Retail REITs Are on Fire

In this episode of Industry Focus: Financials, host Jason Moser and Fool.com contributor Matt Frankel, CFP, take a look at Simon Property Group (SPG 1.43%), Seritage Growth Properties (SRG 1.78%), Tanger Factory Outlet Centers (SKT 1.48%), STORE Capital (STOR) and more. Hear why these stocks have rallied so sharply, and whether there could be more growth ahead.

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This video was recorded on June 8, 2020.

Jason Moser: It's Monday, June 8^th. I'm your host Jason Moser, and I'm joined today, of course, by my partner in crime, Certified Financial Planner, Matt Frankel. Matt, how's everything going?

Matt Frankel: Oh, just great. It's a beautiful 90° day here; how's it going up there?

Moser: [laughs] It's about the same here in Northern Virginia; maybe not quite 90°, but it's getting close, beautiful and sunny. And, yeah, it does feel like Summer is here, and we never got Spring. We just said, we don't get Spring up here apparently anymore, which is kind of frustrating, but it's nice to at least have some good sunny weather up here, and it does feel like things are starting to open back up a little bit, maybe not quite on the pace that you guys are witnessing down there in South Carolina, but slowly, but surely, life is getting back to a little bit of what we would consider normal, I think.

Frankel: Yeah, I hope they accelerate that for you guys, because it's been [laughs] very refreshing here to be able to go out to restaurants and I could go get a workout at a gym instead of in my, you know, basement. So, it's been a nice change.

Moser: Yeah. Crazy year so far in 2020, maybe the back-half will be a little bit better to us. Well, on today's Financials show, we're going to talk specifically about Real Estate Investment Trusts, REITs, more specifically, we're actually going to be talking about retail REITs Real Estate Investment Trusts and why investors better not be sleeping on them.

Matt, you fired off a tweet over the weekend giving listeners a choice. You fired off a tweet with a poll, you gave listeners a chance to vote. And I'll read the tweet here for you, you said, "Real estate REITs have been on fire this past week -- and I'll be talking about them with TMF's [...] on tomorrow's Industry Focus -- which of these will be the best performer over the next five to 10 years?" And you listed off Simon Property Group, which is ticker SPG; you mentioned Tanger Outlets, which is ticker SKT; STORE Capital, which is ticker STOR; and Seritage Growth Properties, ticker SRG.

Now, Matt, I know who I voted for, and it does seem like the majority of folks here, close to the majority, it certainly is the winning vote-getter, Simon Property Group. And we'll get into why that might be the case, but let's talk about this first-and-foremost, just what prompted the tweet here? Real estate REITs have been on fire this past week. So, talk to us a little bit about why that is the case?

Frankel: Well, retail REITs, you got to realize, first of all, were among the most beaten-down stocks in the market, in many cases, they did even worse than hotels, cruise lines and airlines. The reason is, being a retail REIT is not that high a profit margin of a business. So, if you're not collecting rent, things can go south real quick. And we saw, as stores were forced to close, especially in discretionary retail, meaning nonessential businesses, in pandemic terms, we saw widespread closures. You mentioned Simon Property Group, at one point, 100% of their malls were closed, period. Like, nothing was running. Even if there was an essential business inside the mall, it was closed.

Moser: I mean, there was nothing they could do about that too. I mean, that was out of their control.

Frankel: Right. And they weren't ordered to close down at the time, they did, but they were about to be, so. [laughs] So, Simon, Tanger, their properties were essentially all closed at one point. STORE Capital, the other one I mentioned, is actually the one that most of the properties weren't closed, only about one-third of their properties were closed at the peak. And Seritage, if you're not familiar, not that many of their properties are open on a normal basis, because their whole business model is redevelopment, so ...

Moser: Doesn't Seritage, isn't there Sears connection there?

Frankel: Yes, they were specifically created to buy a portfolio of old Sears properties.

Moser: Yeah, I mean, that's like, I don't know, that I'm necessarily feeling all that great about Sears, even in retail's heyday, right? I mean, obviously, now it's faced with its own set of challenges.

Frankel: Well, neither is Seritage. Out of all their properties -- they own, I think, 220 properties right now -- they only have 17 that are occupied by Sears or Kmart and they just canceled the leases on 12 of those. So, they're pretty much washing their hands of Sears and Kmart at this point.

Moser: Yeah, as is the rest of the world apparently.

Frankel: Their whole business model is that, at the time when most of these Sears were built, these were the premier shopping locations, I mean, people used to, you know, get dressed up in their Sunday best to go to Sears in the 70s and 80s. So, the locations are fantastic, but nobody wants to own a Sears, Sears doesn't even want to own a Sears, that's why they created Seritage.

