In recent years, investors have become increasingly fearful about the so-called "death of the mall." As a result, shares of top-tier mall REITs like Taubman Centers (NYSE:TCO), Simon Property Group (NYSE:SPG), GGP (NYSE:GGP), and Macerich (NYSE:MAC) have tended to trade at a discount to their net asset values (NAV), the underlying value of their assets.
That discount widened late last month, after GGP agreed to be acquired by Brookfield Property Partners (NASDAQ:BPY) for substantially less than its NAV. Let's take a look at what this deal means for other high-quality mall REITs like Taubman Centers, Simon Property Group, and Macerich.
GGP's board gives in easily
Brookfield Property Partners currently owns a 34% stake in GGP. It has been looking to buy the rest of the company for a while. In late 2017, Brookfield offered a cash and stock deal valued at $23 per share to acquire the other 66% of GGP. However, a special committee of the latter's board of directors rejected the offer, declaring that it was inadequate.
Brookfield didn't have to sweeten the offer very much to get the support of GGP's board. Last month, it submitted a revised offer that valued GGP at $23.50 per share and included a larger cash component (roughly 61%, compared to 50% in the original offer).
This new offer was still well below GGP's NAV, which REIT analysts have estimated at about $30/share. Brookfield countered that current GGP shareholders will benefit from having the option of an immediate cash payment, plus a higher dividend and upside potential if they convert their GGP shares to Brookfield Property units, or shares of an equivalent REIT that will be created. In any case, the special committee voted to accept this offer.
GGP investors now must decide whether or not to vote for Brookfield Property Partners' offer. Unfortunately for them, Brookfield's existing 34% stake in GGP deterred other potential bidders from submitting rival offers.
Some analysts believe GGP could fetch a higher total price by selling properties one by one and using the proceeds to buy back stock. That said, investors can't be sure that management will follow this strategy if they vote against the Brookfield deal. Thus, the only real alternative for GGP shareholders is to be patient and hope that mall REIT valuations eventually recover.
Bad news for other mall REITs?
Retail REITs are typically valued based on "cap rates": the annual income from a property or set of properties as a percentage of its market value. (Lower cap rates are the equivalent of higher earnings multiples.) Declining customer traffic has severely affected cap rates for low-quality malls, but most REIT investors have been confident that "Class A" malls -- those with the highest sales per square foot -- would be immune to this pressure.
GGP's willingness to sell itself for a cap rate near 6% (versus the 4.5% to 5.5% cap rates typically used to value high-quality mall REITs) punctured this belief. It thus had negative implications for the valuations of rivals like Simon Property Group, Taubman Centers, and Macerich. Yet the GGP-Brookfield deal may just be an unusual case.
This isn't quite what it seems
There are three big reasons to think a lower valuation for GGP doesn't mean much for other top-tier mall REITs. First, while GGP owns a lot of extremely valuable malls, on average, it's not quite in the same echelon as its rivals. In a 2017 investor presentation, Taubman Centers noted that sales per square foot for its portfolio averaged $792 during 2016. That compared to $630 for Macerich, $614 for Simon Property Group, and $581 for GGP.
Indeed, in its own 2017 annual report, GGP acknowledges that only 75 of its 125 properties were Class A real estate. These properties had sales per square foot of $705 in 2017, compared to an average of $587 for the full portfolio. Additionally, sales per square foot rose less than 1% at GGP last year, compared to an increase of more than 2% at Simon Property Group. Thus, there are some duds in GGP's portfolio that could reasonably affect its cap rate.
Second, Brookfield Property Partners is paying for 39% of the deal with its own units, which also trade at a big discount to NAV. Given the weakness of this "currency," it was inevitable that the offer for GGP would come in below NAV.
Third, Brookfield's 34% stake in GGP gave it a huge amount of negotiating power by driving away other potential suitors. By contrast, high-end mall owner Westfield was sold at a 4% to 5% cap rate just a few months ago. GGP shareholders may be getting a raw deal, but investors in other top-tier mall REITs shouldn't be too concerned about the value of their holdings.