9 Things You Should Know About Malls and Mall...

19 Things You Should Know About Malls and Mall REITs

9 ThingsYou Should Know About Malls and Mall REITs

This material has been prepared by A.T. Kearney. This document is for information and illustrative purposes. It is not, and should not be regarded as, investment advice, or as a recommendation regarding any particular security or course of action. Opinions expressed herein are current opinions as of the date appearing in this material only and are subject to change without notice. Reasonable people may disagree about the opinions expressed herein. In the event any of the assumptions used herein do not prove to be true, results are likely to vary substantially. All investments entail risks. There is no guarantee that investment strategies will achieve the desired results under all market conditions and each investor should evaluate its ability to invest for a long term especially during periods of a market downturn. No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those discussed, if any. This information is provided with the understanding that with respect to the material provided herein, you will make your own independent decision with respect to any course of action in connection herewith and as to whether such course of action is appropriate or proper based on your own judgment, and that you are capable of understanding and assessing the merits of a course of action. A.T. Kearney does not purport to and does not, in any fashion, provide broker/dealer, investment consulting, or any related services. You may not rely on the statements contained herein. A.T. Kearney shall not have any liability for any damages of any kind whatsoever relating to this material. You should consult your advisors with respect to these areas. By accepting this material, you acknowledge, understand, and accept the foregoing.

Contacts

Mike Brown, partner, New York [email protected]

Amiya Setu, principal, Dallas [email protected]

Ivan Yiu, consultant, Toronto [email protected]

Mike Moriarty, partner, Chicago [email protected]

Andres Mendoza Pena, principal, Chicago [email protected]

Overview: The Making of the MallMalls have had a long and storied history in America’s consumer fabric since the first fully enclosed regional malls were designed in the 1950s, one example of which was built by Victor Gruen in Edina, Minnesota. Over the decades, the mall has become ingrained in the American psyche, with generations of families making it the epicenter of their shopping and leisure time.

Over time, ownership of these malls passed into public hands in the form of real estate investment trusts (REITs), then started to concentrate among a number of owners such that several of the regional malls are today owned and operated by a group of regional mall REITs.

REITs were designed as a way for investors to participate in private real estate ownership, with the retail REIT sector paving the way for the sector’s genesis in the early 1990s. Within retail REITs, mall REITs are now some of the largest capitalized companies within the REIT sector.

The mall model has always been a simple one: create attractive spaces for retailers to sell their goods, collect rent from retailers over a fixed period, and sign new tenants up at a higher rent than the existing base. Over the years, the highest-quality malls have continued to improve their physical spaces and services to entice new retailers—and keep existing ones—at increasingly higher rental fees. Consistent rent spread growth (the difference in rent from one year to the next) indicates the ongoing effectiveness of this model.

Through the years, malls and mall REITs have weathered many challenges to their position, including failed retailers, recessions, and alternate shopping channels from catalogs and TV shopping to e-commerce.

In addition, mall REIT stock prices have been subject to the vagaries of the stock markets, with adverse macroeconomic events such as high interest rates and inflation pressuring prices, sometimes on the basis of perception alone. Despite all of this, the mall REIT sector has continued to grow.

This paper explores the mall REIT story by looking at past performance and the future outlook in the face of e-commerce advancements and evolving consumer behavior.


Performance1. REITs have outperformed the S&P on a total returns basis since 1994,

with retail REITs outpacing all other REITs. 5

2. Mall REITs have displayed stability in dividends and cash-flow growth, with mall REIT adjusted funds from operations (AFFO) outgrowing S&P earnings by 40 percent over the past 10 years. 7

3. REITs have generated mostly positive returns during rising interest rate periods over the past 20 years. Mall REITs have also deleveraged since 2008 and have a laddered maturity debt schedule, better positioning them for future rising rates. 9

4. REITs are not correlated to the S&P 500 over the long run, making them potential candidates for investors with investment criteria that includes broad diversification among asset classes. 11