So, the point is, these are top locations that are huge pieces of property that Seritage is now developing into more modern, mixed-use retail assets. It's a long, slow value-creation model, they're not profitable yet. And I understand why only 7% of the poll respondents said that Seritage would've been the best performer, but you might have gotten it wrong, because today alone Seritage is up 38%.

So, let me just read you off this one line of statistics I have. Seritage is up 38% today, 171% over the past week, and 330% off the March lows.

Moser: That's unheard. Typically, with your REITs, Real Estate Investment Trusts, essentially, they need to pay out most of their net income in the form of a dividend, right? The crux of investing in a REIT is that you know you're getting a high yielding instrument. And so, the capital gains side of it, it tends to be a bit more modest because we know that that yield is there. But clearly, this was not a normal time, I could certainly understand where investors felt like retail was falling off a cliff and certainly every stock was just killed over that period of time. But from what it sounds like, in this past week going into today, there is more optimism. We're reopening the economy here and that people are able to, kind of, get back to business, I guess.

Frankel: Right. And you're seeing better than expected -- I mean, the jobs report on Friday, just to name one thing. You're seeing consumer confidence was way higher than expected. You're seeing things like air travel pick up a little faster than people thought it would, hotel occupancy. And just some of these retail REITs are putting out numbers that are impressing investors.

You know, a lot of retail REITs were reporting collecting [laughs] virtually no income in April and May, Seritage just reported they got 62% of their April rent, and over half of their May rent. And agreed to defer, meaning that they'll get it eventually, another 6%. So, that's actually pretty -- I mean, in a normal non-pandemic month, the retail REIT that only collects 60% of its expected rent is pretty bad. But this is not a normal environment. And when other retail REITs are collecting -- one of our favorites, EPR Properties, collected 15% of their April rent. When you compare it to things like that, that's actually a really impressive number. So, things like that.

And the biggest question with Seritage, why they were priced for essentially an imminent bankruptcy, was a funding question. If you remember, Berkshire Hathaway is their lender. To get access to their revolving credit line, they need to have a certain amount of non-Sears leases signed, they don't have that, so they need to get funding other ways, specifically through rental income or asset sales. And we got good news on both of those, which is why you're seeing the giant move.

You know, I just mentioned their rent is much higher than expected, they've actually sold over $40 million of assets since the end of the first quarter, which a lot of people thought that nobody would be buying retail properties at this point.

So, their funding questions, I don't want to say that they're answered, but you're getting a lot more clarity which is why you're seeing that one move so much.

Moser: Okay. So, let's talk about Tanger here for a minute, because that's certainly a name I'm familiar with. I think you see a lot of these outlet shopping centers -- I mean, I believe Tanger is one of the names behind those. And Tanger did come in third place as far as the votes go. I mean, this is 438 votes, this is a nice little cross-section here, you know, some decent numbers to turn there, but in third place was Tanger Outlets. And there was a question that came from that tweet that you sent out that I wanted to get your perspective on here.

And the question comes from Steve Finch, who asks, "What do you think are the chances of Tanger going bankrupt. You know, given the rent situation for certain REITs, maybe a week ago the answer to this question might have been a little bit different, but what would you say to that today?

Frankel: Well, the reason I actually bought some shares of Tanger during the pandemic was because, out of the four companies in that poll, Seritage is the only one I ever thought had a realistic chance of going bankrupt in the next year or two. And the reason for that is, it's not about what they're doing today, it's about how much money they have to get through the tough times and whether they're going to be profitable on the other side.

So Tanger, unlike Seritage, until this pandemic, was a very profitable company. I mean, their stock price had underperformed for the past couple of years. There's a lot of questions about some of their tenants. Gap, which we'll talk about in a second, is a big tenant of theirs. You know, all these companies that are generally mall-based and have off-price outlet stores are Tanger tenants. So, mall retail, obviously, is a terrible place to be right now. I mean, I'm talking about the individual retailers, it's not a space you really want to invest in.

So, those were a lot of the companies that Tanger rents to. For the time being, Tanger's occupancy is over 90%. The sales per square footage was actually going up until the pandemic hit. So, the business hasn't been doing terribly. I mean, it's been earning more than enough money to cover its dividend, which is pretty high. It has a lot of liquidity; I know it drew down several hundred million dollars of its revolving credit facility. And not to mention, as this started to unfold, Tanger made a fantastic CEO hire; the son of the company's Founder, Steven Tanger, is currently CEO, but they just hired Stephen Yalof. Who was formerly the CEO of Simon's Outlet division, and Tanger essentially stole him away to be their next CEO. And no company has done better at the outlet business than Simon. If you've ever seen an outlet property under the Premium Outlets brand, that's a Simon property. They have about two-thirds of the entire outlook market.

