It's no secret that the retail industry is facing serious headwinds. With high-profile retail bankruptcies such as Toys R Us in the headlines, and many other retailers struggling to stay alive, it's no wonder many of you are afraid to put any money into retail-focused investments.
However, not all retail is in a downward spiral. In fact, some areas of retail are doing quite well -- and I'm not just talking about e-commerce. With that in mind, here's why retail REIT Simon Property Group (SPG -2.17%) is definitely worth a look, but it may be smart to avoid some other retail real estate stocks such as DDR Corp. (SITC -2.25%) and CBL & Associates (CBL).
Some retail REITs are struggling -- here are two to avoid
I'm a big fan of real estate investment trusts, or REITs, as long-term investments, and there are some excellent opportunities in retail REITs right now, thanks to the sector weakness.
However, some retail REITs look more like value traps than bargains at the moment, particularly those that have a lot of exposure to troubled retailers. While there are plenty of retail REITs that I'd stay away from right now, here are two examples of retail REITs to avoid right now:
DDR Corp. owns a portfolio of 258 shopping centers located throughout the U.S. While the company has certainly made significant progress, heavy exposure to now-bankrupt retailers like Toys R Us and hhgregg has been a major drag on the company, as has DDR's exposure to Puerto Rico.
CBL & Associates is another example, and looks like even more of a value trap. The REIT operates lower-quality malls and shopping centers (Class B, C, and lower), and has experienced a dramatic drop in revenue as well as a spike in vacancies and tenant bankruptcies. Just to give you an idea of the ongoing risk, it's no secret that Sears and J.C. Penney are struggling to survive right now. Well, more than 60% of CBL's properties contain either a Sears or J.C. Penney anchor. The company recently cut its dividend, and further cuts seem likely unless CBL can turn its properties around in a hurry.
One stock to buy
However, it's important to point out that not all retail properties are struggling. In fact, so-called "A" malls are doing quite well, as are discount-oriented retail and retail properties with an experiential component to the business.
Simon Property Group is a retailer that covers all of these areas. The largest REIT of any kind, Simon Property Group owns and operates malls and outlet shopping centers, including properties operated under its Premium Outlets and The Mills brand names. In fact, five of the 10 most valuable REIT-owned malls are among Simon's properties.
At the end of 2017, Simon owned 190 U.S. retail properties and another 27 in international markets. And despite the overall challenging retail environment, Simon's business is doing quite well. Not only that, but the company is doing a tremendous job of adapting to changing consumer preferences and driving traffic at its properties.
Simon's business is doing well
Let's put some numbers behind my perception that "Simon's business is doing quite well."
In its first-quarter earnings, Simon reported that sales per square foot in its U.S. properties actually increased by 4.2% year over year. The company's base minimum rent per square foot increased 3.2%, and releasing spreads were extremely impressive.
As a result of this success, Simon recently boosted its 2018 dividend by more than 11% and yields 5.2% based on the current stock price. In addition, the company is taking advantage of its depressed stock price by repurchasing shares at a rather aggressive pace (more than $220 million worth in the first quarter alone), and Simon just increased its full-year FFO guidance.
The news isn't all perfect. Simon's occupancy rate is a strong 94.6%, although this has fallen a bit recently. However, Simon is doing an excellent job of setting itself up for future success.
Why Simon has a bright future ahead
The biggest reason investors should be excited about Simon Property Group going forward is that it has done a great job of adapting to changing consumer preferences -- such as adding innovative dining options and experiential destinations (think theaters and family amusement centers).
Going forward, the company envisions turning its properties into even more "mixed-use" centers. As CEO David Simon said in the most recent annual report, the company wants to incorporate more "live, work, stay, and play elements" into its properties.
For example, during 2017, Simon opened three hotels, a 120,000 Class-A office space, and a 300-plus unit residential development at its mall. The reasoning is easy to understand -- after all, if there are thousands of people staying, working, or living at a mall, there's a built-in source of customers.
In fact, Simon sees its closing Sears and other troubled department stores as one of its biggest opportunities. For example, the company replaced one former J.C. Penney store with a Life Time Athletic healthy living and entertainment destination, a 146-room hotel, and other specialty shops and restaurants.
Also, Simon has the financial flexibility to do whatever it needs to in order to make its properties the best in the business. In 2017 alone, it spent more than $630 million on redevelopment projects like these, including the completion of 34 anchor replacements -- and another 35 are expected in 2018.
Not all retail properties are the same
The bottom line is that while there's a lot of uncertainty in the retail industry right now, it doesn't affect all stocks in the same way. In the retail real estate space, DDR and CBL & Associates have far more exposure to the troubled parts of retail than Simon Property Group, and also don't have nearly as many resources available to take their properties forward into the new retail landscape.
Don't get me wrong -- if DDR and CBL & Associates are successful in adapting to the new retail environment, their current stock prices could certainly turn out to be bargains. However, I'm far more confident about Simon Property Group's future, and the risk/reward of the stock makes much more sense to me.
Finally, based on the midpoint of its recently increased FFO guidance range, Simon Property Group trades for an astonishingly low valuation of just 12.6 times 2018's expected FFO. Now could be an excellent opportunity for long-term investors to add this best-in-breed REIT to their portfolios while the difficult retail environment is causing depressed valuations, even among the top-notch players in the industry.