The year 2020 hasn't been kind to mall owners like Macerich (NYSE:MAC). Many malls were forced to close for months during the lockdown phase of the COVID-19 pandemic. Even after they reopened, traffic typically remained depressed, as many consumers are wary of crowded public spaces.
These tough conditions have put severe pressure on Macerich's results for the past two quarters. However, the company's third-quarter earnings report -- and particularly management's commentary during the subsequent earnings call -- should give investors comfort that the mall REIT will make a full recovery from the pandemic over the next few years.
Dismal results -- but there's more than meets the eye
In the third quarter, Macerich's same-center net operating income (NOI) plunged 29.3% year over year, from $215.6 million to $152.4 million. Meanwhile, adjusted funds from operations (FFO) fell to $83.4 million ($0.52 per share) from $133.2 million ($0.88 per share) a year earlier.
While those results look awful, they include numerous short-term headwinds. First, Macerich's allowance for bad debt increased $21 million year over year, reflecting uncertainty that it will be able to collect unpaid rent from some struggling tenants. Second, the REIT incurred over $20 million of short-term rental assistance as it granted rent abatements to tenants that needed the most help (such as restaurants and local merchants). Third, common area revenue and percentage rents declined by $9 million due to lower traffic and temporary property closures. Fourth, parking income fell by $4 million due to long-term mall closures and reduced traffic, particularly at properties in New York City and Chicago.
Even before the pandemic ends, bad debt expense should moderate over the next few quarters, simply because most of Macerich's weakest tenants have already filed for bankruptcy year to date. Furthermore, about a dozen of the REIT's malls were closed for a significant part of the quarter, but all had reopened by Oct. 7. The reopenings reduce the need for tenant assistance while boosting common-area and parking revenue. In short, Macerich is well positioned for sequential earnings improvement over the next few quarters.
To be fair, occupancy fell to 90.8% by the end of Q3: down from 93.8% a year earlier. There will be some additional occupancy loss in the near term from tenants that have filed for bankruptcy this year and aren't finished closing stores. Lower occupancy represents a longer-term headwind to NOI and FFO. However, Macerich should be able to backfill vacant spaces over the next few years to restore its earnings power.
The environment is already normalizing
During Macerich's recent earnings call, management projected optimism about improvements in the retail environment. First, while traffic remains well below normal, people have been buying more when they do visit the mall. As a result, excluding Apple and Tesla (which have high and volatile sales driven by product cycles), September sales at Macerich's malls were 92% of prior-year levels.
Second, with malls reopening and sales improving, rent collections are on the rise. The average collection rate reached 80% last quarter, up from 40% in April and May. Rent collections continue to improve, and Macerich has already reached agreements with most tenants that are not paying full rent that will allow it to recover unpaid amounts over the next year or so.
Third, leasing activity is already rebounding. Macerich signed 120 leases for 342,000 square feet of space last quarter: roughly triple its Q2 leasing volume. Most of its tenants with expiring leases are ready to commit to renewals, and a growing number of retailers are also looking to open new stores.
There certainly could be more bumps in the road for Macerich in the near term, especially with COVID-19 cases rising rapidly again across much of the country. Yet there's no sign that the pandemic is doing long-term damage to consumers' desire to visit the company's malls -- or tenants' desire to open stores there. As a result, FFO is likely to recover to more or less 2019 levels as retail conditions normalize in the years ahead. With Macerich stock trading for just two times 2019 FFO, there's a substantial margin of safety to compensate investors for the near-term risk of investing in this high-quality mall REIT.