Moser: What do you think as far as, I mean, beside, obviously, leadership matters in regard to any company, but I mean, it does feel like, with Real Estate Investment Trusts or business development companies, those are areas where maybe it does feel like maybe you're making a little bit more of a jockey play, it does feel like to me management matters even maybe a little bit more. We want to make sure we've got management in there who can allocate capital really well. I mean, real estate is a very difficult market to fully grasp, it's not a one-size-fits-all, certainly location, location, location comes into play. But do you feel like I do, in that, Real Estate Investment Trusts real estate investments, those are a bit more dependent on good management?

Frankel: Yes, and that's actually one of the big reasons I love Tanger. Like I said, it's family run, family founded. They went public in '93, they've raised the dividend every year since 1993. I mean, how many other retail -- this year excluded, that streak obviously came to an end in 2020 ...

Moser: I was going to say, that could be getting close to dividend aristocrats.

Frankel: ... but that would have been really impressive, and based on the dividend, they would be yielding something in the 20% range right now. But good management is key. Simon is also a family run -- you know, it's run by the Founders or the Founder's children. So, management is a big deal.

That's actually one of the biggest complaints I often hear about Seritage, because well, the Manager, a guy named Benjamin Schall, who's doing a fantastic job; the Chairman of the Board is Eddie Lampert from Sears. A lot of people don't really care [laughs] to be involved in a company that he has a hand in.

Moser: Yeah, I can at least understand that, having followed him, you know, over my time at The Fool and even before, as a member, I mean, he's had a bit of a hit-or-miss sort of track record, it feels like.

Frankel: Yeah. Well, [laughs] that's putting it kindly. Whenever I bring this up to fellow Fools, the biggest thing is, "Yeah, but doesn't Eddie Lampert have a hand in the company?" I mean, he's the biggest stockholder.

Moser: I mean, I can understand the trepidation there. I don't know that I necessarily see that as a plus, and I don't think that's an argument for the bull case.

Frankel: But the other biggest stockholder in Seritage, actually it's worth noting, is Warren Buffett. I mentioned Berkshire Hathaway is their lender, so Berkshire Hathaway doesn't own the common stock, you won't find that in Berkshire's portfolio. But when you look at Seritage's SEC filings, you'll notice that the biggest individual shareholder listed is Warren E. Buffett, who owns a little over 5% of the company, I want to say. So, Buffett not only feels comfortable lending Seritage money, but he puts his money into the common stock itself, so I mean, that kind of helps offset the Eddie Lampert involvement, in my mind.

Moser: Yeah, I guess so. Let's talk a little bit about STORE, because I think that's a really interesting one. And we did have second place here, STORE Capital. And there was even one of the responses to your tweet in the growth stock doc, you said, STORE is well-diversified, comparatively, it has gas stations, day cares, et cetera, in addition to retail-type properties, and is a large Berkshire holding.

What about STORE Capital has you excited about its outlook here for the future? Is it that diversified real estate portfolio, is it that it goes well beyond just your traditional mall- and retail-type establishments?

Frankel: Well, STORE Capital is kind of like the oddball on this list, I'll say; it's a net lease REIT. And the company I would actually best compare to is Realty Income, which I've talked about a few times on the show; meaning that it invests primarily in single tenant properties. Actually the "ST" in STORE stands for Single Tenant; the name stands for Single Tenant Operational Real Estate.

So, there's kind of a complicated answer to that question, because STORE's diversification is actually kind of the reason it's underperformed Realty Income, National Retail Properties and a lot of its other peers. Most of those are occupied by just essential businesses, think of say, gas stations, dollar stores, things that have been open during the pandemic.

In STORE's case, one-third of the portfolio is occupied by restaurants, by day care centers -- which have not been opened -- by movie theaters, by family entertainment centers, by gyms. So that's one-third of the portfolio. So, they've actually been hit a lot harder by the pandemic in terms of their tenants being closed than pretty much every other net lease REITs. Which is why you're able to get it at such a discount right now, in my mind. Again, everything on that poll, I've bought since the pandemic started. So, putting money where my mouth is.

Moser: You are. Okay. Well, let's talk about the winner, Simon Property Group. And you know, you'd mentioned earlier, talking about the rents and the percentages there, we saw headlines here, over the past couple of days here, that Simon Property Group is actually suing Gap, the retailer Gap, over missed rents. And Gap, apparently one of its largest U.S. store tenants, withheld three month's rent plus, totaling close to $70 million here.

