Like its fellow mall REITs, Macerich (NYSE:MAC) has been hit hard by the COVID-19 pandemic. In fact, due to its ownership of many urban malls in hard-hit regions like the Northeast and California, Macerich has experienced more disruption to its properties' operations than many of its peers.

As a result, rent collections were quite poor last quarter, putting pressure on Macerich's cash flow. That said, considering the scale of the headwinds it faced, the REIT's financial metrics held up surprisingly well -- highlighting the strength of its mall portfolio. Furthermore, management pointed to several signs indicating that the worst of the pandemic's impact is already over.

A tough quarter

Virtually all of Macerich's properties were closed for all of April, and while some reopened in early or mid-May, the majority remained closed until Memorial Day weekend or later. This made it hard to collect rent in the early part of the second quarter. Many tenants were facing financial distress due to their stores being closed and could not afford to pay.

Indeed, Macerich disclosed during its recent earnings call that it had collected just 40% of billed rent for April and May. For June, the collection rate improved to a still-dismal 58%.

Cash rent collections don't directly impact earnings metrics like revenue and net operating income (NOI). As long as Macerich thinks it can collect the rent eventually, it gets booked in the month it is originally due. Nevertheless, revenue fell 21.7% year over year, while same-center NOI, excluding lease termination revenue, declined by 23.1%. (These declines were still far less severe than what mid-tier mall REITs reported.)

The rash of retail bankruptcies sparked by the pandemic was a key factor in Macerich's NOI decline. Bad debt expense surged to $40 million (including the company's share of joint ventures), compared to $3 million in the year-ago period. This drove the vast majority of the decline in same-center NOI. Management attributed about half of the bad debt expense to writing off unpaid rent from tenants that had declared bankruptcy. Most of the rest relates to Macerich's decision to forgive rent for some local tenants and restaurants. (It is moving aggressively to collect unpaid rent from most national tenants, generally through negotiated deferral agreements.)

An entrance to Macerich's Vintage Faire Mall

Image source: Macerich.

Conditions are already improving

Most of Macerich's properties reopened by the end of June (the major exceptions being two malls in New York City). Perhaps surprisingly, sales at reopened malls have been down only 10% year over year, roughly speaking. Pent-up demand from shoppers who do choose to visit the mall is nearly offsetting the loss of traffic from people who are still avoiding crowds.

Rent collections have improved dramatically as malls have reopened. Macerich has collected 66% of billed rent for July. So far, August rent collections are trending even better than July, which is impressive, as Macerich had to close nine malls in mid-July after California reversed parts of its economic reopening to combat rising COVID-19 case numbers.

Macerich's future tenant pipeline also looks solid. The REIT has signed leases for new tenants covering 1.3 million square feet of space. Within that group, only six tenants (totaling 47,000 square feet of space) have decided to back out.

The elevated level of tenant bankruptcies in 2020 will have a lingering impact on NOI, as many of these retailers will close stores and/or demand rent reductions. However, virtually all of the tenants that have fallen into bankruptcy were already on Macerich's "watch list" and were known to have high bankruptcy risk. (Essentially, several years of bankruptcies were accelerated into 2020.) Once it replaces those tenants, Macerich will have a much healthier tenant base, providing a solid foundation for a return to growth.

The balance sheet remains the biggest risk

Despite signs that rent collections are improving and most tenants have no plans to close up shop, lenders are very hesitant to finance malls right now. That's a problem for Macerich, which has more than $800 million of property mortgages maturing within the next eight months. More broadly, the REIT has very high leverage, with over $8 billion of net debt, compared to a market cap of just $1.3 billion.

Leverage is definitely something for investors to keep an eye on. However, the risk is limited by the fact that virtually all of Macerich's debt is non-recourse: i.e. defaults would allow lenders to foreclose on individual properties but wouldn't impact the company as a whole.

Management plans to dust off a tried-and-true strategy from the global financial crisis to address this issue. It expects its lenders to agree to short-term maturity extensions. That would buy time for retail conditions to stabilize and the mortgage market to unfreeze. In short, while Macerich stock certainly carries plenty of risk, it has a much better chance of bouncing back than investors seem to expect, making it one of the most intriguing turnaround plays of 2020.