Enclosed malls are complicated assets. The success or failure of individual tenants can impact the overall mall and location issues and retail trends can also play an outsized role in how the mall does. When you add in the complications created by something as big as the negative effects of the COVID-19 pandemic, it's easy to see why some businesses and some mall real estate investment trusts (REITs) got pushed into bankruptcy court.
Mall REIT giant Simon Property Group (SPG 0.42%) muddled its way through the crisis reasonably well, which is a testament to its abilities and the strength of its portfolio of assets. What's even better, Simon Property Group is getting ready to show just how strong its portfolio really is.
The retail apocalypse and other problems
Enclosed malls have been broadly out of favor for a number of years, falling victim to the so-called retail apocalypse. Put simply, the concern is that the shift toward online shopping will make going to the mall an obsolete pastime. There's a grain of truth to this concern. E-commerce has trended broadly higher for several years and continues to capture share of the retail market. But the great majority of shopping is still accomplished in physical stores, and frankly, humans are social animals and malls are great places to get together.
Image source: Getty Images.
That said, leading up to when the pandemic hit in 2020, there were a lot of retailers and malls that were struggling. As the pandemic hit and non-essential businesses were temporarily shuttered, the retail sector saw a major shakeout. Financially weak retailers closed or were bought by stronger companies. Retailers with too many stores closed their weakest locations. And many malls in less desirable areas, unable to keep their stores filled or attract enough customers, shut down. Those trends left investors worried about the outlook for all mall REITs, and perhaps rightly so.
Simon Property Group cut its dividend in 2020 in anticipation of tough times, just like all of its peers. However, it quickly got back to payout growth in 2021 as pandemic worries eased, and it has increased its dividend five times in the last six quarters. It also used the downturn to invest (with partners) in acquiring iconic retailers such as Brooks Brothers and J.C. Penney. This strategy had two key benefits -- first, Simon got the assets for cheap prices, and second, saving those chains helped it maintain occupancy levels at its malls.
It's been a slow build for Simon Property Group
Occupancy is probably one of the most important metrics to watch in the REIT space, and it is particularly vital for malls. Malls are massive, and the totality of their offerings is what attracts customers -- which in turn, attracts more retailers. It's a complex process to oversee a mall. For example, high-end brands and discounters probably wouldn't coexist happily in the same mall because they serve different clientele. Simon needs to carefully curate its tenant lists, not just fill empty spots with whatever retailers come along.
This is part of why it can take some time for a mall to bounce back from a retail downturn. That said, Simon's occupancy was up more than 2 percentage points year over year in the second quarter to 93.9%. For reference, its U.S. mall and outlet occupancy ended 2020 at 91.3%, which isn't exactly terrible given the headwinds at the time. Still, there's a nuance here that's really important.
For starters, the company noted that its number of lease terminations through the first half of 2022 was at a record low level. This suggests that the retailers that made it through the pandemic are strong, and are happy to be in Simon malls. In addition, around 40% of its lease activity has been new deal volume, which suggests that the company's malls will be getting more tenants in the future.
CEO David Simon addressed this point directly during Simon Property Group's second quarter 2022 earnings call:
... Our pipeline is as strong as it's been. We're doing a bunch of new deals. ... when you sign a lease, the store doesn't open tomorrow in a lot of cases. And this is really, really important for everyone to understand, we're very optimistic because a lot of the leasing that we've done really doesn't open until [2023, 2024]. So not only are we outperforming our budget this year off a strong last year, but we actually feel really good that as we get these stores open that we leased to over the last six, nine months, that will continue to fuel positive comp [net operating income].
Put everything together and it looks as though Simon is bouncing back nicely today, but the really good news is set to start showing up next year.
Simon is still getting better
Investors got more excited about Simon's stock in 2021 as business started to pick up again. But they seem to have soured on it in 2022. Perhaps this is because they anticipated a more rapid and robust recovery than industry dynamics allowed given the time needed to upgrade space for new tenants.
However, Simon management has told investors to look out to 2023 and 2024, when new stores are likely to start opening in greater numbers. In the meantime, those who buy the stock now can collect a generous and growing dividend that, at the current share price, yields 7% while waiting for occupancy levels to start reflecting those new leases.
