My childhood mall has become very sexy over the past two years.
Roosevelt Field Mall, a property owned by Simon Property Group (SPG) that is situated in the generally rich-people area of Garden City, N.Y., recently completed a major two-year renovation. All I can say is that I barely recognize it as the same place I visited with my mom and grandmother as a kid in the pursuit of affordable schools. The all-new Roosevelt Field Mall makes no attempt to hide whom it's targeting -- a high net-worth clientele that can afford to buy apparel and shoes three times a week, and then return for even more junk the next week.
The renovation brought Long Island its first Neiman Marcus, decked out in some form of art deco façade. A humungous food court was added that focuses on better-for-you fast food, including several that I think have national potential. Hollister underwent an impressive remodel, retrofitting it with storefront windows and a giant digital screen. Banana Republic, a chain owned by Gap (GPS) that I believe is dead, is undergoing an overhaul (it's open during the overhaul -- good for Gap).
But, amid the shiny new structures sit on the main floor two retailers -- Aeropostale and Pacific Sunwear (PSUN) -- that are indicative of the major shakeout continuing in the retail space. Aeropostale is nearing a bankruptcy filing, and Pacific Sunwear has already filed. The stories of each of those chains -- as well as those of Sears (SHLD) and Macy's (M), which are dealing with store closures -- primarily were undone by the rise of fast fashion houses and online shopping, which is why I can't believe the continued enthusiasm for the sector's future by Simon Property CEO David Simon and most mall executives.
I certainly appreciate their perspective that media is overhyping the death of the mall. For years, mall owners have been able to grow occupancy and rents and thumb their noses at news reports of their demise at the hands of Amazon (AMZN) and the websites of their own tenants. More recently, the sector has done an impressive job attracting tenants for exited anchor stores, redeveloping hulking former two-level department stores into grocery stores and entertainment facilities. In other words, the companies have kept the assets at some of their top malls generating cash, which is necessary for mall real estate investment trust (REITS) given how much they pay out in dividends and interest expense.
Simon's financials looked solid in the first quarter, too. Earnings per share increased 15.4% year over year, and the company hiked its dividend by 6.7% after a double-digit increase last year. The stock has been on a tear the last year due to the company continuing to defy the naysayers. Boasted CEO Simon on a call with analysts, "I think our simplistic view is it's not as bad as people want to write about, and I think the biggest issue out there is the U.S. economy has flat-lined, and yet we are holding our own and gaining market share with a lot of our properties, and obviously we've got great tourist-oriented centers that have had a tough year." Three cheers for Mr. Simon.
His latest comments brushing off concerns on the industry's health echo ones he made to me in an interview in September 2014.
The store closures, for better or worse, have been part of our business. In most cases, not all, if real estate is valuable, the fact is that over the years we have been able to take an underperforming retailer and put in a better one. In the period from 1990 to 1997, every year I dealt with store closures, huge ones. We didn't have enough demand to deal with the store closures.
The one difference, right now, right as we speak, the store closures you hear about, we think we have enough demand to deal with them. It's nowhere near what I have seen historically, but it's ongoing throughout our business.
The store closures, yes, maybe they are a bit more than what they were about a year ago, but we think the pipeline of demand is more than capable of dealing with whatever comes up. Primarily what I am seeing is more closures in the teen apparel category. It's important for the retailer to change to what the teen wants. But it's incumbent on us to find the retailers that could feed the changing tastes. Those include names such as TopShop, Zara, H&M, Lululemon (LULU), Athleta, American Girl, and fast-casual restaurants. Seeing mostly shrinkage in the teen sector, that is primarily because they just didn't changed, they had a great run for 15 years.
But there was one stat in Simon's latest release that underscores why investors need to be cautious on a sector that has long been billed as an attractive long-term arena due to stable earnings and dividend checks. Simon's occupancy rate fell to 95.6% from 95.8% a year ago. Sales per square foot declined to $613 from $621 last year. These are two key metrics that are very likely to continue to weaken in the next several years due to a wave of major retail bankruptcies (see Sears), store closings and the fundamental shift toward online shopping. In turn, the entire thesis around owning a mall REIT is at risk.
A couple of things to consider:
Where is the next great big retail chain? I just don't see another Gap out there on the horizon (excluding well-known names such as H&M and Primark). You know, that retailer that explodes onto the scene, and before one knows it, has 500 stores open and plans to open another 500 more. Further, I don't think the future retail leaders of America are inclined to aggressively open stores. They likely will focus on the very top markets and look to innovate with their existing boxes (such as Kit & Ace, launched by Lululemon founder Chip Wilson). This is a problem for mall REITS, and one they didn't encounter from 1998 to the heights of their strength in the mid-2000s.
Wave of store closures likely to depress rents. So far, we haven't seen this happen in the major mall REITs. They have been able to refill many of the vacant anchor stores with retailers that generate strong sales per square foot, such as grocery stores. But, I do believe continued store closures will start to weigh on the rents mall owners will be able to command over the next three to five years. I think that will become more apparent in 2017, especially considering the continued sizable amount of strip mall real estate out there vacant across the country.