's best, and the mall operator itself says the strip malls it will be spinning off have an occupancy rate of 94.2%. Its community/lifestyle centers that will be included in the spinoff saw rents increase 3.3% last quarter. That should mean those shopping centers can still command something of a premium for its operators and ought to provide the new REIT, tentatively called SpinCo, with a higher valuation.

Stripped down strip malls
The mall as we know it, strip or otherwise, almost came to an end in the recession. Malls became ghost towns as consumers reeled from the financial upheaval that fractured the market. According to the researchers at IBIS World, the recession and concurrent drying up of credit also crippled strip mall construction, sending the value of commercial building construction down 12.6% annually between 2008 and 2011. 

But Simon might have also seen the success General Growth Properties (NYSE: GGP  ) had in calving off Rouse Properties (NYSE: RSE  ) and 30 malls two years ago, and then watching shares of the spinoff appreciate 80% in value.

Spinning its wheels
SpinCo is expected to initially own or at least have an interest in 54 strip malls as well as in 44 smaller enclosed malls with annual net operating income of up to $10 million each. Those smaller malls have an occupancy rate of 90.4%, but it will still leave Simon atop the mall-operating heap, with roughly 225 malls, outlets, and other retail properties in the U.S. and Asia.

In spinning off these small shopping centers, Simon intends to focus on its global portfolio of larger malls, mills, and premium outlets, much as General spun off its lower-quality malls and smaller Glimcher Realty Trust (NYSE: GRT  ) has directed its focus toward attracting higher-end retailers to its 24 mall properties in 14 states. 

Simon says "Do this!"
SpinCo will pay a dividend that Simon estimates will be at least $0.50 per share in the first year, representing 100% of taxable income. REITs must pay out at least 90% of their taxable income to shareholders as dividends in return for being taxed at lower levels. For that reason, REITs typically pay higher dividends than other companies.

Simon will be taking the cash generated from the debt SpinCo will take on, which will total around $2 billion at the end. Yet the spinoff should still have a relatively strong balance sheet, with debt at around five times its EBITDA.

As the premier mall operator now focusing on premium malls, Simon Property Group ought to perform well even if on most common metrics, the REIT doesn't look cheap. The strip center spinoff, however, can expect to prosper as the malling of America regains momentum. Even with the debt load it's taking on, investors might want to consider shopping here.

Not your mother's mall
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