Seven Major Retail REITs Share These Troubling Characteristics

The financial stress of this year’s economic lockdown first impacted retail consumers, followed by the retailers those consumers frequent and then the real estate owners leasing space to those retailers. With retail continuing to take the brunt of the COVID wallop, some REITS are managing to weather the storm while others are filing for bankruptcy protection.

In fact, two REITs declared bankruptcy on the same day last month for the first time in history: CBL Properties and Pennsylvania Real Estate Investment Trust. Moreover, more than three dozen publicly traded retailers filed for bankruptcy this year including JC Penney, Sears, Lord & Taylor and Forever 21.

There are six factors that certain REITs have in common with CBL and PREIT, according to S&P Global’s December research brief. These are: 1) a high percentage of anchor tenants that have declared bankruptcy 2) a decline in building permit activity 3) a decline in foot traffic 4) a high degree of leverage 5) declining cash flow and 6) a high proportion of tenants that have filed for bankruptcy.

S&P Global then identified seven REITs including CBL and PREIT that share these characteristics: Macerich, Brookfield Property, Washington Prime Group, Simon Property Group and Taubman Centers (which Simon is acquiring). These seven are located far from the cluster of data points associated with the other REITs in the universe, according to S&P.

And, all seven REITs manage regional malls, a business that was already under stress prior to COVID-19 as more consumers shifted to online shopping. This may make it more challenging going forward for those REITs to repair balance sheets impaired by the pandemic.

When property owners are under financial stress, they delay or discontinue expansionary projects. Such behavior can be tracked by monitoring building permits. Both REITs in bankruptcy had a decline in permit-requiring activity, behavior previously shown to correlate with negative contemporaneous returns, says S&P.

Combined with fundamental data, accompanying foot traffic can help identify REITs in poor financial health. And indeed, all seven REITs had a year-on-year decline in foot traffic that was worse than peer foot traffic in October 2020. An extended deterioration in footfall at property locations likely translates to lower sales and reduced cash flows for a given REIT.

All told, each of the seven REITs have unfavorable exposures to one or more of the three fundamental metrics S&P selected to assess the financial health of REITs. Washington Prime Group is the only one out of the seven REITs with an unfavorable exposure to all three fundamental risk metrics.

Separately, Fitch Ratings recently downgraded Simon Property Group’s long-term issuer default rating to A- from A. The rating outlook is negative.

It is somewhat surprising to discover that Simon Property is at all embattled given its position in the retail REIT marketplace and the relative size of its balance sheet. Fitch Ratings, however, argues that SPG’s credit metrics, particularly net debt to recurring EBITDA, will remain weakened by both the stress on its department store and apparel retailer tenant roster and the majority debt-funded Taubman transaction.

Fitch expects Simon will continue to experience cash flow pressure as store closures mount, more retailers declare bankruptcy and secular trends shift tenant demand to street-facing, open-air centers allowing for curbside pickup. Also landlords are increasingly finding their pricing power limited in rent negotiations, Fitch adds.

Fitch also pointed to Simon’s upside, namely its premium outlet portfolio, which is generally more flexible and has greater capacity to evolve with consumer needs at lower expense to the landlord.

Besides, Simon has been taking many strategic steps to bolster troubled tenants and to generally retain its competitive position.

Just this week, Simon and Brookfield Property Partners (another REIT on S&P Global’s watch list) completed their $800 million rescue of J.C. Penney from bankruptcy. They may be weighed down by the pandemic but they are still large enough and have enough cash on hand to still significantly reshape the retail market.