REITs Get Rich off Mallrats

Malls are alive and kicking despite the odds, and that's good news for their landlordsand their investors

Nothing can destroy the mall.

Not online shopping. Not high gas prices. Not the housing slump. Not a 129-point drop in the stock market. Each time you think they're doomed, malls just keep getting bigger and bigger.

Remember when (AMZN) was supposed to put all the malls out of business? Didn't happen. Now, as gas prices and interest rates creep up and home values stagnate, consumers should theoretically spend less on nonessential items like garden furniture at Home Depot (HD) or high-definition TVs at Best Buy (BBY).

But retailers are plodding along, sustained by a steady job market and a strong stock market. The International Council of Shopping Centers (ICSC)-UBS Retail Chain Store Index, a measure of same-store sales, rose 2.5% in May, an improvement from April's 1.9% drop. For the week ended June 9, same-store sales rose 1% from the prior week and 2.1% from a year earlier.

Both Macy's (M) and JC Penney (JCP) posted sales declines in May, but more upscale stores are faring extremely well—Saks (SKS), which operates Saks Fifth Avenue, reported a 37.5% gain in same-stores sales in May. In early June, preppy retailer J. Crew (JCG) said its first-quarter profit more than tripled.

Still Thriving

The ICSC predicts that same-store sales will rise 2% in June, the second most important month of the year for retailers after December, when merchants begin to clear out summer merchandise to make room for fall.

According to the trade organization, national mall sales figures have increased more than 5% in each of the past four years, outpacing general merchandise sales.

"In general, malls haven't been hurt very much at all [by competition or problems in the economy]," says Murray Shor, publisher of trade magazine Shopping Center Digest. Average mall sales per square foot are now in the $400 range, he estimates. The national average in 2005 was about $340. Because, love it or hate it, the mall is more than a place to buy things, it's an American institution—one with movie theaters, fine restaurants, and museums. In some places, going to the mall is the social highlight of the week. And as summer kicks off (with a little help from climate change), it becomes a refuge from the sweltering heat.

REIT Place, REIT Time

Benefiting from malls' endurance are real estate investment trusts (REITs)—corporations investing in real estate that are required to distribute at least 90% of their taxable income to shareholders in the form of dividends. Seven of the 10 biggest malls in the country are owned by publicly traded REITs, which get most of their revenue from rent that is determined by monthly sales.

REITs have had an extraordinarily profitable run, beating all major equity benchmarks for the past 3-, 5-, 10-, 15-, 20-, and 30-year periods, according to the National Association of Real Estate Investment Trusts. In 2006, REITs returned 34.35% to investors, versus the S&P 500's 15.79%. But now, overall REITs are roughly flat for the year as a result of profit-taking and concerns about the slowing residential real estate market and other economic hiccups.

Mall REITs, however, are doing just fine. Returns on regional mall REITs have increased about 3% in the past 12 months, making it one of the three top-performing REIT segments, along with lodging and specialty REITs. The total REIT Index is down 1.6% year-to-date, while industrial, office, and apartment REITs have fallen 1.2%, 1.7%, and 2.4%, respectively.

On May 30, Deutsche Bank (DB) raised its rating on the regional-mall REITs sector to buy from hold after Tishman Speyer Properties and Lehman Brothers (LEH) made a $15.5 billion offer to buy apartment REIT Archstone-Smith Trust (ASN).

Less Volatile Market

"After being cautious on the group the past three months as fund flows turned negative and investors pursued other alternatives, we are turning slightly more positive on the heels of the Archstone announcement," wrote analyst Lou Taylor in a research note. "These stocks have the most meaningful upside potential from current levels to our targets." Taylor has buy ratings on retail REITs Developers Diversified Realty (DDR), Kimco Realty (KIM), Macerich (MAC), and Simon Property Group (SPG).

"The retail business generally is healthy; tenant demand is good," said Simon Property Group Chief Executive David Simon during a presentation at REITWeek 2007 on June 6. "Retail real estate tends not to have the volatility in market rents that office does. Everyone gets excited about Manhattan real estate, but if Wall Street sneezes, the $100 [per square foot] that they're getting today will go down to $70 or $60 in 12 seconds."

Simon, based in Indianapolis, is the largest publicly traded retail real estate company in North America, with a market capitalization of $56 billion. The company currently owns or has interest in 323 properties in the U.S.; 53 European shopping centers in France, Italy, and Poland; five outlet centers in Japan; and one outlet center in Mexico.

Simon owns most of the biggest malls in the U.S., including (through subsidiary Kravco Simon) King of Prussia Mall in Pennsylvania, the biggest mall in the country by leasable area. The company recently closed on its $1.6-billion purchase of Mills Corp. Through Mills, Simon can now add the fifth biggest mall in the country, Del Amo Fashion Center in Torrance, Calif., to its holdings.

Staying Fresh

One mall Simon doesn't own (anymore) is the Mall of America in the Minneapolis-St. Paul area. The company sold its stake in MOA—the biggest mall in the country by total area and the second biggest by leasable area—to private developer Triple Five Group in late 2006 for $1.8 billion (see, 12/26/06, "Biggest Real Estate Deals of 2006").

The Mall of America may not be second biggest for much longer. The mall is adding 5.6 million square feet in the next two years that will include upscale shops and restaurants, a 6,000-seat performing arts center, three or four hotels, a skating rink, and condominiums.

"What malls have been doing over the last 50 some years is they constantly reinvent themselves," says Shor. "The mall becomes essentially a downtown area where people come to be entertained. They're shopping, they're eating. They're doing everything but taking a shower."

"Lifestyle centers," which combine apartments with retail, office buildings, or entertainment, took center stage at the ICSC's annual convention, held in May in Las Vegas. The idea is to have everything you need—home, work, and entertainment—in one place. "That's where most of the new development is going on," says Shor, who was one of 55,000 attendees, a record high for the conference. To meet demand, the ICSC had to double its exhibition space from 1 million to 2 million square feet.

Time Equals Money

"The trade organizations are really upbeat," says Emile Pocock, a professor of American Studies at Eastern Connecticut State University, who compiled's list of America's Biggest Malls. "But they are quite aware that the traditional mall is probably past its peak." The amount of money that people spend in a mall directly correlates to how long they are in the mall itself, Pocock explains. For that reason, developers are renovating old enclosed malls by adding outdoor cafes, fitness centers, and mini golf.

Simon currently has more than 38 retail centers undergoing redevelopment, expansion, or renovation, with $5 billion in its redevelopment and development pipeline for the next five years. The company has six lifestyle centers in its portfolio and has recently opened lifestyle centers such as the Domain in Austin, Tex., which has 700,000 square feet of restaurant and retail space, 390 apartments, and 75,000 square feet of office space. Chicago-based General Growth Properties (GGP) recently built the Jordan Creek Town Center in West Des Moines, Iowa, which includes an enclosed shopping center and a 3.5-acre lake surrounded by bike trails, with a boardwalk offering waterfront dining, a hotel, and an amphitheater.

Highly specialized centers keep the right customers—those with plenty of disposable income—coming to the mall and driving up sales, even in times of economic uncertainty. The upscale stores and sit-down eateries at today's newest malls attract older, wealthier customers, and keep out the broke teenagers that came to typify the mall experience in the 1980s and '90s. As innovative mall REITs continue to renovate and build modern shopping centers in the U.S. and abroad, returns should continue to rise, especially long term.

Click here to find out which are the biggest malls in the U.S.