Mall landlords like industry giant Simon Property Group (NYSE:SPG) have been hit hard by the impact of COVID-19. In fact, the story behind mall real estate investment trusts (REITs) has changed dramatically because of the pandemic. To update my thesis on the space, I traveled to 13 malls around where I live in New York. I came away with some good news and some bad news.
The plan changed
I own stock in real estate investment trusts Simon and outlet specialist Tanger Factory Outlet Centers (NYSE:SKT). The shares of both are down materially in 2020, as government efforts to slow the spread of COVID-19 closed many of their locations (or at least the stores within them) and led to dismal rent collection rates.
The truth is I may harvest some tax losses here before the year is out to offset capital gains seen elsewhere in my portfolio. Once I do that, however, I have to decide if I want to buy back into the sector.
At the start of 2020, the thesis was that the so-called "retail apocalypse" was an important but slightly misunderstood trend. The United States does have too much retail, and retailers that have taken on too much debt and/or have failed to keep up with changing consumer buying habits (including but not limited to online shopping) are destined to go the way of the dodo. However, well-placed retail assets, in my estimation, will end up benefiting in the long term, as store closures will also lead to weak malls getting shut down. The malls that are left will have to curate their tenant lists, which will take time -- but at the end of the day, they will be more attractive to customers and tenants alike.
That premise hasn't changed, although I expected it to transpire slowly over a number of years. COVID-19 has compressed the time frame in a dramatic way. Both Simon and Tanger have cut their dividends in response to the pandemic disruption, as have other mall players. To get a better handle on what is going on in the sector, I decided to put some boots on the ground and venture out to the malls near me. I went to 13 malls in all (one indoor mall in my area still wasn't fully open in early September, so I skipped it). Here are three things I came away with after my excursions.
1. The mall is not dead
The most reassuring thing to come out of my research venture was that people are still going to malls despite concerns about COVID-19. In fact, some stores remain extremely popular, with sizable queues outside of them that can result in wait times of an hour or more (I know because my spouse insisted on waiting in one such line). Apple, lululemon athletica, Nike, and in many places L Brands' Victoria's Secret often had sizable lines outside of them. While that's partly a function of occupancy constraints, the willingness of shoppers to sit in line is a big statement.
The way in which people shop is, indeed, changing. But online shopping has not destroyed physical retail. The internet is merely another shopping option that will continue to grow in importance but is unlikely to replace going to stores entirely. The key, however, is that not all stores are created equal -- but that's not actually different from any other point in the history of the retail sector. Stores go in and out of fashion all the time. As long as people are willing to head to the mall, despite concerns about COVID-19, malls will eventually adjust their offerings -- even if it takes a while to get it right.
2. Outdoors is better, for now
In my travels, I visited four outlet centers that were not within enclosed spaces and two traditional malls that were also open-air. There were variations in the numbers of shoppers (I didn't visit all of the malls in one day, so this isn't exactly an apples-to-apples comparison) and the number of store vacancies, but there was one very obvious takeaway. On the whole, consumers appeared to be more willing to go to open-air malls than enclosed malls. That makes total sense given the fears about COVID-19.
That said, there's a bigger picture here as well. I firmly believe the world will eventually adjust to COVID-19. When that happens, people will become increasingly willing to shop at indoor malls again. The demand for open-air facilities suggests there's ample pent-up consumer demand. The truth is, some people just like to shop -- it's their chosen form of entertainment. Doing that in-person and with family and friends is simply more enjoyable.
There is a negative here, however. Indoor malls are probably going to feel the pain of low attendance levels until there's more progress on the COVID-19 front. That's bad news for both landlords with well-placed malls, like Simon, Taubman (NYSE:TCO), and Macerich (NYSE:MAC), and for REITs with poorly located assets, like CBL & Associates (NYSE:CBL). The question, in the end, will likely be about who can weather the storm financially, as even well-positioned mall REITs will only survive if they have the balance sheet strength to make it through this period of rapid and difficult readjustment.
3. Malls have very real problems to face
That leads right into my last takeaway: Despite the positives I see, there are big issues to deal with that will result in many malls getting shut down for good. Poorly positioned malls have been declining for years, and that process has only sped up because of COVID-19. In fact, some mall REITs are at a very real risk of going bankrupt, with CBL expected to be one of the first to fall, as the performance of its generally lower-quality malls continues to deteriorate. Well-positioned malls that operate in markets with high barriers to entry and have sizable, wealthy populations nearby, are likely to get through this in one piece.
That, however, assumes that the owner of the mall is financially strong enough to keep going, which some may not be. Notably, Simon and Tanger were two of the financially strongest names in the mall REIT sector as it entered this difficult period. CBL, Pennsylvania REIT, and Macerich have historically had debt-heavy balance sheets.
There's still one more complication to deal with, however. Desirable regions often attract more than one mall and include multiple other shopping options. For example, Stamford Town Center in Connecticut, owned by Taubman, looks like it is struggling, with an alarming number of vacancies. A part of the reason for that is likely the main town in Greenwich, Connecticut, just a short drive away, which is basically a giant open-air mall that has long supported an Apple store (the one in the Stamford Town Center has shut), a plethora of high-end and name-brand retailers, and even a department store (Saks Fifth Avenue).
In other areas there are two or even three malls within just a few miles of each other, cannibalizing tenants from each other. For example, several years ago Simon built an open-air mall in Rockland County just a couple of miles away from the giant Palisades Mall, luring Apple away as one of its first tenants. Noting the long lines outside of Apple stores these days, it's still an important draw for consumers. Palisades Mall was left with a big hole to fill. Ultimately, even malls in good regions could continue to face difficulties if they are competing with other malls or shopping areas for tenants. This will probably prolong the shakeout in the mall REIT space, and make investing in the sector even more trying.
My big takeaway from all of this is that I believe malls are still worth owning, though, as noted, I may end up selling Simon and Tanger in the near term to gain a tax advantage on my losses. While that will keep me out of those two for at least 30 days, I'm likely to get back in after the wash sale rule is no longer an issue.
That said, I am going in knowing that there are still some material negatives to deal with in the sector and that the companies I choose to own need to have the financial fortitude to muddle through an extended period of adjustment -- just like I'll need the fortitude to stay the course if I want to see this investment through.