Retailers and Consumers5. Leasing supply and demand dynamics in the next few years are

favorable for regional malls. 13

6. Digital is not a challenge, but an opportunity to supplement the stores to better engage today’s connected shoppers who prefer to interact with retailers through multiple channels. 15

7. Mall REITs are driven more by long-term discretionary consumer spending than the short-term performance volatility of retailers. 17

8. Faltering retailers are not new for mall REITs (for example, Montgomery Ward, JCP, Sears, Mervyns, W.T. Grant, Phar-Mor, and Jacobson Stores, among others); malls have been able to adapt in the past by re-leasing vacated space, and they continue to do so. 19

9. Published shopper traffic numbers may not truly represent the overall shopping activity that is occurring at malls. 21


REITs’ Historical PerformanceREITs, and particularly retail REITs, are not simply payout machines. They offer the chance for capital appreciation in addition to steady dividends. These two facts have led them to outperform the S&P 500 over the past 20 years.


REITs have performed well compared to the S&P 500, with retail REITs outpacing others over five yearsREITs have outperformed the S&P 500 on an absolute basis by 32 percent and a 14 percent difference in CAGR (10.6 percent vs. 9.3 percent) over the past 20 years

REITs have fared better than broader equities even while they pay out steady distributions. From 1994 to 2014, the National Association of Real Estate Investment Trusts (NAREIT) equity index has outperformed the S&P 500 by 32 percent when taking into account both capital appreciation and dividends.

REIT Returns vs. S&P 500

(20-year period from 1994–2014)January 1, 1994

February 1, 2014

NAREIT Equity REITTotal Return index

S&P TotalReturn Index

1,607

12,034

567

3,347

10.6%

9.3%

Notes: REIT is real estate investment trusts. NAREIT is the National Association of Real Estate Investment Trusts.

Sources: Bloomberg; A.T. Kearney analysis

Returns in the REIT sector have been comparable, but retail REITs have outperformed other REIT sectors and the S&P 500 over a five-year period

Retail REITs have been the strongest performer in the REIT sector since the 2008 credit crisis and have continued the rebound from their pronounced dip.

REIT Sector Performance Total Returns

(2009–2014)One year Three years Five years

350%

–50%

021%

56%

166%

3%38%

241%

–12%

29%

182%

4%49%

337%

5% 22%

257%

9% 27%

206%

14%

69%

274%

50%

100%

150%

200%

250%

300%

S&P 500 NAREIT Health Retail Apartment O�ice Industrial

Notes: REIT is real estate investment trusts. NAREIT is the National Association of Real Estate Investment Trusts.



Mall REIT Dividend Stability and Cash- Flow GrowthBecause of their payout requirements, REITs typically maintain their distributions even during market downturns. In addition, REITs have steadily grown cash flow, supporting capital appreciation and valuation.


Bloomberg Regional Mall REIT Index vs. S&P 500

(AFFO per share vs. EPS growth, 2007-2013)

Notes: REIT is real estate investment trusts. AFFO is adjusted funds from operations. EPS is earnings per share.


60%

80%

100%

120%

140%

160%

180%

2007 2008 2009 2010 2011 2012 2013

Bloomberg Regional Mall Index (AFFO per share)S&P 500 (EPS) 40% Di�erence

Mall REITs maintained stable payouts through the credit crisis while steadily growing cash flowIn addition to performing well as equities, mall REITs have provided investors with cash-flow stability via dividends

Mall REITs have consistently provided investors with strong cash flow via dividend distributions, even through volatile periods such as the 2008 credit crisis. This payout stability can give investors a margin of safety during market downturns.

1 AFFO is adjusted funds from operations. EPS is earnings per share.2 FFO is funds from operations.

Bloomberg Regional Mall REIT Index vs. S&P 500

(Dividends per share growth, 2007-2013)

Note: REIT is real estate investment trusts.


