The COVID-19 pandemic severely affected even the best malls during 2020. Most malls were forced to close for months because of government mandates. Even after they reopened, many shoppers chose to stay away.

However, vaccinations are starting to tame the pandemic in the United States. As a result, malls that were well positioned entering 2020 have started to recover. Simon Property Group's (SPG -0.55%) first-quarter results highlighted the sector's budding turnaround.

Big sequential improvement

In the first quarter, Simon Property Group's net operating income (NOI) declined 8.4% year over year, excluding its recently acquired 80% stake in Taubman Realty Group. That marked a huge improvement over the fourth quarter of 2020, when portfolio NOI plunged 23.9%.

Factoring in the benefit of the Taubman acquisition, the mall REIT's results look even better. Simon's share of total NOI (including NOI from joint ventures) rose 1.1% year over year.

A wing of Simon Property Group's Roosevelt Field Mall

Image source: Simon Property Group.

The net result was that funds from operations (FFO) per share declined 11% year over year, from $2.78 to $2.48. This performance comfortably beat the average analyst estimate. Furthermore, Simon raised its full-year guidance for FFO per share to a range of $9.70 to $9.80, compared with the original forecast range of $9.50 to $9.75.

Momentum is building

In some respects, Simon Property Group is still facing pressure on its results because of the pandemic. Occupancy at its U.S. malls (excluding the Taubman properties) fell to 90.8% at the end of last quarter from 94% a year earlier. In addition, the REIT reported leasing spreads of minus-13.6% for the quarter, indicating that leases signed over the past year for small-shop tenants have lower base rents on average than Simon's expiring leases.

However, management noted during this week's earnings call that it has traded lower base rents for higher-percentage rent opportunities in some cases. If tenants' sales rebound strongly from the pandemic -- and the trends are very encouraging, with sales at Simon's malls surpassing 2019 levels as of April -- the REIT will capitalize on that recovery with higher percentage rent payments.

The average lease rate of around $60 per square foot on new small-shop leases also compares favorably with the minimum rents for leases that will expire over the next few years. If Simon can continue signing new leases at or above $60 per square foot, leasing spreads will naturally turn positive in the near future.

An empty mall corridor

Image source: Getty Images.

On a qualitative level, management described a favorable leasing environment, with lots of successful brands looking to expand their brick-and-mortar footprints at high-quality malls. It will take a year or two to fill all of the vacancies that opened up during the pandemic, but Simon's properties should make a full recovery by 2023.

An attractive dividend stock

Simon Property Group's upgraded 2021 FFO guidance leaves plenty of room for improvement over the next few years. After all, the REIT posted FFO of more than $12 per share in 2018 and 2019. And while Simon modestly diluted shareholders with a late-2020 equity offering, that offering helped pay for the Taubman acquisition, which will deliver a meaningful amount of incremental NOI and FFO.

Despite the pandemic, Simon has investment-grade credit ratings in the A range. This strong balance sheet makes Simon Property Group a much safer investment than most mall REITs. It allows the company to raise debt very cheaply. (The average interest rate on its debt is just 3.18%.)

Simon Property Group reduced its dividend last year, but its new quarterly payout of $1.30 per share -- $5.20 annualized -- still offers a solid 4.2% yield. Importantly, the REIT has plenty of room to increase that payout as FFO recovers over the next few years. That makes Simon Property Group an attractive stock, particularly for investors looking for reliable dividend income.