Normally, investors in real estate investment trusts (REITs) pay particular attention to occupancy, which shows how full a landlord's properties are. During the early days of the pandemic, the focus switched to rent collection, since an occupied space that doesn't generate rent isn't particularly profitable. Now that rent collection rates have strongly recovered, occupancy is again the key metric being watched. This is an important number, but there's a third metric you don't want to overlook.
It was a tough time
Occupancy is a logical number to monitor for a REIT. These companies are landlords, so their basic business is to buy properties and marry them up with lessees who wish to occupy them. A property that's half empty isn't a good thing, though it's important to remember that finding the right tenants is often vital. It can take time to curate a property so that it meets the needs of the area it serves while also generating an attractive return. That's particularly true in the shopping center space, where properties are deeply intertwined with the area around them.
Image source: Getty Images.
For example, during Regency Centers' (REG 0.35%) third-quarter earnings conference call, CFO Jim Thomson explained that the REIT doesn't want to "....fill it up with everything and hope they stick. We are very, very specific in our merchandising mix and really try to make good long-term decisions." This strip mall REIT's leased occupancy was 94.8% prior to the pandemic in the fourth quarter of 2019, and at the end of the third quarter of 2021, it's at 93.5%. It's doing pretty well filling up vacant space. Further increases here will clearly lead to improving results.
The pandemic hit isn't over yet
The interesting thing is that Regency is now collecting 98% of the rents it is owed, which is basically everything. Indeed, there are always problematic tenants, so rent collection this close to 100% is probably as good as you can expect in the shopping center space. That trend, meanwhile, is roughly similar in other major strip mall REITs as well, with the leased occupancy levels at peers Kimco (KIM 0.21%) and Brixmor (BRX 0.83%) increasing to 94.1% and 91.5%, respectively.
But there's more to this story, because there are two ways to handle tenant rents from an accounting perspective. For a tenant that is financially strong and expected to pay on time, a REIT uses accrual accounting. Simplifying things, this method of accounting assumes that rent gets paid each month as expected. Time variations are ignored.
When there are questions about whether or not a tenant can pay, that tenant usually ends up in cash basis accounting, which means rent is only accounted for once it is actually collected. In this scenario, timing matters a great deal; a few days' difference can mean rent shows up in a given month or the following one. The point is that a REIT doesn't want to assume rent will be paid for a tenant that may not actually pay the rent.
Cash basis accounting is the new figure to watch now that collection rates are so high. It is, effectively, how you can see whether or not a REIT's portfolio is filled with tenants that are on the mend or still struggling. Simply put, the more cash basis tenants a REIT has, the more you need to worry.
But the trends in the strip mall space are encouraging here as well. For example, during Regency's third-quarter 2021 earnings conference call, management pegged cash basis tenants at 22% of total rent. That may not sound like a good number, and it's not, but it was a five-percentage-point improvement. Things are getting better.
During Brixmor's third-quarter earnings call, management explained that it had moved 31 tenants from cash accounting back to accrual accounting, representing around $800,000 in rent. That's exactly what investors should want to see, as it highlights an improving trend. Brixmor now has around 14% of its rents in the cash basis category.
Kimco noted during its third-quarter 2021 earnings conference call that it was able to collect 80% of rent due from cash basis tenants, up from 77% previously. Cash basis tenants now make up 9.1% of its rent roll. Clearly, it has the strongest portfolio here.
The takeaway for investors
The decision to account for a tenant on a cash basis is up to each REIT, so these numbers aren't perfect comparison points. However, they do provide valuable information about how strong a strip mall's portfolio is. Right now, with occupancy levels rising and collection rates so strong, shares of strip mall REITs have rebounded strongly. However, they aren't all created equal, and the percentage of rent being tracked with cash basis accounting is probably the clearest picture investors can get of each REIT's underlying portfolio strength.