80%

100%

120%

140%

160%

2007 2008 2009 2010 2011 2012 2013

Recessionaryperiod

Bloomberg Regional Mall REIT IndexS&P 500

Mall REIT AFFOs have grown by about 67 percent since 2005, outpacing S&P 500 EPS growth by 40 percent1

Mall REITs have beaten the S&P 500 when it comes to growing their underlying valuation measure (FFO and AFFO for REITs vs. Earnings for the S&P) over the past 10 years.2


REIT Performance Under Rising Interest RatesSince 2000, REITs have posted positive returns during rising interest-rate periods. Their efforts at lowering leverage since the 2008 credit crisis, coupled with a laddered maturity debt schedule, may also help better insulate them against future rate increases.


Mall REITs have performed well in high interest-rate periods; lower leverage will be positive for mallsREITs have posted mostly positive returns during rising interest-rate periods over the past 20+ years

Part of REIT positive performance during rising rate periods can be ascribed to better economies, which typically accompany rising rates. (For example, they can have better rent spreads.)

10-Year Yield vs. NAREIT Equity REIT Index

(Total Return Index, 1994–2014)

Notes: NAREIT is the National Association of Real Estate Investment Trusts. REIT is real estate investment trusts.

Sources: Bloomberg, the National Association of Real Estate Investment Trusts, 10-K reports; A.T. Kearney analysis

Equi

ty R

EIT

Inde

x(‘0

00)

10-year bond yield

NAREIT Equity REIT total return 10-year bond yield

0.01.02.0

3.04.05.06.0

7.08.0

January 2010 January 2005 January 2000January 1995

–9% –6% +51% +30% +27% +15% +3%

0

6

4

2

12

10

8

14

With lower leverage ratios since 2008 and a laddered maturity debt schedule, mall REITs could be well insulated from high interest-rate periods

After 2009, the end of the credit crisis, mall REITs have achieved growth while keeping leverage steady. Additionally, the top mall REITs have a laddered maturity debt schedule, spreading out the amount of maturing debt in any given year. This could put mall REITs in a better position to weather rising rates.

Bloomberg Mall REIT Index

Debt-to-Equity and Debt-to-Asset Ratios(2006–2013)

1 Maturing debt is fixed-rate debt.


Sources: Bloomberg, the National Association of Real Estate Investment Trusts, 10-K reports; A.T. Kearney analysis

Tota

l deb

t-to

-equ

ity

Total debt-to-assets

Debt-to-equity Debt-to-assets

2006 2007 2008 2009 2010 2011 2012 2013

4x3x2x1x

0.8x 0.7x 0.6x 0.5x 0.4x 0.3x 0.2x

6x5x

Top Mall REITs Debt Maturity Schedule

Maturing Debt1

(% of total debt as of fiscal year 2013)

2014

6%

2015e

9%

2016e

15%

2017e

10%

2018e

10%

There-after

50%

Total

100%Maturing debt (% of total)


Real Estate and Mall REITs as a Diversification PlayAlthough mall REITs have tracked the broader equities index more closely in the past five years, private real estate has also displayed this behavior. Over the long term, REIT correlation to equities is relatively low, making REITs a diversification candidate.


Long-term REIT correlation to the S&P is weak, making REITs a portfolio diversification candidateThe S&P 500 and NAREIT indexes have only been very recently correlated, but this new phenomenon contradicts a long-run weaker correlation

In a long-term investment horizon, the weak correlation of REITs to equities indicates the diversifying effect of REITs. The recent closer correlation to equities is not confined to REITs. Private real estate has also been closely tracking the S&P 500 since 2008.

NAREIT Index vs. S&P 500

Historical Price Correlation (1994–2014)

Note: NAREIT is the National Association of Real Estate Investment Trusts.


