Market analysis by our public securities expert, Geoff Shaver
June 24, 2020
Retail REITs: How the COVID-19 Pandemic Has Affected Brick & Mortar and Future Retail Demand
by Geoff Shaver
Director of Public Securities
While certain real estate investment trust (or REIT) segments are benefiting from the increasing virtualization of the economy including data centers, cell towers and industrial REITs, these secular trends are coming at the detriment of brick and mortar retail. The continued challenges of many retailers are well-known and have culminated in a spate of bankruptcy filings. Experiential retail owners and operators whose tenants include movie theaters, bowling alleys, TopGolf and food halls, to name a few, have all suffered due to prolonged COVID-related shutdowns. Large mall operators benefit from a diverse mix of tenants; however, most of their mall assets are comprised of a collection of the aforementioned tenancy, along with struggling fashion apparel.
Through the pandemic, only a handful of retailers have maintained or increased prior sales volumes. Outside of Amazon, brick and mortar retailers that have emerged stronger include Wal-Mart, Costco, Target, and Home Depot, with the first two experiencing a dramatic increase in online sales. We will explore further the fate of a number of retailers that have filed for bankruptcy and, as a result, which retail REITs are likely to continue to struggle and which retail REITs are poised for a rebound.
Who’s Fared Well – and Who’s Suffered
Even before the pandemic forced temporary closures of retail stores around the world, in 2019 17 major retailers plunged into bankruptcy, including Payless and Gymboree. As cities and states around the U.S. began enforcing shelter-in-place ordinances and closure of businesses in mid-March, 14 more struggling retailers have filed for bankruptcy, including mall anchors Neiman Marcus and JC Penney, along with J. Crew, Aldo, Pier 1 and discount retailers Stage Stores and Tuesday Morning(1). Due to struggling sales volumes and in an effort to stave off bankruptcy, Macy’s has raised $4.5 billion in financing to cover operating losses, purchase new inventory and retire existing debt. Macy’s reported in May that its first-quarter sales fell by as much as 45% and that it expected to book a roughly $1 billion operating loss when it reports financial results for the quarter on July 1(2). Online retail sales were not strong enough to offset the lack of foot traffic within these retailers due to prolonged shutdowns.
Retailers who have invested in expanding their online retail platform, such as Walmart’s strategic purchase of online retailer Jet.com in 2016 for $3.3 billion, have weathered the COVID-era well. Walmart reported that online sales surged 74%, lifting overall sales by nearly 9% from February to April(3). The increase in demand at Walmart has led to the hiring of more than 235,000 workers since mid-March, according to chief executive Doug McMillon. All 5,355 of the company’s U.S. stores have remained open during the pandemic.
Meanwhile, over that same period, Home Depot reported its revenue rose 7% as homebound Americans increased their home improvement and landscaping projects during the pandemic (4). Despite not having a brick and mortar presence outside of their Whole Foods operation, Amazon has been by far the biggest winner within the retail industry. Amazon posted first quarter 2020 revenues of $75.4 billion, which translates to approximately $33 million in sales per hour and represents a 26% increase from the same period last year(4). While Amazon has a unique business model and brand, retailers who are lagging in their online presence are moving quickly to augment their brick and mortar operations or risk the fate of the 14 others that have filed for bankruptcy so far this year.
Many of the landlords who own the properties where these struggling retailers operate have also come under pressure. Several retail REITs including EPR Properties (EPR), Essential Properties (EPRT), Urban Edge (UE), National Retail Properties (NNN), Macerich (MAC) and Simon Property Group (SPG) all have varying exposures not only to previously listed bankrupt retailers, but also to a growing list of tenants who have elected not to pay their contractual rent that is due.
Decreases in Rental Collections Reflect Recent Challenges
While relative performance is an indicator of these challenges (shopping center REITs are down 41% YTD, regional mall REITs are down 52% and free-standing REITs are down 30% YTD)(5), the ability to achieve rental collections by these landlords is also a telling indicator. National retail chains paid 58% of billed rent last month, down from 96% during the same period last year, according to data firm Datex Property Solutions. Tenants including Supercuts, Barnes & Noble, Red Robin, General Nutrition Centers, Gap, H&M, Foot Locker and Men’s Wearhouse were among the 21% of the 135 major chains paying no rent or a small fraction of it in April, according to a new report (6). The experiential-focused retailers such as EPRT, who operate a number of movie theaters and entertainment venues, reported 65% of their rents were collected as of May with 18% of their properties reported as still closed and 21% operating at a limited capacity(7). Urban Edge (UE), which has a high concentration of retail assets in the New York metro area, reported April collections of 50%.