Now understanding, obviously, a very unique time and everybody has been stuck in one way or another. And we've even seen companies, like, Chipotle and Starbucks, companies that are really in tremendous positions, even negotiating with their landlords to try to negotiate better rents here in the near-term just because of everything that had to be shut down and the costs that are coming from this pandemic here.

Simon, taking it to Gap here, and who knows how this is going to work out? I kind of feel like maybe Simon might have a little bit of a tough time getting everything that they want from this. But does that even matter, what kind of a look is that for Simon to take Gap to court with this?

Frankel: I mean, there's two sides to every story here. First of all, say, I don't buy for a second that Starbucks needs rent concessions.

Moser: [laughs] Yeah. Well, you're probably right.

Frankel: I don't know about you, but even during the depths of the pandemic, the Starbucks by me, it never had longer drive-thru lines. So, I mean, they might not be as profitable as they were, but they're making enough to pay their rent. So, anyway [laughs] moving on.

The two sides to the story here are, one, Simon says Gap owes rent because they signed the lease, the lease says that they have to pay rent and most leases, for retail or otherwise, specifically exclude viruses; if you have to be closed because of a viral outbreak, say, like, your whole staff gets the flu, that's usually excluded from a reason not to pay rent. And Gap has a lot of stores in Simon properties; 391 at last count. So, they're a pretty big tenant.

Moser: So, Simon has somewhat of a leg to stand on here.

Frankel: Right. And, according to Simon, Gap decided to close all of their North American stores before Simon decided to shut down their mall. So, they can make the argument that if Simon's malls would have been open that they would have still been operating, because that would have been a really solid argument. You know, it depends who closed first is, kind of -- I don't know if that's the legal argument, but it definitely helps Simon's case.

On the other hand, there's also usually a clause in leases that says you're guaranteed access to the property. If you're renting an apartment and you don't have access to the apartment, you generally don't have to pay rent. So, it'll be interesting to see how this legal battle plays out. I have a feeling they're just going to come to some, sort of, settlement.

Moser: I feel like that's the inevitable conclusion here. I can't imagine anyone to draw this thing out, especially if have the opportunity --

Frankel: Yeah, a long-drawn-out court battle is in nobody's best interest. That costs both of them money. And, I mean, Simon is suing for any court costs, but they're still taking the chance that they're not going to win and spending millions of dollars on lawyers and court fees and things like that; it's in no one's best interest. So, I have a feeling they're going to say, OK, pay half your rent for those three months and we'll call it even.

Moser: Yeah. And I guess I wonder too, you know, we're talking about all of this happening in the context of right now the one thing we don't know is, will we see some type of second wave that puts these companies on weaker footing again? I mean, do we see a second wave where these stores have to close down again? If that's the case, they maybe look back to this point in time as some type of precedent. So, I mean, there's, sort of, that uncertainty that hangs out there as well.

Frankel: Yes. And I agree there's a lot of uncertainty here. If Gap continues to operate, which I don't see Gap going bankrupt anytime soon, I don't know about you. I think they're in a pretty decent financial footing. I mean, retailers are struggling, but they're one of a bit better-positioned ones. As long as they continue to operate, I really don't see them making a really good case that they should have to pay nothing for those times. Especially because they're withholding June rent. In most cases, Simon properties are open in June.

Moser: Yeah. I was going to say, it does seem like most things are, kind of, getting back into the swing of things here now, and it's only June 8^th, so, yeah, that's --

Frankel: So, that feels like the textbook definition of willfully withholding rent.

Moser: [laughs] Yeah. Maybe reaching for a little bit more than they are entitled there.

Frankel: Yeah. April and May maybe, I could have gotten onboard, but when they said June as well. That kind of sounds, kind of, opportunistic on Gap's part.

Moser: Okay. So, talk to me here then, because this is essentially, you know, we love to form stock baskets, right, we love putting together a collection of stocks based on big, long-term opportunities. We talk about the War on Cash; we talk about Healthcare. This is a basket of stocks that you're looking at following here, isn't it?

Frankel: Yeah, I'm calling this my "Retail isn't dead" basket.

Moser: Alright.

Frankel: Yeah. [laughs] It's not just these four, I would actually add Realty Income to there too, because that's one of my favorites, but I didn't buy any more Realty Income during the pandemic, since it's already one of my big positions, so that's why it wasn't included in the poll. But if I was going to make a formal basket, since your basket has done so well, so I need to kind of compete a little bit, I would do those four plus Realty Income. So, that would be STORE Capital, Seritage Growth Properties, Simon Property Group, Tanger Factory Outlet and Realty Income. I would call them my "Retail is not dead" basket. And notice that this isn't a bet on any individual retailers, so ...

