May 25, 2016
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U.S. shopping mall REITs hurt by department store woes

May 25, 2016

After a spate of disappointing quarterly results from big-name retailers, mall real estate investment trusts (REITs) have come under pressure.

The FTSE NAREIT regional mall index is on track for its second straight month of declines, after department store operators such as Macy's and Nordstrom reported disappointing earnings and soft monthly sales results, raising concerns about possible store closings.

High-end malls, where names such as Nordstrom serve as an anchor, are considered more resistant to department store closings as they are able to attract new occupants often paying higher rents. A glut of store closings at lower-end malls could prove more problematic for REITs that own them.

"It wouldn't be surprising if high-end malls ended up with two traditional department stores compared to the roughly four traditional department stores currently at most malls," said Cedrik Lachance, Director of U.S. REIT Research at real estate research firm Green Street Advisors in Newport Beach, California.

"The high-end mall still has a lot to offer to retailers and customers, but many lower-end properties will face sizable challenges in the coming decade and could garner a disproportionate share of headlines."

Even if high-end mall REITs lose some department stores as tenants, analysts said they are able to turn over those locations at higher rates to stores such as Apple, Tesla and popular grocer Wegmans.

Alexander Goldfarb, an analyst at Sandler O'Neill Partners LP in New York points to Simon Property Group Inc and General Growth Properties Inc as mall operators that have been able to successfully book newer tenants at rents more than 10 percent higher.

"It's not about traffic in a mall, it's about conversion to shopping. That shows the desirability of their centers," said Goldfarb. By bringing in shoppers willing to spend, the malls are able to charge new tenants higher rates.

The mall REITS may have been hit with a double whammy - following quickly on those poor retail reports were numerous indications from the U.S. Federal Reserve that it could lift interest rates as early as June.

Higher interest rates could make other investment vehicles such as bonds more attractive than REITs and other high dividend stocks. Still, it appears most of the industry took the Fed warnings in stride. The broad FTSE NAREIT All REIT index is up more than 4 percent for the year, and fell just 0.4 in the last week since the release of the latest Fed minutes. The S&P is up about 2.3 percent year to date.

A factor that could help insulate REITs is additional exposure to investors that will be brought about by their classification as an eleventh sector by S&P Dow Jones Indicies - starting September 1.

"The new sector classification will shine a brighter spotlight on real estate and REITs in particular," said Lachance.


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