3 trends that every regional mall investor should watch
Aug 29, 2012
Two major impediments have slowed regional mall performance over the last five years: the retail sales slump induced by the Great Recession and competition from online retailers. The impact on any individual mall varies greatly depending on its competitive position.
Though regional malls have struggled to deal with these trends, a study by SNL Financial indicates that despite these setbacks, regional malls remain a smart investment. Our institutional investment clients echo these feelings. The report found that real estate investment trusts (REITs) that own regional malls posted a 269.8 percent return from May 2009 to May 2012. But how much of this improvement is attributable to increasing performance measurements as compared to investors chasing yield and driving cap rates down? Our research reveals that average mall cap rates have declined 150 basis points during this time period, from 7.5 percent to 6.0 percent. This represents a value increase, all other things remaining the same, of only 20 percent. Therefore, there is much more going on than what can be explained through cap rate compression. Retail sales have started to come back in recent months, which are helping rebuild optimism surrounding regional mall investments. In June, retail sales were up by 3.5 percent year over year and 13.3 percent over June 2010. Better quality malls have fared much better based on data compiled by IRR.
When I led the appraisals for 30 regional malls earlier this year, a few more trends emerged that are having a large impact on the future of regional malls. These developments are also creating new opportunities that every regional mall investor should be watching. Let’s take a look at three trends and what they mean for investors.
1. Apple is skewing the results of many regional mall health reports. When I dug into the source of recent retail sales growth, I saw that Apple stores have been doing so well that they can skew the total sales of a regional mall by up to 10 percent. This is notable because Apple stores are typically 5,000 to 7,000 square feet, but their productivity can exceed that of 150,000-square-foot department stores. This finding is unprecedented in the retail market. In fact, some investors have begun isolating Apple from their data analysis to gain a more accurate picture of regional mall health. Apple also boosts the performance of other tenants by drawing more traffic to the mall. Regional mall investors really can’t get a better tenant than an Apple store. At the same time, however, Apple will be facing new headwinds from Microsoft, which plans to open 44 retail stores by the end of June 2013. It’s too soon to predict how this will play out. For now, investors should watch Microsoft’s retail strategy closely.
2. Big box stores reconfigure. The growth in online retail continues to threaten big box retail stores. Best Buy laid off 2,400 employees and closed 50 stores earlier this year, and Sears, Circuit City, and Staples are all shrinking their footprints. Big box stores need to begin implementing new strategies to thrive, such as splitting up into smaller, more specialized stores with fewer product lines that could become mainstays of larger centers or mini shops within larger stores. In addition, brick-and-mortar retailers must continue to find ways to complement online retail. For instance, one strategy that many retailers have implemented is giving the option for shoppers to purchase more products online and pick them up in-store. In this transitional stage, be careful that you don’t get stuck with too much big box space in your portfolio. When you have a 20,000-square-foot space left behind by a shuttered Best Buy, you might be able to find a replacement tenant or split it up among multiple tenants. L.A. Fitness, which is opening 50 locations a year over five years, and Dollar General, which is opening 625 new stores in 2012, are two examples of companies moving into big box spaces.
3. Class B is the new Class A. Investors are increasingly turning to Class B malls for two reasons. First, nearly all Class A malls are spoken for by REITs and institutional and foreign investors that have no desire to sell these historically safe investments. At the same time, Class B malls have more upside because the uptick in retail sales presents an opportunity for improvement and the difference in cap rates is sufficient to warrant the additional risk that comes with a Class B mall. As a result, we’re seeing more investments. For example, Starwood Capital bought a 90 percent stake in seven U.S. malls in April, including mid-tier malls, and KKR & Co. has also announced acquisitions of Class B malls. When weighing an investment in a Class B mall, look at the three-year history of sales to distinguish strong and weak performers. Retail sales started turning around in 2010, so if sales have not shown 10 percent or more improvement since then, you better ask the question, why not?
Demand in regional mall investment has come back with the uptick in retail sales. Investors can avoid risk by investing in regional malls with Apple stores, avoiding too much big box space, and considering a Class B mall with upside potential. What do you see in store for regional malls? Let us know in a comment below.
Author: Raymond T. Cirz