S&P

500

Inde

x NA

REIT Index

0

500

1,000

1,500

2,000

0

100

200

300

400

500

600

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

R2 (20-year period) = 0.4

NAREITS&P 500

REIT correlation to private real estate has tracked more closely since 2008

The NAREIT Index is more volatile than the National Council of Real Estate Investment Fiduciaries (NCREIF) Private Property Index, but the two have been relatively correlated with even closer ties recently. For diversification purposes, recent trends show there may be little benefit to selecting one over the other, although REITs have the added benefit of liquidity and financial transparency.

NAREIT Index vs. NCREIF Property Index

Historical Price Correlation (1994–2013)

Notes: NAREIT is the National Association of Real Estate Investment Trusts. NCREIF is the National Council of Real Estate Investment Fiduciaries.


NC

REI

F In

dex N

AR

EIT Index

0

500

1,000

1,500

2,500

2,000

0

200

400

600

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

R2 (20-year period) = 0.64

NAREITNCREIF


The Mall Leasing Supply and Demand StoryThe 2008 financial crisis was the worst since the Great Depression of the 1930s. Supply flattened out during this period and has remained stable since then, while retailers continue to seek high-quality space. These factors paint a positive supply and demand picture for malls and mall REITs.


Quality mall space is in demand, and malls are in a favorable position to benefitAs the recovery from the 2008 crisis has accelerated, occupancy has risen steadily and could continue growing until 2017

With supply growing at about 1 percent per year and retailers seeing value in high-quality space, the supply and demand outlook for regional malls is favorable, especially given that historic peak occupancy of 94 percent won’t be reached until 2017 or beyond.

Regional Mall Supply and Demand Dynamics

Sources: International Council of Shopping Centers, Bloomberg, Reis, analyst reports, company filings; A.T. Kearney analysis

88%89%90%91%92%93%94%95%

200

400

600

800

1,000

Gro

ss le

asab

le a

rea

(mill

ion

squa

re fe

et) O

ccupancy rate

2008 2009 2010 2011 2012 2013 2014e 2015e 2016e 2017e

Gross leasable area (million square feet)

Forecasted gross leasable area (million square feet)

Occupancy rate

Forecasted occupancy rate

+1% CAGR +1% CAGR

Peak occupancy 2005: 94%

With limited high-quality mall space available, mall REITs have been able to lease and re-lease space at favorable lease spreads

Retailers are willing to pay higher rent when entering into new leases with regional malls. This demand is driven by retailers’ strong focus to enhance their brick-and-mortar operations, either as part of omnichannel or market expansion strategies. (Think H&M and Uniqlo.)

Average Lease Spreads for Top Regional Mall REITs


Sources: International Council of Shopping Centers, Bloomberg, Reis, analyst reports, company filings; A.T. Kearney analysis

(2009–2013)

Lease spreads

Occupancy rate

0%

5%

10%

15%

20%

88%

89%

90%

91%

92%

93%

2009 2010 2011 2012 2013

Leas

e sp

read

Occupancy rate


The Challenge of e-Commerce or the Omnichannel OpportunityShopping malls have been the epicenter of shopping activity since the 1950s, and they will continue to play a pivotal role for consumers, retailers, and investors. Although the retail world is evolving with the adoption of digital, consumers prefer to engage with retailers through multiple channels, with the store still playing a key role. Retailers that understand the complementary roles of stores and digital are winning in the new environment.


Retailers that successfully meet consumer preferences for integrated channel experiences are advantaged95 percent of sales are still made by retailers with a physical retail presence

Multichannel retailers are in the best position to leverage and capture the significant benefits of doing business in an omnichannel world.

