The COVID-19 pandemic continued to take a heavy toll on Macerich (MAC -3.10%) last quarter. The owner of high-quality malls reported another set of sharp declines in net operating income (NOI) and adjusted funds from operations (FFO). But while the company's first-quarter results looked pretty ugly, Macerich is poised to turn the corner soon. Let's take a look.

Pandemic pain continues

Earlier this week, Macerich reported that same-center NOI (excluding lease termination income) plunged 29% to $148 million in the first quarter. This result was slightly better than the mall REIT's 33% decline in same-center NOI a quarter earlier, but it still gives the impression of a company in crisis.

This reduction in NOI -- augmented by recent shareholder dilution -- drove a sharp decline in Macerich's FFO per share. (Macerich ended the first quarter with approximately 207 million common shares and equivalents outstanding, up from around 161 million a quarter earlier and 152 million at the beginning of 2020.) Adjusted FFO per share plummeted 44% year over year to $0.45.

An exterior view of Macerich's Santa Monica Place mall.

Image source: Macerich.

However, rent abatements drove about half of Macerich's NOI decline. For the most part, these rent abatements relate to rent payments that tenants missed in 2020 and that were officially forgiven under lease amendments signed last quarter. As a result, Macerich's Q1 NOI results don't accurately reflect its underlying performance. Excluding rent abatements, NOI fell 15%.

Signs of a turnaround

Management warned that there will still be some rent abatements recorded in the second quarter, but the impact on Macerich's results will be much smaller. Moreover, rent abatements should be minimal thereafter.

Meanwhile, the underlying trends for Macerich's properties are improving. Year to date, Macerich has signed more leases than it did during the same period in 2019, which was a very strong year for leasing activity. Notably, the REIT recently signed two more leases with British fast-fashion giant Primark. Macerich expects to announce at least two more department store replacements in the near future.

Most encouragingly, sales are surging at many of Macerich's malls. First-quarter tenant sales fell just 2% compared to Q1 2019, even though the pandemic didn't begin to ease until the second half of the period. Excluding food and beverage tenants -- which were still laboring under capacity restrictions last quarter -- tenant sales rose 2%. And in Arizona, which is recovering faster than other markets, tenant sales surged 18% above 2019 levels in the month of March.

A bird's-eye view of Macerich's Kierland Commons outdoor mall in Arizona.

Image source: Macerich.

There's a light at the end of the tunnel

Macerich's first-quarter results indicate that it is struggling significantly more than top rival Simon Property Group right now. However, unfavorable geography is the main problem. Half of Macerich's pre-pandemic NOI came from California and New York, where state and local governments implemented stricter lockdowns than many other jurisdictions.

Those states have now firmly entered the reopening phase, paving the way for shopper traffic to return to Macerich's malls there. Strong leasing demand indicates that retailers see a big sales opportunity from opening stores in top-tier malls like those Macerich owns.

Of course, it will take time for Macerich to recover fully. Occupancy stood at just 88.5% at the end of March, down from 94.7% two years earlier. Leasing spreads have been modestly negative over the past four quarters as management prioritizes filling vacancies over maximizing rents. Some promising redevelopment projects were delayed due to the pandemic. And the dilution from Macerich's recent stock sales will permanently reduce FFO per share.

Still, there's plenty of room for Macerich to grow FFO per share beyond the $1.77 to $1.97 range it estimates for 2021. Furthermore, the stock sales and a recent non-core asset sale have helped Macerich reduce its debt to below pre-pandemic levels, with more progress expected by 2023. These factors make Macerich stock look like a bargain at its recent trading price below $14.