As the COVID-19 pandemic forced non-essential retailers to close earlier this year, retail landlords -- especially mall owners -- suddenly found it very difficult to collect the rent they were owed. Some tenants argued that the pandemic entitled them to temporary rent breaks. Others simply didn't have the financial wherewithal to pay what they owed.

Washington Prime (WPG) was hit hard by rent delinquencies this spring. This caused shares of the embattled mid-tier mall real estate investment trust (REIT) -- which had already fallen from double-digit territory as recently as 2016 to less than $4 by the end of 2019 -- to plunge below the $1 mark.

WPG Chart

Washington Prime Stock Performance, data by YCharts.

Last week, Washington Prime revealed that rent collections improved significantly over the summer. Unfortunately, this improvement may be a case of too little, too late for shareholders.

Rent collections rise

Washington Prime has only collected 48% of contractual rent and other charges for the second quarter. Based on deferral agreements signed with various tenants, it expects to recoup another 26% of the rent it was owed over time. However, management views the last 26% as uncollectable. Many retailers and restaurant chains have filed for bankruptcy, and in some cases, Washington Prime agreed to forgive rent payments as a goodwill gesture -- and to avoid driving more tenants out of business.

The good news is that collections have been improving steadily in recent months. As of mid-August, Washington Prime had collected 71.3% of billed July rent. And in an update last week, the REIT said it "has collected over 80% of expected July and August rents and associated charges."

More than 90% of Washington Prime's tenants have now reopened, and comparable sales for reopened stores have been close to 2019 levels. With customer traffic continuing to recover, management is optimistic that rent collections will improve steadily in the months ahead, as well.

A corridor in a shopping mall

Image source: Getty Images.

Too much debt and not enough rent

While rent collection trends are moving in the right direction, that alone won't fix Washington Prime's problems. Even before the pandemic hit, the REIT had too much debt relative to its net operating income (NOI), and its leverage metrics were deteriorating rapidly.

In 2019, comparable NOI totaled $444 million, down 5.2% year over year. Including tier two and noncore properties, comparable NOI was $476 million. Meanwhile, Washington Prime ended the year with more than $4.3 billion of debt, including its share of joint venture debt. For comparison, just two years earlier, Washington Prime generated $548 million of NOI, and debt was modestly lower at $4.2 billion.

Between the slew of retail bankruptcies year to date, additional bankruptcies likely over the next few quarters, and retailers shifting toward fewer stores and greater e-commerce penetration, the pandemic is likely to amplify this pattern of NOI declines. That will put further pressure on the balance sheet.

Washington Prime executives have loudly proclaimed that leasing volumes remain robust. The REIT has signed leases for 2.9 million square feet of space year to date, on top of an average of more than 4 million square feet a year over the previous three years. However, these raw leasing numbers don't mean much. After all, NOI has declined consistently in recent years despite strong leasing volumes between 2017 and 2019.

No real alternative to restructuring

Less than two years ago, Washington Prime had an investment-grade credit rating from Moody's. Since then, its credit rating has fallen precipitously. After its most recent downgrade a month ago, Washington Prime carries a corporate family rating of Ca from Moody's, 10 notches below investment grade. Its unsecured debt is rated one notch lower at C -- a rating that implies default is likely sooner rather than later.

Between falling NOI and debt that keeps creeping higher, Washington Prime's balance sheet is coming under severe stress. Furthermore, the REIT needs to keep investing in its malls to replace department stores that have closed. (This liability is likely to grow, as department stores are not done shrinking yet.) That will make it hard to reduce leverage organically.

Washington Prime has over $2 billion of unsecured debt maturing within four years, with half of that due in 2022. That limits its room to maneuver. As a result, it seems virtually inevitable that the REIT will have to restructure its debt within a few years. Its publicly traded unsecured debt has been trading around 50 cents on the dollar recently.

With creditors not expecting to come close to recovering their full principal, shareholders need to brace for the high likelihood that the stock will turn out to be worthless.