Total Category Sales by Channel and Retailer Type

Sources: eMarketer, Forrester, Internet Retailer, eDataSource, Bloomberg, company presentations, 10-K reports, International Council of Shopping Centers; A.T. Kearney analysis

(% split, 2012)

Foodand

Beverage

Healthand

PersonalCare

HomeImprovement

Appareland

Accessories

Computersand

ConsumerElectronics

Furnitureand Home

Furnishings

Autoand

Parts

SportingGoods

Books, Music,and Video

Jewelry Toysand

Hobby

O�iceEquipment

and Supplies

Pets

Store sales Bricks-and-clicks web sales Pure-play web sales

100% 97%

7%

91%

5% 1%3% 2%

11%

84%

5%10%

85%

20%

79%

5%2%

94%

4%8%

88%

12%

15%

72%

15%

78%

3%11%

85%

5%

37%

58%

5%

24%

72%

7%

The mall tenant mix is diverse with multiple category sales, and e-commerce only drives change in a few

Categories such as books, music, and video, consumer electronics, and toys and hobby are the only ones where e-commerce penetration is significant. But as evidenced above, many e-commerce categories are still being driven by bricks-and-clicks retailers.

How Multichannel Creates Momentum

Source: Study conducted by Verde Group and Jay H. Baker Retailing Center at the University of Pennsylvania Wharton School, 2011

Multichannelshoppers are loyaland spend more

E-commerce sales arehigher in areas with aphysical retail store

Integrated channelsspawn cross-sellopportunities

• Studies show that loyalty leads to more retailer and brand endorsements (multichannel consumers are 15 percent more likely to recommend retailer to others versus monochannel).

• The average spend of multi-channel consumers is twice that of mono-channel.

• Clicks-to-bricks retailers reporte-commerce sales lifts of three to five times in geographic areas where they open a physical location.

• A multichannel presence createspost-purchase sales opportunities:almost a quarter of consumers purchase further items when picking up an online order from a store.

• Of consumers returning an online item, 20 percent make an additional purchase.

$


Mall REITs, Consumer Spending, and Retailer PerformanceA vibrant retail environment is undeniably important to the long-term success of the mall. However, a bad holiday season or faltering retailer does not immediately translate into lower revenue for malls, thanks to the long-term nature of leases.


Mall REIT performance is tied to retail discretionary spending, not to short-term retailer performanceThe stock price of REITs is correlated to retail sales and spending. In a healthy retail spending environment, mall REITs tend to do well.

For regional malls to succeed, a vibrant retail spending environment is vital. With retail spending in recovery since 2008, mall REIT stock prices have continued to trend upward.

Bloomberg Regional Mall REIT Price Index vs. Retail Sales Spend

(2000–2014)


Sources: Bloomberg, Reuters, CNN, The New York Times, company filings; A.T. Kearney analysis

Bloomberg Regional Mall REIT Price IndexRetail Sales Index

0

10

20

30

40

50

60

January 2000 January 2002 January 2004 January 2006 January 2008 January 2010 January 2012 January 2014

240

150

210

180

Bloo

mbe

rg R

egio

nal M

all

REI

T Pr

ice

Inde

xR

etail Sales Index

Mall REIT cash flow remains healthy in a strong retail sales environment and is not adversely affected by retailer performance volatility in the short term

Even though a few retailers are struggling, overall long-term retail spending is healthy. This is ultimately what drives healthy cash flow for regional malls.

Bloomberg Regional Mall REIT Index FFO vs. Retail Sales Spend

(2000–2014)

Note: REIT is real estate investment trusts. FFO is funds from operations.

Sources: Bloomberg, Reuters, CNN, The New York Times, company filings; A.T. Kearney analysis

Bloomberg Regional Mall REIT Index—Trailing 12-month FFO Retail Sales Index

0

100%

200%

300%

400%

500%

600%

January 2000 January 2002 January 2004 January 2006 January 2008 January 2010 January 2012 January 2014

240

150

210

180

Recessionaryperiod

Montgomery Wardbankruptcy

Circuit Citybankruptcy

Mervynsbankruptcy

Sears announces120+ stores

closing in 2011

JCPenney closesseven stores in 2012

REI

T In

dex

Trai

ling

FFO

grow

th fr

om 2

000 R

etail Sales Index


The Effect of Faltering Retailers on Mall REITsAlthough faltering retailers are a concern for mall REITs, the impact on malls might not be as negative as the press would lead us to believe. Malls have successfully addressed and dealt with retailer bankruptcies in the past.