Moser: ... Well, I was going to say, that's one of the things I really like about this "Retail isn't dead." And really, you're looking at retail from a different perspective and I think that there's a good lesson to be learned there, particularly when it comes to investing in that. You know, there's looking at one market opportunity directly, but then it's also looking at it from a little bit of a different perspective and the other players in that value chain. And while, you know, there's a direct name in Gap and what they do, as far as retail goes, you know, there's another party in that value chain when it comes to something like a Simon Property Group, it's maybe you don't hear about that when we talk about Gap and how they're performing, but Gap certainly needs Simon in order to be able to support that real estate presence that they have. And so, it's a neat way to look at how these markets work together and the different players in those value chains.

Frankel: Yes, it's like, this is a basket that's betting that physical retail, in some form, will do just fine, not necessarily that Gap, American Eagle, Abercrombie & Fitch are going to be fine in five years, but that the physical retail is not going anywhere. Just kind of like the War on Cash basket isn't betting on any specific recipient of cash payments, you are betting on the fact that cash is going to go away as a whole. So, that's kind of the thought process here.

And even now that all these have rebounded -- I mentioned that Seritage is 330% off the lows, but the worst performer of that group since the March lows is STORE Capital, up by 101%.

Moser: The worst performer?

Frankel: That's the worst out of the four. Not since I bought, I wish I would have timed them all exactly at the lows, but it just didn't happen. STORE Capital is up 101% from the lows. Simon Property Group is up 119% from the lows. Tanger Outlets, 140% from the lows. All of them are up 35% or more in the past week alone. So, it's fair to say that things seem to be moving along with the economy a lot faster than people thought, and that's really good news for these companies.

Moser: Well, let's hope it continues. And the "Retail isn't dead" basket, I love it, Matt, we'll be tracking it from here on out, you heard it here first, folks, "Retail isn't dead" basket. Thanks so much for that, Matt.

Well, Matt, before we wrap up for the week, let's go ahead and give our listeners one to watch. What is a stock that you'd be watching here this coming week?

Frankel: I am going to watch Seritage, just because it's been so fun to watch. I hate repeating myself, but it's just been such a fun one to watch, not just because I own it, if I didn't own it, I would be really, kind of, glued to this one. And just seeing some of the comments that are coming in, where a lot of people are, I think Seritage still has a lot of room to go, it's still about 50% lower than its pre-pandemic level. So, when I say it's up 330%, it's not back to even yet, it's just, you know, slightly less bad.

So, I mean, under the right circumstances, if their plans go right and their business bounces back, Seritage could be a pretty valuable stock in a few years. So, it's one that I've owned since before the pandemic, I added more. And it's a great business model, I've written about it a few times. So, that's one I'm watching going forward, especially over the next week or two.

Moser: Good deal. Well, I'm going a little bit of a different direction here, focusing a little bit more on the digital economy. Adobe earnings are coming out on Thursday. And this is one that I have been following for a while.

Adobe ultimately is a digital media company, and it's just a really attractive business model where ultimately that 90% of revenue is tied to subscriptions, which it's just, you know, we love seeing those subscription businesses. And while the pandemic certainly knocked plenty of businesses on their backsides, you know, I'll be really interested to see how Adobe managed its way through that stretch.

And I will say that when the bear market occurred, when all of these stocks were just being sold indiscriminately, Adobe was one that was tanking with the rest of them. That was probably the stock I bought the most during that bear market. I had always wanted to start a position in that company, and so I started a position, and I basically built out my full position in Adobe over that time.

I feel like it's going to do really well in most any market given that subscription model and the reach that they have in that digital media world. But I'll be looking forward to their earnings report on Thursday to see how they have managed their way through it, and what they see the rest of the year holding.

But, Matt, I think that's going to do it for this week, so appreciate you jumping here with me and talking some Real Estate Investment Trust for listeners this week.

Frankel: Of course. I could talk about this stuff all day.

Moser: [laughs] Well, we might just take you up on that. But for now, folks, remember you can always reach us on Twitter @MFIndustryFocus. Look out for the occasional poll. You know, we're always trying to come up with some new things to vote on there and get some ideas as to what the market sentiment out there is. Or feel free to drop us an email at [email protected], let us know how things are going.

As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

Thanks, as always, to our man Austin Morgan for keeping it real this week. For Matt Frankel, I'm Jason Moser, thanks for listening, and we'll see you next week.