When the U.S. economy was effectively shut down to slow the spread of COVID-19, retail landlords like Tanger Factory Outlet Centers (NYSE:SKT) were hit very hard. That's not unreasonable, since mall owners like this real estate investment trust (REIT) were already facing headwinds. At this point, Tanger has suspended its dividend. However, there is a mixture of pros and cons here that more adventurous investors may want to consider. When you add it all up, Tanger may not look as bad as you think.
The bad news
The United States has an overabundance of retail, one of the key facts behind the so-called "retail apocalypse." There are other issues involved, including companies that over-leveraged and fell behind changing customer trends, but too much physical retail is a prime factor. So, even before COVID-19, stores were struggling to compete. When non-essential stores were shut and people were asked to stay home, weaker players simply crumbled.
Key tenants for retail landlords like Tanger Factory Outlet Centers have been closing locations and going bankrupt. That's a problem for mall owners in multiple ways. First, there's less and less reason to go to a mall as stores shut. Second, as stores shut, there are lease clauses that can be tripped (called co-tenancy clauses) that may give other tenants the right to reduce their rent payments or even allow them to break their leases and leave. That furthers the downward spiral. These things were already happening, but COVID-19 has sped up the timeline.
COVID-19 has also increased the tension between landlord and tenant in the mall space, with some large tenants basically using the coronavirus as a reason to stop paying rent. Without customers, that's understandable to some degree. However, mall landlords still have to pay their own bills. If lessees hold out too long, mall landlords could end up going bankrupt. This is a bad situation and there's no easy fix, especially since consumers shifting toward online shopping is a key factor.
The good news
Tanger, however, isn't your typical mall-owning real estate investment trust. As its full name implies, it owns factory outlet centers. This is among the least developed of the retail property types, with Tanger estimating that factory outlet centers account for only 1% of the U.S. retail property market. So there's a strong reason to believe that Tanger, which is uniquely focused on this niche, will be able to muddle through without the need to materially alter its portfolio. Yes, it may have to sell some older assets, but overall, it's still potentially in a relatively well-positioned sub-sector of the retail space. It's also one with low tenant costs, so retailers tend to find outlet centers to be highly profitable locations.
Add to this that most of Tanger's properties are open-air facilities. These are cheaper to operate than enclosed malls (which leads to lower tenant costs), but today they also offer the benefit of airflow for those who wish to socially distance. That's a key factor in the COVID-19 fight, and Tanger's facilities don't need to change much to accommodate shoppers on this front. In fact, the REIT has noted that foot traffic at its malls has picked up quickly once stores start to reopen, hitting 90% of previous-year levels in as little as 30 days.
And then there's Tanger's financial strength, which was better than many of its mall peers as it entered this difficult period. It acted quickly to ensure it had ample liquidity, drawing down a line of credit and cutting the dividend. That increased leverage, but shortly after the government-mandated shutdowns, management estimated that it could go as long as two years without collecting any rent at all. A strong financial position also gave Tanger the opportunity to offer all of its lessees immediate rent concessions for two months, to help them get through what it realized would be a difficult time. Being a good partner will likely have long-term benefits. The upshot is that, unlike some more heavily leveraged peers, Tanger looks highly likely to muddle through this period.
Second-quarter earnings, which were released Wednesday, weren't great. But Tanger managed to generate funds from operations (FFO, the REIT equivalent of earnings) of $0.10 a share, with occupancy at roughly 94%, and a July rent collection rate of 72%. Management has also started to pay down the credit facility now that the outlook for the business has started to improve. Given the COVID-19-related shutdowns, these are pretty solid results.
What comes next?
There are no crystal balls on Wall Street, so there's no way to tell what happens from here. The next few quarters' worth of earnings reports are likely to be terrible reading, but that doesn't mean that Tanger has been dealt a knockout punch. It has quickly protected itself while doing all it can to help its tenants. Meanwhile, its properties are fairly well positioned to reopen successfully, given that they are predominantly outdoor facilities. For long-term investors willing to take on some risk, Tanger could actually be one of the best-positioned mall REITs as the sector deals with the hit from COVID-19. And that, for more aggressive types looking for a turnaround play in the retail space, could easily make it a business worth owning.