| BUSINESSWEEK ONLINE : DECEMBER 20, 1999 ISSUE | ||||||||
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| COVER STORY
Bargain Days for Mall REIT Investors Fears of an e-tailing takeover have driven their stock prices down to tempting levels It's hardly surprising that stocks of companies that own and develop shopping malls have trailed the market this year. Investors have staked billions on the future of e-commerce and the potential for hassle-free point-and-click shopping to woo consumers away from bricks-and-mortar stores. What could be more old hat, by contrast, than facing crowds, long lines, and parking woes at the mall? And the Internet isn't the only problem mall stocks are facing. Many investors expect consumer spending to slow next year as economic growth inevitably wanes. The valuations of e-commerce stocks are based on performance that's projected so far into the future that those shares ironically seem immune from business-cycle worries. But mall stocks are not. Moreover, a backdrop of rising interest rates this year has hurt mall REITs, which have high debt expenses. Leading real estate investment trusts such as Simon Property Group (SPG), Rouse Co. (RSE), and General Growth Properties (GGP) are down at least 25% from their 52-week highs. What may surprise investors is that, while the stocks are getting hammered, 1999 is shaping up to be a banner year for the mall business. Retailers are expanding into new cities, increasing demand for leased space. Rents are rising, and mall occupancy rates are running at 90% to 95%, says Merrill Lynch analyst Craig Schmidt. Many mall stocks have reported growth in funds from operations (FFO) per share (a measure of profits applied to REITs) in the double digits this year. ADAPTING TO A WIRED WORLD. An emphasis on providing new kinds of entertainment to draw more shoppers to the mall could breathe new life into these stocks. Rather than being buried by the Internet, leading malls are finding ways to adapt to the wired world. They're building their own Web sites and arming shoppers with electronic gizmos for creating shopping lists, which can either be posted on the Web for family members to browse or simply handed over to a sales clerk for easy purchase and home delivery of goods. Simon Property Group, the largest retail property owner in the U.S., is leading the charge with its "Clixnmortar" subsidiary. "All their peers are looking to them to see what works," says Paul Morgan, an analyst with PaineWebber. Combine these positive trends with sliding share prices and you end up with cheap stocks, say analysts. Mall REITs are now trading about 25% below the private market value of the underlying real estate they own. Plus, the yields of many REIT stocks are around 9%, when traditionally they have yielded about 6% (REITs are required by law to pay out 70% to 80% of their free cash flow as dividends). Another measure -- the FFO multiple of REITS -- also makes them look like bargains. Now the group is trading at a multiple of about seven times their projected 2000 FFO. Typically, they trade at 10 times forward FFO per share, says Morgan. "The whole story of the Internet has spooked a lot of people and created some interesting opportunities," says Samuel A. Lieber, who buys bargain real estate stocks for the Alpine Funds he manages. He started adding select mall REITs last summer, including West Coast mall operator Macerich (MAC), which he calls "incredibly cheap" with an 11% yield, and Simon Property, which he says is "really cheap" with a nearly 9% yield. "Really, this is the first opportunity we've had in five years to own some of these stocks, and from my perspective, that's great," he says. AD SALES STRATEGY. Morgan's favorite stock is Simon Property, which he upgraded in mid-November to a buy. He commends its "forward-thinking management team" for its groundbreaking clicks-and-mortar strategy, as well as its new plan to sell more advertising in its 160 malls, which he expects to generate $30 million in additional revenues by 2001. He has an accumulate rating on General Growth, which has been a top grower among mall REITs, with 16% compounded FFO growth. But it has been punished recently by investors since it has high exposure to floating-rate debt (making it more vulnerable to rising interest rates). He also likes Macerich, which he says owns some of the best properties on the West Coast. Schmidt favors Simon as well but also mentions other names. Urban Shopping Centers (URB), a smaller company that runs high-end malls; Mills (MLS), which runs megamalls and has a strong pipeline; and Developers Diversified Realty (DDR) are other inexpensive mall REITs he likes. Cheap stock prices aren't the only things mall REITs have going for them. They should have steady cash flow into the future, since most of their leases with retailers are long-term (about seven years on average). Due to consolidation in the industry, many REITs operate as "quasi-monopolies" and enjoy high barriers to entry, says Lieber. By contrast, e-tailers are highly vulnerable to competition, especially this holiday season, and will get slammed if they don't meet sales expectations. Lieber believes that investors will grow less pessimistic about mall REITs as Internet hype inevitably fades. "I think you'll see a revaluation after the first of the year after analysis of the second Internet Christmas comes in," Mark Rivers, executive vice-president and chief strategic officer at Mills, says hopefully. E-TAILERS WITH SHELVES? Indeed, many industry observers believe the Internet may change the mix of stores at malls but won't kill them. There may be fewer music stores and electronics stores, for example, since CDs and consumer electronics are easily bought over the Web. But many malls emphasize apparel, which isn't Internet-friendly, and malls may rent more space to e-tailers who want real-world outposts, says Schmidt. Plenty of risks for mall REITs remain. Even if the Internet steals just 10% or 15% of mall sales, it'll wreak further havoc on the stocks, Lieber points out. Plus, there isn't much room for new mall development, which limits these companies' expansion prospects. Retail sales growth may indeed slow next year, in part because sales have been so strong this year. "It's hard to imagine things getting much better in the sector," says Schmidt. Another thing to keep an eye on: new Web-related services and entertainment features will cost mall REITs money and could crimp profit growth if they don't pay off. The bottom line is that many mall REIT watchers believe that current stock prices more than reflect such concerns. So investors who like to buy companies with real assets at bargain prices, might want to go shopping for a mall REIT. By Amey Stone in New York, with Janet Ginsburg in Chicago _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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 RELATED ITEMS Xtreme Retailing COVER IMAGE: Xtreme Retailing TABLE: Real World vs. Cyber World ONLINE ORIGINAL: Bargain Days for Mall REIT Investors INTERACT E-Mail to Business Week Online | |||
