The Internet hasn't killed shopping mall REITs (yet)

Share

Perhaps you laughed at the prospect of Amazon.com Inc. delivering parcels with drones. But the online retailer's chief executive, Jeff Bezos, nonetheless added one more reason to ponder the end of shopping malls when he floated the drone idea in December.

While shoppers may not worry about a transition away from malls as e-commerce rises, investors in real estate investment trusts should: If tumbleweed replaces tenants, distribution streams will vanish. So far, shopping mall REITs have shown little concern over the threat – recent weakness seems more related to positioning away from interest-rate sensitive investments – but could things change?

Green Street Advisors has weighed in with a provocative report that calls the evolution in consumer behaviour a "sea change": As impressive as online retailing has already grown, "the impact of the internet of consumer behavior is still in its early stages."

Yikes. But the report also assures investors that quality malls, which offer a shopping experience over convenience, are in a better position to handle the change.

"Commoditized products – which typically make up a small per cent of mall sales but a large percentage of power center sales – remain most at risk," the report said. "Books, office supplies and electronics sales have moved online at a break-neck pace."

So where does that leave REITs? The S&P 500 retail REITs index has so far been shrugging over the threat of online retailing. The index – which consists of Simon Property Group Inc., The Macerich Company, General Growth Properties Inc. and Kimco Realty Corp. – has risen 400 per cent from its post-financial crisis low in 2009. Similarly, Riocan Real Estate Investment Trust (full disclosure: I own units in this REIT, and I believe the company now owns the floor under my desk) has risen nearly 120 per cent over the same period.

Green Street sees the e-commerce threat as just another in a series of changes that were supposed to kill malls, from the department stores of the 1960s to the big box stores of the 1990s. Each time, malls evolved.

"Malls have grown stronger over time, mostly because of the ability to adapt to new retail concepts and changing consumer needs," the report said. "Two decades ago, restaurants and services were mostly absent from the mall. Today, these non-traditional tenants are opening across the quality spectrum."

Some malls are being used as "mini distribution centers" – stores serving not only shoppers but as warehouses for those who prefer to have their purchases delivered to them. And some companies usually associated with Internet distribution, including Microsoft, Apple, Warby Parker and Piperlime, are now opening physical locations in malls to promote their products.

That said, Green Street warns that changes are coming: "The most likely outcome of eCommerce growth will be a sizable change in the competitive position for a large number of malls. Over the next several years, mature retailers will rationalize (i.e. downsize) their store count. Some already have. The proper balance between online and brick & mortar continues to evolve. One thing is certain: most retailers want and need a presence in the mall. The physical location helps set the image for the brand and retailers will likely see rent partially as a form of advertising. However, sales generated by 'fourth and fifth best malls" in a given market could be shifted online."

In the United States, that could mean that 15 per cent of malls – the lower productivity ones – close or become used for something other than retail. However, mall REITs tend to own the better-quality shopping spaces.

"The mall sector offers compelling relative value compared to other sectors," the report said. "Yet, concerns about eCommerce and anchor uncertainty (JC Penney and Sears) have weighed down recent stock price performance. The concerns are understandable, but the magnitude of the negative reaction in most cases seems unwarranted."