Overpriced Mall REIT Should Be Avoided

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Overpriced Mall REIT Should Be Avoided

By Chris Worthington, Editor-in-Chief of Income

In 2014, real estate investment trusts (REIT) had a banner year. Using the Vanguard REIT ETF (VNQ) as a proxy, REITs gained an amazing 30.4% on a total-return basis. That beat the S&P 500 by 2.2x.

That’s great for anyone who was invested prior to the run-up . . .  but it’s also a sign that investors should be wary going forward.

In particular, mall REITs are one investment that yield seekers should avoid at all costs. Despite some tempting dividends, the future is bleak for companies that own enclosed mall properties, as they’re quickly becoming ghost towns . . .

Consider this: The number of enclosed shopping malls with a vacancy rate at or above 40% – the point at which malls typically enter their death throes – has more than tripled since 2006. Nearly 15% of all enclosed malls are suffering from a vacancy rate between 10% and 40%, according to Green Street Advisors.

The reasons for the decline are numerous, ranging from online shopping to so-called “power centers” that feature big-box retailers like Target (TGT) and Best Buy (BBY). But no matter the cause, the trend should be a major warning sign, particularly when it comes to mall REITs.

Mall REIT Prices Are Sky-High

Today, most of the major mall REITs (as well as some other retail REITs) are trading at excessive valuations, as you can see in the chart below:

Every one of these companies is trading well above its 10-year median price-to-funds from operation (P/FFO) ratio, and many lack the growth to back up their price.

In fact, Simon Property Group (SPG) – the world’s single largest REIT – recorded exactly 0% one-year FFO-per-share growth (diluted) in 2014. That makes it even more dangerous than, say, Federal Realty Investment Trust (FRT), whose one-year FFO-per-share growth (diluted) was nearly 10%. There’s a chance FRT can justify its valuation . . .  but Simon simply can’t.

And that’s not the only reason investors should be worried about SPG. Indeed, after the stock rose an amazing 27.3% in 2014, its price-to-forward FFO is now close to an all-time high:

Meanwhile, Simon’s dividend yield of 3.1% is hardly worth the risk that accompanies it. And it’s not as though the dividend is growing quickly, either – in fact, the dividend increase has been smaller each year over the past three years.

Of course, if SPG’s unreasonable valuation and mediocre dividend aren’t enough to scare you away, then perhaps its recent attempt to acquire even more doomed properties will do the trick.

You see, on March 9, SPG announced an unsolicited $16-billion bid for rival Macerich (MAC). The total cost of the potential takeover – which would combine the first- and third-largest mall owners in the United States – would be $22.4 billion, including assumption of debt.

Simon’s bid of $91 per share is a 30% premium to MAC’s closing price on November 18 – the day before Simon disclosed that it had bought nearly six million shares of MAC, the first sign of SPG’s “hostile” intentions.

Yet the deal couldn’t come at a worse time for SPG. Macerich is trading at its highest valuation since 2007, influenced by a whopping 55% run-up in its stock price over the last 12 months. It makes one wonder why SPG waited until this moment to make its move.

Now, Macerich hasn’t received the offer kindly so far. In fact, according to The Wall Street Journal, the firm has hired Innisfree M&A Inc., a proxy-solicitation firm known for helping defend against hostile bids. But if the deal were to go through, it could easily be damaging for Simon in the long run.

Take the Money and Run

Finally, it’s worth noting that SPG is the largest component in the popular iShares U.S. Real Estate ETF (IYR). In fact, over 10% of IYR’s holdings appear in the chart of overvalued REITs shown above. Now, not all real estate is a terrible investment, as I noted back in February. But this particular ETF is dangerously exposed to a number of companies with bleak outlooks.

Bottom line: SPG had a good ride in 2014, but the days of the enclosed mall are nearing their end. Take some profits, and treat yourself to some well-deserved online shopping, instead.

Good investing,

Chris Worthington

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By Chris Worthington