Despite the challenging collection data and spate of retailer bankruptcies, the reopening of regional economies has resulted in a strong surge in retail sales, as evidenced in May’s better-than-expected numbers. The nearly 18% headline gain, including food sales, more than doubled the prior record from October 2001 of 6.7% and significantly topped the 8% estimate from economists surveyed by Dow Jones(8). The May bounce in retail sales follows two months of record-breaking declines, as Americans abruptly pulled back on discretionary spending. Retail sales fell 8.3% in March, and 14.7% in April, which is a revised figure, so the May gains are generated from a substantially depressed level.
What's Next for Retail?
Regional mall operators such as Macerich (MAC) and Simon Property Group (SPG) will be forced to re-tenant or reinvent large footprints left behind by shuttered anchor spaces once occupied by Neiman Marcus and JC Penney, as well as several other inline spaces vacated by J. Crew and Aldo. Many regional mall properties were already experiencing a renaissance through a conversion of dormant spaces into more experiential uses such as waterparks, interactive video arcades, breweries, large format fitness, among others. At a Macerich property in Scottsdale, what was once a Barney's department store is now home to a co-working location from Industrious -- a competitor to WeWork – and an Apple store. With MAC and SPG still down 66% and 55% respectively year-to-date, the recovery that the broader FTSE All Equity REIT Index has enjoyed, which has rallied to down 17 percent over that same period, is evidencing concerns on operational stability and prospects for future earnings growth within the regional mall sector(9).
Anyone considering investing in retail related REITs should operate cautiously. While there might appear to be some good deals on the surface, it behooves investors to pay extra attention to a REIT’s balance sheet and cash flows. Can the REIT continue to make their own expense and interest payments while receiving reduced rents, and for how long? We’ve recently seen mall operator CBL & Associates (CBL) miss interest payments on senior unsecured notes, which could lead to their equity being wiped out entirely in a bankruptcy scenario. In addition, dividends may no longer be sacrosanct. Many mall and shopping center REITs have cut their dividends recently and there are likely more to follow. Lastly, it’s critical to know the REIT’s tenants. Are they paying rent now? Are they likely to pay it in the future? Are they likely to be around in the future? Is it all concentrated in one or a few tenants?
These are just some of the things we think we about when constructing the REIT Blocks in our Path by Origin app. We offer multiple strategies for different investment objectives. Download the Path app to learn more about our REIT Blocks and see if they might be a good fit for your portfolio.
(1) - https://www.retaildive.com/news/the-running-list-of-2020-retail-bankruptcies/571159/
(2) - https://www.wsj.com/articles/macys-raises-4-5-billion-funding-its-operations-through-fiscal-2021-11591659400
(3) - Company Reports
(4) - Company Reports
(5) - NAREIT
(6) - https://therealdeal.com/2020/05/12/retail-rent-collection-plunges-to-58-in-april/
(7) - Company Reports
(8) - https://www.cnbc.com/2020/06/16/us-retail-sales-may-2020.html
(9) - Yahoo Finance
Director of Public Securities
Geoff leads the construction and monitoring of the public real estate securities portfolios available in our Path by Origin app. Prior to Origin, Geoff spent the last 12+ years researching and investing in public REIT securities at both Duff & Phelps Investment Management Co. and J.P Morgan Asset Management.
Geoff Shaver and clients of Path by Origin, LLC own SPG.
Path by Origin, LLC (“Path”) is an SEC registered investment adviser. Mr. Shaver is the Director of Public Securities of Path. The views expressed herein are subject to change, and no forecasts can be guaranteed. The comments provided are for educational purposes only and may not be relied upon as recommendations, investment advice or an indication of trading intent. In preparing this document, the author has relied upon and assumed, without independent verification, the accuracy and completeness of information available from public sources. The stocks mentioned in this article have been highlighted based on some reported news, quality or characteristic and do not necessarily represent all of the securities recommended for a particular portfolio. Path is not soliciting any action based on this communication. Investments involve risk, including the possible loss of principal and fluctuation of value. Past performance is not indicative of future results. Mr. Shaver and Path disclaim responsibility for updating any information herein. In addition, Mr. Shaver and Path disclaim responsibility for any third-party content.