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Can Simon Property Group Keep Its Earnings Up By Buying Its Tenants?

By Rich Duprey - May 19, 2021 at 8:05AM

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Adding more distressed retailers to its portfolio could hurt it down the road.

The retail landscape is still hurting, but don't tell that to Simon Property Group (SPG -2.05%), whose first-quarter earnings results indicate the shopping mall operator remains a step ahead of most of the competition.

Although Simon was able to beat analyst expectations, a truly healthy retail environment wouldn't require a shopping mall to bail out its tenants, and even if Simon's existing portfolio is performing adequately, it remains a growing risk for investors.

Young adults with shopping bags walking through mall

Image source: Getty Images.

Showing it still has the REIT stuff

Revenue fell from $1.35 billion last year to $1.24 billion this year while funds from operations, or FFO, a key metric for real estate investment trusts, was $934 million, or $2.48 per share. That was down from $2.78 per share last year, but it's not surprising considering the lingering impact of the COVID-19 pandemic, and it did beat Wall Street's forecasts, which helps explain why Simon Property Group raised its guidance.

Full-year 2021 FFO is now guided to be between $9.70 and $9.80 per share, compared to its previous forecast of $9.50 to $9.75 per share as it continues to see rising demand, sales, and foot traffic.

Yet it's also possible the uptick is the result of so-called "revenge shopping," as one Citi analyst put it. After months of being cooped up and locked down, consumers are going shopping. It suggests, though, retail's boom might not last.

Simon Property chairman and CEO David Simon admitted as much, though he also said not all areas of the country are experiencing the same trend. Residents in California and New York, for example, are still under stricter control measures, compared to Florida where even wearing masks is no longer required.

Simon, though, noted that's why the mall operator continues to be conservative: The good times may not last or could come in bunches. But that also suggests continuing to invest in retailers may not be a good long-term decision, even if it is working now.

Operating above plan

Simon said the retailers in its SPARC Group joint venture with brand management firm Authentic Brands Group (ABG) are doing especially well, particularly Aeropostale and Forever 21. They were among the very first retailers the mall operator bailed out of bankruptcy. More recently, SPARC added outdoors brand Eddie Bauer to its collection.

For March and April, Simon said SPARC retailers outperformed on their sales plan by more than $135 million and on their gross margin plan by more than $75 million. Even troubled department store chain J.C. Penney, which it acquired last year, is operating above plan.

Still, while the retailer has moved beyond the stabilization and capital preservation mode, and its liquidity is now at $1.2 billion, it remains very much a work in progress.

Because the bump in retail sales is likely a combination of pent-up demand and stimulus checks out of Washington, D.C., the damaged brands performing well now could revert to form when the spigot is turned off.

And because running a retailer is not the same as operating a mall, Simon may experience the swift return of the troubles that forced the retailers into bankruptcy in the first place. This time, though, it would be on the receiving end twice, as it is on the hook as both landlord and tenant.

Changing the rules of the game

To help mitigate the risk, Simon and other mall operators are lobbying Congress to increase the percentage stake a REIT can take in a tenant, raising it from 10% to 50%, which changes the dynamic not only between landlord and the tenant, but also between the landlord and the other tenants in the mall, who may begin to view the mall as their competitor.

Moreover, malls are obligated to derive their FFO from a minimum level mix of rent, mortgage, and real estate sales, which could become compromised the more retailers a mall owns or its percentage of ownership grew, which could subject them to penalties and cause them to pay more taxes to the IRS, not investors.

Also, it could lead Congress to change the requirement that REITs pay at least 90% of their taxable income as dividends. REITs struck a balance between giving investors a relatively low-risk vehicle in exchange for exempting the REIT from most federal income taxes. Undoing that would make them a less attractive investment for many.

Right now Simon Property Group has good reason to be bullish about its business. Coming out of a deep slump is always an optimistic period, especially for retail stocks, but investors may begin to wonder whether Simon being on both sides of the transaction is in their best interest over the long term.

Citigroup is an advertising partner of The Ascent, a Motley Fool company. Rich Duprey has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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