Store closures and retailer bankruptcies have become a huge drag on mall REITs' financial results in recent years. Owners of low- and mid-tier malls have been hit hardest. Falling traffic to those properties caused two department store chains, Bon-Ton and Sears Holdings, to file for bankruptcy last year. In 2019 alone, numerous chains that were once ubiquitous at mid-tier malls -- such as Gymboree, Crazy 8, Payless ShoeSource, and Things Remembered -- have closed their doors for good.
However, one of the more recent retail bankruptcies is impacting a different slice of the REIT world. Fast-fashion giant Forever 21 filed for bankruptcy a little over a month ago and announced plans to close up to 178 stores in the U.S. Its restructuring is disproportionately hurting high-end mall REITs, as seen in recent earnings reports from Taubman Centers (TCO) and Macerich (MAC 2.31%).
Another setback for Taubman Centers
Taubman Centers owns some of the best malls in the U.S. It recently reported that sales per square foot for comparable centers in the U.S. reached $964 for the 12-month period ending on Sept. 30, up nearly 14% from $848 during the prior 12-month period. Yet Taubman has struggled to translate this portfolio of superior malls into strong growth in funds from operations (FFO) per share, due to a combination of poor execution and questionable investment decisions.
Taubman's third-quarter earnings report revealed more of the same. Adjusted FFO per share plunged to $0.86 from $1.01 a year earlier. Higher interest expense, lower land sale gains, and a decline in lease termination revenue all contributed to the FFO decrease. Management also said that the Forever 21 bankruptcy reduced FFO per share by $0.03.
Excluding lease cancellation revenue, net operating income (NOI) from comparable centers fell 1.5% year over year, driven entirely by the Forever 21 bankruptcy and exchange rate fluctuations. Taubman now expects full-year comparable-center NOI to increase just 0% to 1%, compared to its previous guidance for 2% growth. Looking ahead to 2020, the Forever 21 bankruptcy will reduce comparable NOI by 1% to 1.5% and will hurt FFO per share by $0.08 to $0.10.
Management noted that only one or two of the Forever 21 stores in Taubman's portfolio are likely to close, whereas Forever 21 had initially planned to close a dozen stores at the REIT's malls. However, Taubman Centers had to offer substantial rent reductions to avoid immediate store closures. In the years ahead, it will look to replace some of those stores with new tenants paying market rents.
Similar trends at Macerich
Macerich also owns a collection of extremely strong malls, with portfolio sales per square foot of $800 over the past 12 months, up from $707 in the year-earlier period. It has done a little better on the execution front than Taubman in recent years, but has faced many of the same challenges.
Last quarter, Macerich's adjusted FFO per share fell to $0.88 from $0.99 in the prior-year period. Excluding lease termination revenue, same-center NOI ticked up 0.2% year over year. For both of these metrics, Macerich performed slightly better than Taubman Centers in the third quarter. Nearly all of the FFO decline was driven by higher interest expense, lower land sale gains, a decrease in lease termination revenue, and an accounting change.
Macerich management said that on an annualized basis, the Forever 21 bankruptcy will reduce FFO per share by $0.08, including a roughly $0.01 hit in each of the third and fourth quarters of 2019. The annualized impact on comparable NOI will be approximately 1.3 percentage points. Like Taubman Centers, Macerich expects only a few of its Forever 21 stores to close -- and most of that space has already been released. Most of the impact of the bankruptcy will be felt in the form of rent concessions.
The outlook is stronger at Macerich
In the long run, Taubman Centers and Macerich should have no trouble replacing most of their Forever 21 stores with new tenants paying higher rents, due to the high quality of their properties. The Forever 21 bankruptcy will remain a significant headwind in the first half of 2020, but the impact will recede quickly thereafter. That said, Macerich is likely to see a quicker recovery in NOI and FFO than Taubman Centers.
First, Macerich has reported higher growth in average base rent and stronger releasing spreads than its rival over the past year. Second, Macerich owns 50% of Fashion District Philadelphia, a completely redeveloped city-center mall that recently opened in Philadelphia. As that property moves toward full occupancy during 2020, it should begin to make a meaningful contribution to NOI and FFO. Third, Macerich has a promising redevelopment pipeline. It is nearing completion of a major expansion of Scottsdale Fashion Square -- one of its premier malls -- and has more than half a dozen projects in the works for the next few years to replace closed Sears stores.
Thus, Macerich has a good chance to return to strong FFO growth as soon as the second half of next year. By contrast, based on its anemic rent spreads, it may take Taubman Centers longer to turn things around. Both REITs are likely to perform well in the long run, but Macerich looks like a better investment opportunity today.