REITs: Four Mall Bargains

S&P says that funds focused on the largest shopping centers will benefit most from current conditions and should draw investors

STORY TOOLS

Search for business contacts:

PREMIUM SEARCH
Search by job title, geography and build a list of executive contacts

From Standard & Poor's Equity Research
Ask any shopper: Rising interest rates can take the fun out of a trip to the mall. And they have certainly weighed on shares of retail real estate investment trusts (REITs). Bears appear to be betting that higher rates will slow consumer spending, cutting into merchants' profits—and by association, rental income for the outfits that own the retail space.

But despite the downbeat outlook, there are attractive opportunities in the sector. Indeed, S&P sees buying opportunities among selected names, particularly mall developers. "Retailers are still expanding because they think there is untapped demand. That means there should be more demand for space, which should lead to improved occupancy levels and rental growth," says S&P REIT industry analyst Robert McMillan, who recently attended the National Association of Real Estate Investment Trusts conference, where the presentations reinforced his positive outlook for select names in the group.

Though McMillan has a neutral recommendation on the overall group as a result of valuations, he says that REITs focused on regional and super-regional malls will likely be the top beneficiaries of still-strong retail demand, retailer expansion, and limited opportunities for new shopping-center development, particularly in land-scarce major metropolitan areas.

And with high gasoline prices—$2.896 on average for a gallon of regular unleaded on June 14, according to the Automobile Association of America's Daily Fuel Gauge report—a trip to the mall can help cut down on expenses by offering one-stop shopping, he says.

ROBUST INCOME GROWTH. This group of REITs has other strengths, including significant barriers to entry by competitors, and the mall outfits' ability to capitalize on their dominant market position in the areas they serve. But the smaller players face less favorable odds. "We look for less robust results from community and strip-center malls," because they lack those benefits, he says.

McMillan has 4 STARS (buy) rankings on four big mall operators: CBL & Associates Properties (CBL), Federal Realty Investment Trust (FRT), General Growth Properties (GGP), and Glimcher Realty Trust (GRT).

McMillan recently upgraded CBL to 4 STARS from 3 STARS (hold). "After recent declines, which in our opinion were based on concerns about potential increases in interest rates, CBL shares have attractive appreciation potential," he says. He likes the fact that most of the company's debt is at fixed rates, and with long-term leases in place for most of its portfolio, McMillan looks for operating results to continue growing at a robust level, driven by continued retailer expansion and new developments.

For Federal Realty, McMillan expects total rental and other property operating income to grow 8% in 2006, up from nearly 6% in 2005. In the first quarter, the REIT's occupancy level rose to 96.2% from 95.1% in the year-earlier period.

RENTS DRIVE REVENUE. "We see robust demand for space enabling [Federal] to continue to achieve double-digit rent increases when expiring leases are renewed; rent increases per square foot for comparable retail space in the first quarter averaged 16%," McMillan says.

The analyst sees total revenue at General Growth Properties climbing about 10% this year, after a 70% gain in 2005 on higher rents and tenant reimbursements, and the acquisition of the Rouse Company in late 2004.

As for Glimcher, while the REIT reported 87.3% occupancy in its mall portfolio in the first quarter, down from 87.4% a year earlier, the average rents for its mall stores increased nearly 3% year-over-year. McMillan thinks continuing acquisition activity and the disposal of underperforming or nonstrategic assets will benefit Glimcher's operating results.

As with any shopping excursion, those eyeing retail REITs would do well to be selective. The savvy investor, like the dedicated shopper who prowls the clearance racks, may still be able to snap up bargains among mall operators.

Sanders is a reporter for Standard & Poor's Global Editorial Operations

All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report.
Standard & Poor's Regulatory Disclosure

Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard & Poor's" reflect the views of Standard & Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard & Poor's. Standard & Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc.

READER COMMENTS

Get BusinessWeek directly on your desktop with our RSS feeds. XML

Add BusinessWeek news to your Web site with our headline feed.

Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video.

To subscribe online to BusinessWeek magazine, please click here.

Learn more, go to the BusinessWeekOnline home page