The COVID-19 pandemic crushed mall traffic last year, driving huge drops in occupancy rates, revenue, and cash rent collections for most mall owners. This tough economic backdrop -- combined with high debt levels -- has forced three U.S. mall REITs to file for bankruptcy since the pandemic began, including Pennsylvania Real Estate Investment Trust (PEI).

Unlike worse-off rivals CBL & Associates and Washington Prime, PREIT emerged from bankruptcy quickly. A recent update highlighted how consumers' growing comfort with in-store shopping is revitalizing traffic at its malls, boosting interest from prospective tenants, and potentially paving the way for a recovery.

Traffic snaps back

The U.S. has averaged a little more than 11,000 new confirmed COVID-19 cases per day over the past week, down from a peak of nearly 260,000 per day in early January. The mid-Atlantic states where most of PREIT's properties are located have even lower case rates. These factors, along with the widespread availability of coronavirus vaccines, are making people more comfortable shopping in person at PREIT's malls.

Pent-up demand for in-store shopping and other in-person experiences has also contributed to an impressive rebound in traffic and sales. Traffic at PREIT's malls averaged more than 90% of 2019 levels in May. In fact, traffic exceeded 2019 levels at five of its roughly 20 malls.

Meanwhile, sales grew compared to 2019 at more than half of the REIT's malls. PREIT highlighted particularly strong sales trends at three of its mid-tier malls: Patrick Henry Mall, Capital City Mall, and Magnolia Mall.

The entrance to a Tilt Studio entertainment center at Patrick Henry Mall, with a GameStop store in the background.

Image source: PREIT.

For now, PREIT's best malls appear to be experiencing slower traffic recoveries than many of these mid-tier properties. However, as consumers in more densely populated metro areas like Philadelphia and Washington, D.C. become more comfortable with visiting crowded places, the REIT's top-tier malls should catch up.

Leasing momentum continues

Two months ago, PREIT reported that it had signed new deals for nearly 600,000 square feet of space in the first quarter. Those transactions will generate more than $8.3 million of future annualized revenue, most of which will come online within a year.

On Wednesday, PREIT revealed that it has now surpassed 700,000 square feet signed for occupancy year to date. That already exceeds its leasing activity for 2019 and 2020 combined.

To be fair, some of the new leases last quarter covered big anchor spaces and have very low rents. Still, filling anchor vacancies promptly helps maintain the overall health of PREIT's malls by keeping foot traffic high. In any case, PREIT also signed plenty of small-shop leases at higher rents. Investors will have to wait for the REIT's next earnings report to learn more details about its Q2 leasing activity.

Blurred images of people walking by an Altar'd State store at PREIT's Woodland Mall.

Image source: PREIT.

Heavy debt load still presents major risks

While PREIT continues to move in the right direction, investors should hold off on popping the champagne. The company continues to carry over $2.2 billion of debt. That's a huge amount in comparison to its 2019 net operating income (NOI) of $228 million.

Making matters worse, NOI plunged last year and probably won't recover immediately, given that leased occupancy remains well below pre-pandemic levels. Moreover, much of PREIT's debt now carries high interest rates (exceeding 8%), weighing on its ability to generate cash flow.

PREIT plans to sell land parcels at seven of its suburban malls to multifamily developers over the next few years to raise cash. However, those asset sales won't come close to fully fixing the balance sheet. To clean up its balance sheet, PREIT will probably need to sell some of its malls outright -- or at least sell joint-venture stakes in some of its top-tier properties.

A strong traffic and sales recovery will give the REIT the best possible chance of getting attractive offers for one or more of its malls. But malls have been out of favor with investors for years, so there's no guarantee that PREIT could fetch a high enough price for any of its malls to make a meaningful dent in its debt load. Until management provides more clarity on a strategy for fixing the balance sheet, PREIT stock will remain extremely risky.