Shares of mall REIT Pennsylvania Real Estate Investment Trust (NYSE:PEI) have lost nearly half of their value over the past year -- driving the stock's dividend yield to 15% -- due to investors' fears about the so-called retail apocalypse. There is certainly some truth to these fears. Funds from operations (FFO), an earnings-like metric used to evaluate a REIT's performance, has declined steadily over the past few years. Management currently expects adjusted FFO per share of just $1.20 to $1.30 in 2019, down from $1.96 in 2014.
However, the problems afflicting the U.S. retail industry aren't impacting all malls equally. The best malls continue to attract lots of traffic, enabling them to maintain high occupancy rates while charging high rents. Last weekend, I had the opportunity to visit PREIT's two best malls: Cherry Hill Mall and Willow Grove Park Mall. What I saw confirmed that these two properties remain extremely valuable and hold plenty of long-term potential for PREIT.
Cherry Hill Mall is a regional powerhouse
For many years, Cherry Hill Mall (located in Cherry Hill, New Jersey) has been the dominant retail property in Philadelphia's eastern suburbs. The mall's primary anchors are Nordstrom, Macy's (NYSE:M), and J.C. Penney (OTC:JCPN.Q). These anchors support over 130 retailers, restaurants, and other small-format tenants.
As the dominant mall in Philadelphia's New Jersey suburbs, Cherry Hill Mall is home to nearly all of the "usual suspects" seen at most U.S. malls. For example, L Brands concepts Victoria's Secret, PINK, Bath & Body Works, and White Barn Candle Company are all represented. Gap's Old Navy and Banana Republic chains both have stores there, too, as do American Eagle (and its Aerie brand) and Abercrombie & Fitch (and its Hollister brand).
Thanks to its Nordstrom store and a higher-end Macy's store (it was upgraded with new fixtures and services as part of the department store giant's Growth50 program last year), Cherry Hill Mall also has a solid roster of upscale tenants. These include Armani Exchange, Tapestry's Coach, Hugo Boss, Italian lingerie brand Intimissimi, Tumi, and Williams-Sonoma (and its Pottery Barn chain). The mall even added a kiosk for popular fitness brand Peloton last year.
Cherry Hill Mall was quite busy when I visited on the Saturday morning of Labor Day weekend. Indeed, it remains a highly productive retail destination, due to its strong tenant mix. In-line tenants produced sales per square foot of $699 in the 12-month period that ended this June, up 5.6% year over year. That has allowed PREIT to maintain strong occupancy rates and high rents. Cherry Hill Mall generates more than $30 million of annual net operating income (NOI) -- a property-level measure of operating income -- nearly 14% of the NOI generated by PREIT's 21 malls.
Cherry Hill Mall also holds ample earnings growth potential. With J.C. Penney struggling, PREIT may have an opportunity to buy the Cherry Hill JCPenney store in the years ahead and redevelop it for higher-traffic tenants that would pay market-rate rents. This could also enable PREIT to push the mall in an even more upscale direction. Furthermore, Cherry Hill Mall is one of the many PREIT properties with vast parking fields that are rarely if ever used. The REIT expects to raise between $150 million and $300 million over the next year or so by selling such excess land to developers that would build multifamily housing and hotels.
Willow Grove Park Mall is on the rise
While Cherry Hill Mall has been PREIT's most valuable property for many years, it no longer has the highest sales per square foot in PREIT's portfolio. That title now belongs to Willow Grove Park Mall, which is located in Philadelphia's northern suburbs, less than 15 miles from Center City. Comp sales rose 7.9% for the mall's in-line tenants in the 12-month period ending June 30, boosting the property's sales per square foot to $763. As recently as 2014, the mall's sales per square foot was a far more modest $553.
Like Cherry Hill Mall, Willow Grove Park Mall has a high-end department store anchor (Bloomingdale's) and a well-kept Macy's (although it was not one of the Growth50 stores). However, it doesn't have the same kind of luxury component among its in-line tenants. Instead, the tenant list reads like a Who's Who of mall standbys. While this is a different formula for success, it seems to be working just as well. The mall was bustling when I visited on the Friday afternoon of Labor Day weekend.
Willow Grove Park Mall is set to take a step forward in early 2020, with the opening of a new Studio Movie Grill dine-in movie theater, replacing a JCPenney store that closed two years ago. PREIT also plans to add new restaurant and entertainment tenants as part of the JCPenney redevelopment. This should drive further growth in traffic to the property. As a result, while Willow Grove Park Mall's NOI is currently half that of Cherry Hill Mall, it is primed for strong growth over the next couple of years.
Lastly, like Cherry Hill Mall, Willow Grove Park Mall is a good candidate for PREIT's densification strategy. Even when I went (on a fairly busy day), certain portions of the parking lot were virtually empty. Some of this land could be repurposed for housing or a hotel.
PREIT was wise to upgrade its property portfolio
Hundreds of weaker malls in the U.S. are on the decline, as many tenants can no longer afford to pay high rents in the face of rising competition. That includes many of the malls that PREIT owned as of 2013. However, the REIT's management team had enough foresight to dump most of its lower-productivity malls over the past six years. This drove the REIT's FFO declines of the past few years, but it left PREIT with a stronger portfolio.
Meanwhile, PREIT has invested heavily to upgrade its remaining properties. While Cherry Hill Mall and Willow Grove Park Mall are the best of the bunch, the REIT has lots of other good malls -- and its high-quality properties now outnumber the remaining duds. That's why PREIT's worst days are behind it. It is well-positioned to return to FFO growth beginning in 2020, notwithstanding the retail apocalypse.