There's no question that retail landlords like Simon Property Group (NYSE:SPG) were happy to put 2020 behind them. There are still headwinds ahead, of course, because the coronavirus pandemic is still ongoing. But 2021 is likely to be a year of renewal as the vaccines now being disseminated help the world get back to some semblance of normal. That said, there's been a lot of damage done, leaving Simon with one very big question to answer.
The backstory is important
Coming into 2020, the big story in the retail sector was the so-called "retail apocalypse." Some people viewed this as a shift among customers to online shopping, but that's too narrow a scope. It was a much bigger and slower-moving problem. Essentially, retailers fell behind the curve with regard to customer trends. That included the move toward online shopping, but also more mundane things like fashion shifts and the store experience. Retailers that weren't keeping up were struggling -- and those that had leveraged their balance sheets struggled even more.
The upshot was that industry laggards were closing stores, and in some cases even going out of business. But the key is that this was already going on before the pandemic. When the pandemic hit, the retail apocalypse sped up, truly earning its nickname. Years' worth of store closures were brought forward as retailers were forced to shut down and non-essential businesses struggled to simply stay alive. Many did not make it, with some once important names closing for good. Others used the bankruptcy processes to stay alive, but generally in a reduced fashion.
Real estate investment trusts (REITs) like Simon Property Group, which owns a collection of around 200 malls and outlet centers, count these retailers as customers. So the closure of a large number of stores is a big problem, since it leaves empty stores in the malls that Simon and its peers operate. Even without a pandemic, consumers aren't likely to want to visit a mall that has lots of empty storefronts.
That leads to the really big question that Simon has to answer: How is it going to re-tenant its malls?
A major headwind
There's no easy way to answer this question. The problem lies in the business model of running a mall. Malls are ecosystems, with each store playing an important part in defining the overall consumer experience. For example, you wouldn't want to put a high-end fashion retailer right next to a dollar store -- those are two different shopping experiences that generally don't go well together. Thus, Simon has to be careful about what stores it brings into its properties to make sure they "fit" within each location.
There's also another issue here: A large number of department stores are closing. These are generally considered anchor tenants, because they occupy big spaces and historically have been customer draws. It is far more difficult to fill a large empty building than a small interior shop, and it may require entirely redeveloping the space. Simon has been doing this for a number of years, but the process is far from over, and it's time-consuming and expensive.
In 2020, there wasn't much that Simon, or any mall REIT, could do but hunker down and simply deal with the storm. As the storm passes, however, the REIT needs to start to rebuild. And investors need to keep a close eye on what that rebuilding process looks like.
That said, Simon has been more aggressive than many of its peers in laying down the groundwork for the future. In fact, it has tried to make use of the pandemic to strengthen its industry position. That included the acquisition of a smaller peer with well-located properties, a consolidation move that strengthens Simon's mall footprint. But the REIT, with partners, also acquired a few retailers out of bankruptcy, including anchor tenant J.C. Penney. Basically, by helping retailers survive, Simon will help to keep its malls occupied -- after all, it is highly likely that the REIT will get preferential treatment when store closures are considered by these retailers.
Right now, Simon doesn't have great answers to the re-tenanting question. That's largely because the REIT and its tenants are still dealing with the pandemic. However, as business conditions return to more normal levels, filling empty stores will be a top priority. Investors need to listen to the company's quarterly earnings conference calls so they can hear from the horse's mouth how that process is going. Simon has laid a small foundation via its investment in bankrupt retailers, but much more will be needed before the company can say things are back on track.