Over the past few months, virtually every major mall REIT in the U.S. has reduced or suspended its dividend payments. While the long-term impact of the COVID-19 pandemic on malls remains uncertain, the short-term impact has been devastating, giving mall owners no choice but to reduce their shareholder payouts.

Simon Property Group (NYSE:SPG) was one of the last holdouts. However, on Monday, the largest U.S. mall REIT bowed to the inevitable, announcing a 38% temporary reduction to its dividend.

Mall owners are on the ropes

With the pandemic spiraling out of control, Simon closed all of its properties in the U.S. on March 18. While it initially hoped to begin reopening them before the end of March, all of its malls remained closed through the end of April. Since the beginning of May, Simon has been able to gradually bring most of its properties back on line. Today, 199 of its 204 U.S. retail properties are open.

Yet while most Simon malls have reopened, that doesn't mean things are "back to normal" whatsoever. Many mall tenants withheld rent this spring, as they tried to conserve cash in the face of plunging sales. Simon Property Group hasn't provided any details about how much rent it has collected, but many other mall REITs reported collection rates below 50% in April and May.

Some tenants have reached agreements to make up rent payments they skipped once they stabilize their finances over the next year or so. Others may file for bankruptcy, in which case uncollected rent will probably be written off. Tenant bankruptcy filings will also have a longer-term impact, as Simon may need to reduce rents temporarily to keep various spaces filled -- and some tenants will close anyway, leading to an increase in its vacancy rate.

An interior corridor at Roosevelt Field Mall

Image source: Simon Property Group.

Perhaps the most troubling development is that several big, well-capitalized retailers have been withholding rent for periods when their stores were closed. They include Gap Stores and L Brands: Simon Property Group's top two tenants. These retailers generally argue that the pandemic represents a "force majeure" event outside their control that cancels their lease obligations. In early June, Simon sued Gap for $65.9 million in unpaid rent, but it's unclear which side's legal arguments will prevail.

There goes the dividend

In short, some of the revenue that Simon failed to collect over the past few months may never be collectable. There will also be a significant medium-term loss of revenue from tenant bankruptcies, which could take a long time to fully offset. As a result, the REIT is no longer generating enough income to cover its dividend ($2.10 per share, as of the first quarter).

During the company's first-quarter earnings call in May, CEO David Simon noted that over 175 public companies had suspended their dividends or reduced them by at least 50%. He said that Simon Property Group would not follow suit.

Simon was able to follow through on that promise, but the dividend cut was still painful. The REIT announced that it will pay a cash dividend of $1.30 per share next month: down 38% from its previous payout. The company also said that it expects to pay total dividends of at least $6 per share for 2020 as a whole, which implies that the next two dividends would also be at least $1.30 per share.

A wise move

In the dividend announcement, Simon Property Group said that it had $8.5 billion of liquidity, including $3.5 billion of cash on hand. In theory, Simon could have used that liquidity cushion to maintain its previous dividend. The difference between $6 and $8.40 in dividends per share for the full year works out to less than $1 billion.

However, reducing the dividend to a level more in line with Simon Property Group's 2020 cash flow is the right choice. For one thing, Simon faces litigation related to its recently canceled deal to buy a controlling stake in Taubman Centers. If a court forces the company to go through with the acquisition at the original price, the cash cost would be $3.6 billion. Additionally, Simon could face a substantial capex bill to redevelop properties impacted by significant store closures.

The next few years are unlikely to be easy for mall owners. Fortunately, Simon's strong balance sheet -- along with the cash savings from its dividend cut -- will help it weather the storm. And with the stock down more than 50% from its 52-week high, there's plenty of upside for long-term investors if Simon Property Group can turn its business around in the years ahead.