Pennsylvania Real Estate Investment Trust (PEI +0.00%) survived a brief trip through bankruptcy in late 2020. However, it emerged with as much debt as ever. And with the COVID-19 pandemic still weighing on a wide variety of retail tenants, the mall owner remains in precarious position.
Last quarter, PREIT began to make progress toward a potential turnaround. That said, the company remains far from getting its net operating income back to pre-pandemic levels -- and fixing its balance sheet represents an even thornier problem.
A leasing revival of sorts
In late April, PREIT jubilantly announced that it had signed new leases for nearly 600,000 square feet of space in the first quarter. That's more space than the REIT leased in 2019 and 2020 combined!
Image source: Getty Images.
Leasing this much space before the pandemic has even ended highlights the desirability of PREIT's portfolio. That said, leases to a trio of large-format tenants -- a Tilt Studio entertainment center; a Cooper University outpatient health center, and a self-storage facility -- accounted for about 60% of the square footage PREIT leased last quarter.
Anchors and other large-format tenants tend to pay dramatically less per square foot than small-shop tenants: those occupying less than 10,000 square feet. For example, Tilt Studio will pay just $2.40 per square foot annually for the former J.C. Penney store it will take over. PREIT and its partners also leased about 177,000 square feet of large-format space at joint-venture properties last quarter, at an average rent of $8.21 per square foot.
By contrast, small-shop leases accounted for just 64,414 square feet of new leasing during the first quarter. The average annual rent for these leases was $44.84 per square foot.
PREIT's small-shop leasing volume compares favorably to its performance in 2020, when it signed new leases for just 103,000 square feet of small shop space all year. But PREIT is still trailing the pace it set for new small shop leases in 2019. Given that it ended the first quarter with non-anchor leased occupancy of 88.2% for its core malls -- down from 92.5% two years earlier -- it needs more improvement here.
Decent cash flow despite plunging NOI
The pandemic continued to weigh heavily on PREIT's operating results last quarter. Same-store NOI fell 21.2% year over year. Still, this was much better than the 33.3% drop it logged in the fourth quarter of 2020.
Image source: PREIT.
On the bright side, cash flow continued improving, as tenants are increasingly able to pay deferred rent from 2020. Cash collections totaled 119% of billings last quarter, even though some tenants remained unable to pay rent. (Collections trends improved further in April, when PREIT's cash collections totaled a stunning 149% of billed rent.)
That said, PREIT is getting pinched by a combination of high interest expense and a shrunken rent roll. Despite strong collections, no dividend payments, and a sharp decrease in capital expenditures to just $4.2 million, PREIT's net debt remained essentially flat last quarter.
Debt reduction is essential
The rebound in leasing activity last quarter represents an important step toward turning the business around. While PREIT still has a lot of vacant small-shop space -- especially at its best malls -- interest in mall space is finally recovering. With retail sales surging and the pandemic finally receding, leasing volumes for small-shop space should continue to accelerate.
PREIT's still-massive debt load represents a greater challenge. The company had to accept a significant increase in the interest rate on most of its debt following its bankruptcy filing. The increase in interest expense has made organic debt reduction virtually impossible.
Asset sales may offer a way out. First, PREIT owns seven malls in the Philadelphia and Washington, D.C. suburbs that have excess parking lot space suitable for new apartment developments. It could potentially raise $200 million or more from selling this land. Second, PREIT could look to sell joint venture stakes in some of its more valuable malls to raise cash.
However, getting all of the necessary approvals to sell land to multifamily developers will take years. PREIT expects gross proceeds of just $13.3 million from land sales in 2021. Meanwhile, few if any institutional investors want to invest in malls right now, making it impractical to sell joint-venture stakes. That could change if mall traffic, sales, and tenant interest come roaring back over the next few years, but there are no guarantees.
In short, while PREIT owns some valuable assets and there are signs that demand for space at its malls is recovering, the company lacks a clear plan for addressing its debt load. That makes PREIT an extremely risky stock that isn't suitable for most investors at this time.
