Retail is Dead? Long Live Retail CRE Assets!
Doom and gloom about certain retail assets is justified – but it obscures a much more complex picture.
Earlier this week, the New York Times published an article titled “The Big Short 2.0ʼ: How Hedge Funds Profited Off the Pain of Malls.” It explained how some investors recently made outsized returns by betting against retail real estate, specifically malls.
The article ends with a fitting quote: “I’m definitely bearish on malls,” Ms. McKee [a hedge fund investor] said. “But I think it’s a very case-by-case basis. I don’t think all malls are dying.”
So, which retail assets have promise, and which ones do not?
The Demise of Retail Real Estate…
The retail real estate sector was in demise long before the COVID-19 pandemic hit the global real estate market. The shift to online buying and the “over-retailing” of most locations led to a plethora of bankruptcies and subsequent declines in retail rents and prices. The effects of lockdowns and the unwillingness of consumers to expose themselves to health risks while shopping have further hastened the rapid decline of retail real estate.
While retail rent and price trends are hard to gauge, the stock prices of the major owners of retail real estate are quite telling. Shopping center giant Simon Property Group is down 56% from its peak, shedding more than $20 billion in market capitalization. Unibail-Rodamco-Westfield, a REIT with a global portfolio of shopping centers, is down 65% from its peak.
Some argue that grocery-anchored retail is faring better. Relative to malls, that is probably true. But even owners of grocery-anchored retail have been battered pretty badly. Regency Centers, a large investor in neighborhood shopping areas (also known as strip centers) is down 36%. Kimco, another large owner of strip centers, is down 42%.
…And the Double Whammy of COVID-19
The impact of the COVID pandemic has been devastating for many retail assets. Some areas, however, have been and continue to be more exposed than others.
To determine which retail REITs have the most exposure, we assessed the exposure of each retail asset owned by publicly traded REITs. We overlaid two measures of COVID risk on the respective portfolios owned by REITs and then averaged the total portfolio to model the effects of the pandemic.
First, we use the GeoPhy COVID Risk Score which has two components:
- The percentage of workers in sectors that have been most heavily exposed to COVID’s labour market effects (e.g. people working in restaurants, retail, leisure, etc) at a neighborhood level, and
- The local rent-to-income ratio
Neighborhoods with high rent-to-income ratios and large shares of residents working in service-related jobs are most likely to experience significant impact from the COVID pandemic. Retail assets in these areas will likely suffer from reduced spending driven by the reduced disposable incomes of local residents.
Table one below shows REITs’ varying exposures to COVID-related risks. Taubman and Unibail-Rodamco-Westfield – two large shopping center REITs – have average COVID Risk scores of 66 and 65, respectively. REITs such as VEREIT and Kite Realty have lower, more favorable scores.
Can Surrounding Areas Support These REITs’ Retail Tenants?
Next, we looked at these REITs’ properties through the lens of the recently concluded U.S. Census Bureau’s Pulse Survey data. Census ran this weekly survey for 12 weeks to track the economic impact of COVID, issuing its last report on July 29. Pulse measured the rent-paying behavior of a large, representative sample of people across the nation. GeoPhy used this data to construct Rent-At-Risk, which measures the fraction of residents in an area that cannot pay rent or is unlikely to pay next month’s rent. We again matched Rent-At-Risk to the areas where each publicly traded REIT owned retail assets.
Exposure to areas where residents are unlikely to make rental payments has direct relevance to owners of multifamily assets. However, we believe it may be an equally relevant indicator for the performance of retail assets in those same areas.
Interestingly, most of the 13,000 retail assets owned by REITs across the US are in areas where a large fraction of the population in rental units is unlikely to make rent payments. This ranges from a “low” of 30% of neighboring tenants being in the Rent-at-Risk category for Retail Opportunity Investments Corporation to 41% for Urstadt Biddle Properties. All retail REITs have more than three-quarters of their assets in areas where the Rent At-Risk is at least 25% (or higher).
Not All Malls Are Dying
Using the same processes, there’s at least as much data to assess which of the 13,000 retail assets owned by REITs are not doomed. Also, it’s easy to identify current retail real estate assets located in highly desirable areas. Perhaps the location is no longer valuable for retail, but assets in these areas might profitably be converted to alternative uses such as residential or logistics/fulfillment.
We first applied the GeoPhy Location Score to evaluate the quality and desirability of the locations where REITs own their 13,000 retail assets. Tailored to multifamily assets, our Location Score measures the attractiveness of areas by evaluating the local housing market, demographics, the presence of amenities, and the incidence of crime.
Using this data, the picture of retail real estate and the REITs owning these assets looks distinctly different. Unibail-Rodamco-Westfield’s assets score in the top-3 of best average GeoPhy Location Score. Its malls are located in areas with highly desirable demographics, strong housing markets, and plenty of amenities. Clearly, while the malls may suffer, the underlying fundamentals for commercial real estate are strong, with potential redevelopment opportunities, perhaps to rental housing.
At the bottom of the ranking is VEREIT, with an average GeoPhy Location Score of 47. That number is well below the average Location Score in the U.S. So, even though VEREIT’s stock price is down “just” 36% to date, the data suggests that alternative use cases for its retail locations are more limited than for other REITs.
Selling Losers, Picking Winners
It’s enticing to follow the investors in the New York Times article into shorting the CMBX6 indices with significant retail exposure. You can write off retail real estate as an asset class that dominated the past, but has no future. Beyond the prospect that those shorts will soon be financially unattractive with broader knowledge of the trade thanks to the publication of the Times’ article, there’s ample opportunity in retail!
Some retail assets will perform well going forward because they have the fundamentals right. Other retail assets that don’t have a future in retail are located at highly desirable locations, leading to valuable redevelopment opportunities. Finding those assets will be the challenge, but granular, relevant data can give opportunistic real estate investors the edge they need.
Click here to sign up for a demo and free trial of GeoPhy’s Evra platform, which includes the capabilities we used in this analysis.