Malls And Their Hapless Investors Keep Getting Crushed
via Wolf Richter
(Creative) Destruction in the brick-and-mortar meltdown.
Investors in retail malls didn’t need another wake-up call. They’ve been wide awake all year, hearing from Wall Street that there’s no brick-and-mortar meltdown even as the shares of their real estate investment trusts (REITs) have gotten crushed by the travails of brick-and-mortar retail and the over-malling of America. But late Thursday, mall investors got another unneeded wake-up call.
CBL Properties (NYSE:CBL), a mall REIT with 119 mostly retail-oriented properties, reported earnings, and shares plunged 26% on Friday to $5.92. They’d already been dropping for years because the brick-and-mortar retail meltdown is structural, and not new, and will not turn around before it’s finished melting down. Shares of CBL are down 50% year-to-date and 75% from May 2013.
“This quarter’s results fell below our expectations as our revenues were impacted by additional bankruptcies, store closures and rent concessions,” CEO Stephen Lebovitz summarized it in the third-quarter earnings report.
Though investors knew the brick-and-mortar industry is in turmoil, they were nevertheless taken aback by the fact that it can still get worse – and that the sacrosanct dividends of a REIT can get slashed in no time.
CBL reported fundamental problems with the mall-REIT business (Q3 compared to a year ago, unless otherwise noted):
- Revenues dropped 11% to $224.6 million.
- Funds from Operations (“FFO”) per share fell 7.1% and “FFO, as adjusted,” per share fell 12.3%
- Same-center Net Operating Income (parallel to same-store sales for retailers) at its malls fell 2.8%. This is a beautified version because CBL “excludes the impact of lease termination fees and certain non-cash items of straight-line rents, write-offs of landlord inducements, and net amortization of acquired above and below market leases.”
- Occupancy rate of all properties declined 40 basis points to 93.1%. Mall occupancy rate declined a full percentage point to 91.6%.
- Average gross rent per square foot at “stabilized malls” fell 13.7%: edging up 0.3% for new leases and plunging 16.1% for renewal leases. It shows what landlords have to do keep tenants.
- Stabilized mall same-center sales per square foot for the 12 months ended Sept. 30 fell 1.8% to $373. Hang on to that $373 in sales per square foot; Moody’s has a warning about that in a moment.
The company lowered its guidance for 2017 across the board, including FFO per share (to $2.08-2.12). Same-center NOI is now expected to decline by 2% to 3%. And occupancy rate is expected to decline by 1.25 percentage points.
And then the real shock for dividend investors. Dividends are a major reason to invest in REITs. But the company slashed its dividend by 24.5% to $0.80 per share.
It was done to preserve cash. Many of the malls will have to be repurposed and turned into something else – “into suburban town centers that offer unique shopping, more food and beverage, fitness, health and beauty uses, services and more service-oriented businesses, which should certainly help the company adapt to e-commerce headwinds,” CEO Lebovitz said – and that requires money.
Downgrades hailed on the company, now that its shares have lost half their value so far this year. Wells Fargo downgraded the company to market underperform, and put a price target of $7 a share on it, over a buck above its current price – always lagging behind, always keeping that optimism going.
Moody’s, which rates the company Baa3 (one notch above junk) with negative outlook, had a special word in July about the space CBL is in with its sales per square foot of $373:
Retail REITs that own and operate malls with low average sales per square foot, below $400, are experiencing the most pronounced credit risk.
Moody’s points specifically at CBL along with Washington Prime Group (NYSE:WPG).
CBL and WPG have the highest exposures to distressed retailers as a percentage of total gross leasable assets at year-end 2016, 22.2% and 21.7%, respectively. Operating performance for both REITs is expected to be vulnerable to further deterioration, owing to the anticipation of increased tenant bankruptcies and store closings and because of their regional concentrations and limited financial flexibility relative to other mall REITs.
Moody’s is still fairly gung-ho about the sector overall, despite what it calls its weak-mall exposure. And it mollifies us: the debts outstanding of those two REITs – $8 billion in total – account for only “4% of the aggregate debt outstanding at the end of Q1 2017 for all US REITs that we rate.”
So no problem. One or two at a time. The brick-and-mortar meltdown is not going to happen all at once. It’s picking up momentum, and it will drag on for years. Someone will eventually tear down many of these malls and use their space, including the large parking lots, for something entirely new. But that process – “creative destruction,” we like to call it – has already cost, and is going to cost, existing mall investors a bundle.
So other mall REITs dove in formation:
- Kimco Realty (NYSE:KIM) down 2.1% today and 42% since end of July 2016.
- Macerich (NYSE:MAC) down 2.2% today and 39% since end of July 2016.
- Simon Property Group (NYSE:SPG) down 2.7% today and 32% since the end of July 2016.
- GGP (NYSE:GGP) (formerly General Growth Properties) down 2.9% today and 41% since the end of July 2016.
- Federal Realty Investment Trust (NYSE:FRT) down 1.3% today and 25% since the end of July 2016.
- Regency Centers Corp. (NYSE:REG) down 1.8% today and 22% since the end of July 2016.
An irreversible structural change in an industry, such as brick-and-mortar retail, doesn’t play out in one gigantic crash. It takes its time. Retail will always be around, but the way it is being conducted is changing.
Some segments are considered “ecommerce-proof” for now, such as new and used vehicles, gasoline and other fuels, restaurants and bars, and still – to the greatest annoyance of Amazon (NASDAQ:AMZN) – groceries. That’s 55% of brick-and-mortar retail sales. But the other 45%, the part that is typically taking place in retail malls, catches the full brunt of e-commerce competition and is rapidly losing share. And mall owners will have to find other things to do with many of their properties.