Mall REITs have been able to overcome tenant failures in the past by re-leasing the spaceMall REITs have weathered retailer bankruptcies in the past

The last time mall REITs had a major anchor tenant fail was in 2001, when retailer Montgomery Ward filed for Chapter 7 bankruptcy. Within a year, a major mall REIT was able to re-lease a significant portion of the 28 vacated stores.

A Major Mall REIT’s Repurposing of Montgomery Ward Stores after 2001 Bankruptcy

Note: REIT is real estate investment trusts. Redesignated indicates tenant was found for premises.

Sources: Credit Suisse First Boston (June 2002 and September 2002 data points), Salomon Smith Barney (March 2002 data points), Bloomberg; A.T. Kearney analysis

Anchors vacated

Redesignated

Re-leased

28

0

December 2001:+0 months

0

21

7

March 2002:+3 months

0

14

7

June 2002:+6 months

7 7 7

September 2002:+9 months

14

0

7

December 2002:+12 months and beyond

21

Top in-line tenants of major mall REITs do not appear to be at risk of default

The top 10 tenants (by store count) in regional malls have a low risk of short-term default. These strong profiles show the resiliency of the leading in-line mall tenants and lower the risk of sudden occupancy and rent shortfalls caused by retailer failure.

Short-Term Default Risk of Top 10 Tenants by Brand, Store Count (as of March 2013)


Sources: Bloomberg, mall REIT filings; A.T. Kearney analysis

Likely

Unlikely

No likelihood

0.0%

90.5%

9.5%

Top ten tenants representabout 20 percent of total portfolio count for each mall REIT


Shopper Traffic Relationship to Mall PerformanceShopper traffic has been cited as one of the key influencers in mall performance. However, there are no authoritative sources of mall traffic available, and the subset of retailers that are tracked by available sources does not accurately reflect mall traffic and performance.


Mall REIT performance continues to be robust due to efficient operations and underlying demand. Mall REIT performance has little to do with retailer traffic and is driven by two key metrics

Current limitations of available third-party data sources that collect retail traffic counts can lead to inaccurate assessments and conclusions. Such limitations include the following: 1) Traffic counts come from only a small subset of retailers that do not reflect the actual mix in malls; 2) Often, traffic is not counted in the common areas of malls; 3) There may be inherent limitations to underlying counting technologies; and 4) Many of the largest U.S. malls do not participate in these counts. As such, investors should focus instead on meaningful key performance metrics that are currently available and that accurately reflect the performance of malls, namely funds from operations (FFO) and lease spreads.

Mall REITs have improved their performance since 2009, with little correlation to reported retailer traffic

As evidenced by the growth among the major mall REITs in lease spreads, and the upward trend in FFO, mall REIT performance continues to be robust due to efficient operations and underlying demand.

How Mall REITs Have Increased their FFO and Lease Spreads

(2009–2014)

Notes: Four mall REITs consist of General Growth Properties, Simon Property Group, Taubman Centers, and Macerich. FFO is funds from operations.


January 2010 July 2010 January 2011 July 2011 January 2012 July 2012 January 2013 July 2013 January 2014

Four mall REIT FFO

Four mall REITannual lease spread

500

0

1,000

1,500

0%2%4%

6%8%10%12%

14%16%

Com

bine

d FF

OA

nnual lease spread %

Meaningful Key Performance Metrics

Funds fromoperations (FFO)

Lease spreads

FFO is the best determinant of mall REIT financialstrength. Continued growth in FFO shows demand for mall REIT properties by retailers, as well as underlying operational strength and capability.

Lease spreads and occupancy are the best indicator for underlying demand. Continued demand strength is shown when retailers and service providers sign on or renew at higher lease rates.

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9 Things You Should Know About Malls and Mall...

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