Mall Fundamentals Will Recover More Quickly Than Thought

Mall operating fundamentals are expected to recover more quickly than previously predicted, thanks in part to tenant sales that are better than expected, according to an analysis from Green Street.

Despite the rise of the Omicron COVID variant, which threatened foot traffic when it first appeared, and ongoing supply chain challenges, brick and mortar retail sales remained solid and are up 17% over Q3 2019 levels. Meanwhile, e-commerce sales decreased for the first time this year, down 3% over Q2 2021. Apparel stores⁠—the most significant retailer type for malls⁠—have mostly caught up to other categories, Green Street analysts say.

The firm revised its forecast for mall REIT NOI next year higher; the metric is now 1% down from 2019 levels, up 300 basis points over prior estimates.

“Mall-REIT-reported tenant sales continued to positively surprise in the third quarter, exceeding our expectations that sales would be roughly in line with ’19 levels. Our previous concerns that increasing COVID cases this summer would lead to a pullback in mall sales proved unfounded,” the report states. “International tourism is still significantly below normalized levels, suggesting robust sales trends could continue well into next year in the absence of COVID variant disruption (e.g., Omicron). Our sales forecast has been revised materially higher in the upcoming years, with expected ’22 tenant sales now 300 basis points above our pre-COVID estimate on an indexed basis.”

Rents for new full-time leases are down 6% since 2017, which Green Street analysts say is partially offset by higher variable rents. New leasing activity accounted for around half of all leases signed, a move the firm says is “evidence of retailers’ appetite to grow and reliance on brick-and-mortar stores as a key part of their business, even within the mall format.”

Cap rates for Class A malls and outlets trended down by about 70 basis points on average, and Green Street maintains that cap rate compression across other asset types suggest further declines for the sector.

“With the operating environment improving and cap rates compressing across most other property types, it seems appropriate to lower mall/outlet cap rates despite a lack of tangible transaction evidence. We herein lower ‘A’ mall/outlet cap rates by ~70 basis points,” the report states. “Cap rates for lower-quality properties are unchanged as there have been a handful of deals that indicate double-digit cap rates still persist for this more troubled asset class.”