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2 Retail REITs to Buy Now

These REITs are focusing on the right types of retail properties.


[Updated: Apr 30, 2021 ] Jul 17, 2020 by Matthew DiLallo
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The term "retail REIT" refers to any real estate investment trust whose primary tenants operate retail businesses. And for the purposes of commercial real estate, restaurants, bars, entertainment businesses, and service-based businesses are also typically considered to be part of the retail category.

Most retail REITs specialize in a certain subtype of property. While there are many different retail REITs, each with a somewhat different investment strategy, the vast majority of retail REITs can be classified into one of three categories:

  • Mall REITs: As the name implies, mall REITs own and operate shopping malls. These can be indoor or outdoor malls, and some own a combination of both.
  • Shopping center REITs: Some REITs exclusively own and operate shopping centers, which typically consist of an anchor store or two (grocery stores are extremely common) and several attached smaller retail spaces.
  • Net-lease retail REITs: A net lease is a type of lease structure that requires tenants to pay the building's property taxes, insurance, and most maintenance expenses, and is most common in freestanding (single-tenant) commercial real estate. So, when you hear a retail REIT referred to as a net-lease REIT, it essentially means that it owns single-tenant retail properties.

Why were many retail REITs so beaten down in 2020?

Real estate has been one of the worst-performing parts of the stock market since the COVID-19 pandemic hit, and retail REITs are one of the worst-performing subsectors.

This shouldn't come as a major surprise. After all, retail real estate is occupied by tenants that mostly depend on people being able and willing to go out and spend money. When the pandemic worsened in March, most nonessential retail businesses in the United States were forced to shut down, and many of those that were deemed essential continued to operate on a limited basis (such as curbside service only).

While the profitability of the underlying retail businesses doesn't directly affect the retail REITs that own them, the disruption caused by the pandemic made many retail tenants unable or unwilling to pay rent. Just to name a couple of notable examples, restaurant chain Cheesecake Factory (NASDAQ: CAKE) and apparel retailer Gap (NYSE: GPS) both refused to pay rent during the shutdown. And they weren't the only ones. In fact, Commercial Observer reported that just 46% of retail tenants paid rent in May 2020.

Should investors worry about the threat of e-commerce disruption?

The short answer is yes, but there's more to the story.

First, it's important to note that retail REITs were dramatically underperforming the market before the COVID-19 pandemic set in, and e-commerce was the primary reason. Since 2010, the percentage of retail sales that can be attributed to e-commerce has steadily risen from 4% to 11.5%, and this trend doesn't show any signs of slowing down.

However, not all retail is particularly vulnerable to e-commerce disruption. Service-based retail like restaurants and hair salons are an obvious example, as are convenience stores (especially if they sell gasoline), fitness centers, and auto repair businesses. These businesses sell things that can't be sold online. Discount-oriented retail is another type that isn't particularly vulnerable, as businesses like warehouse clubs and dollar stores tend to offer bargains that even Amazon.com (NASDAQ: AMZN) can't match.

Furthermore, there's a big difference in e-commerce vulnerability when it comes to the quality of the properties and the tenants. As a simplified example, a national big-box retail chain has more resources to compete with e-commerce giants than a local retail establishment. And retail properties with modern dining establishments, entertainment venues, and other attractions are in a better position to keep foot traffic coming in than retail properties that are somewhat run down and depend mainly on the strength of their anchor tenants. In short, quality is very important when it comes to the ability to compete against e-commerce.

Retail REITs to buy now

Through all this, retail REITs are trying to keep their properties occupied to continue generating income. One way they're doing that is by buying or redeveloping properties to attract more resilient retail tenants. Two REITs with solid strategies to battle the retail sector's headwinds are Agree Realty (NYSE: ADC) and Kimco Realty (NYSE: KIM). Here's why that makes them ideal retail REITs for investors to consider buying this May.

Putting a priority on quality

Agree Realty focuses on owning single-tenant properties triple net leased to high-quality retailers. It concentrates primarily on investment-grade retailers highly resistant to disruption from e-commerce and recessions.

Overall, 67.5% of Agree's tenants have investment-grade credit, implying that they have the flexibility to meet their financial obligations (e.g., rent) even if economic conditions deteriorate. Meanwhile, it owns properties leased to essential physical retailers in categories like home improvement, grocery, tire and auto service, convenience, dollar, and pharmacy.

That focus on quality paid off last year, as the REIT collected more than 95% of the rent it billed. Because of that and its solid financial profile, Agree Realty had the flexibility to continue growing its portfolio and dividend. It committed to investing a record $1.36 billion last year and sees the potential for spending another $800 million to $1 billion on additional acquisitions in 2021. That should enable Agree Realty to continue growing its 3.7%-yielding dividend, which it now pays monthly.

A bold bet on the future of retail

Kimco Realty focuses on owning open-air, grocery-anchored shopping centers and mixed-use properties. It concentrates on high barrier-to-entry coastal markets and fast-growing Sun Belt cities. This strategy helped Kimco last year, as most of its shopping centers remained open because people needed access to essential retailers like grocery stores.

The company recently doubled down on its strategy by agreeing to acquire fellow retail REIT Weingarten Realty Investors (NYSE: WRI) for nearly $6 billion. The deal will enhance its exposure to grocery stores from 78% of its properties by ABR to 79%. Meanwhile, it will increase its focus on the Sun Belt region from 42% of its ABR to 53%. The combination will also increase its scale, reduce its costs, and improve its redevelopment pipeline.

The combined company has several projects underway to add multifamily units and grocery stores to existing retail properties, enhancing their appeal to other tenants due to the steady traffic from residents and grocery shoppers. Meanwhile, the acquisition of Weingarten adds a $2 billion redevelopment pipeline that could turn more of its shopping centers into mixed-use properties that blend residential with retail, dining, and entertainment.

As Kimco transforms more of its shopping centers into mini-town centers, it should create value for shareholders over the long term by making it even more resistant to the impact of e-commerce.

Focused on the future of physical retail

While consumers will continue shifting more of their shopping online, physical retail will play a role in meeting their needs. That's why Agree Realty and Kimco Realty are focusing on investing in properties that will benefit from this future by filling their portfolios with properties supported by high-quality, essential retailers. Their strategies should pay off over the long term, making them ideal retail REITs to consider buying now.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Matthew DiLallo owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon and recommends the following options: long January 2022 $1920 calls on Amazon and short January 2022 $1940 calls on Amazon. The Motley Fool has a disclosure policy.