To say that mall owners have suffered over the past few years would be a huge understatement. Changing shopping habits have forced mall owners across the U.S. to reposition their properties to better cater to consumers' desires. However, transforming a tired mall takes a lot of time and money. For many malls, the revival efforts turned out to be too little, too late.
As a result, profitability has plunged at most mid-tier mall REITs, causing their share prices to crater, too. On a total-return basis -- which includes the impact of dividends -- Pennsylvania Real Estate Investment Trust (PEI +0.00%) shareholders have lost nearly 60% of their money over the past five years. Amazingly, Washington Prime (WPG +0.00%) shareholders have incurred even bigger losses.
Washington Prime vs. Pennsylvania real estate investment trust total return. Data by YCharts.
The Q2 earnings reports from both REITs showed that the pain is continuing. However, one of the two is far better positioned for a rebound in 2020.
Another weak quarter at Washington Prime
For several years, outspoken Washington Prime CEO Lou Conforti has been telling investors that the REIT was transforming the malls in its portfolio into dominant town centers. Thus far, the efforts haven't borne much fruit.
Sales per square foot in the company's Tier 1 enclosed mall portfolio, consisting of its better properties, slipped from $401 in 2015 to $399 in 2018. Meanwhile, adjusted funds from operations (FFO) -- a key earnings metric for REITs -- fell from $1.91 in 2015 to $1.51 last year.
FFO per share plummeted to $0.27 last quarter, down 27% from $0.37 in the prior-year period. The underlying health of Washington Prime's properties leaves something to be desired, too. Leased occupancy for its core properties stood at 92.5% at the end of last quarter, down from 93.8% a year earlier. The only relative bright spot was that sales per square foot for the trailing-12-month period increased 3.3% to $410.
Washington Prime's malls haven't performed well in recent years. Image source: Getty Images.
Washington Prime also highlighted its efforts to replace 29 department stores that have closed or are expected to close within its portfolio. However, while it classifies 15 of those vacancies as "addressed," construction has begun on just a handful of those projects, so most of the benefits from redevelopment will not show up for at least a year. Moreover, in several cases, it is solving the problem by replacing one department store with another department store or by demolishing the store and turning the land into green space. Neither option is much of a solution.
PREIT also stumbles
Between 2015 and 2018, PREIT saw nearly as much FFO erosion as Washington Prime, with adjusted FFO per share falling from $1.89 to $1.54. The downward trend accelerated last quarter, as adjusted FFO per share plummeted to $0.22 from $0.39 a year earlier.
Management highlighted that new accounting rules governing leasing costs and a reduction in lease termination revenue reduced FFO by $8 million, or $0.10 a share. Still, PREIT suffered a big decline in FFO even after adjusting for those factors. Management attributed the decline to the huge number of retailers that have liquidated their operations this year.
On the other hand, PREIT's aggressive efforts to get rid of underperforming malls and reinvest in more promising properties have driven incredible growth in sales productivity. Sales per square foot for its core malls reached $531 for the trailing-12-month period, up from just $432 in 2015. Sales per square foot increased more than 5% just over the past year at these core properties.
PREIT also confirmed that it is on track to complete redevelopment projects at about a third of its malls within the next 12 months. Management estimated that these projects together will provide about $25 million of incremental annual net operating income (NOI). That's a substantial amount relative to the REIT's projected 2019 NOI of approximately $235 million.
There are more signs of progress at PREIT
Just based on their recent FFO trends, Washington Prime and PREIT look almost equally bad. However, on a forward-looking basis, the story is far different.
First, PREIT is posting much stronger growth in sales per square foot than Washington Prime, highlighting the superior quality of its malls. Second, whereas Washington Prime is still early in the process of replacing department stores that have closed at its properties, PREIT is nearly done (for now, anyway).
If all goes well, Washington Prime will see a modest recovery in NOI and FFO next year. But it wouldn't take much disruption for the REIT to take another step backward in 2020. By contrast, PREIT has huge growth drivers coming on line over the next several quarters. As a result, it is a far better turnaround bet for investors.
