Simon (NYSE:SPG) and Macerich (NYSE:MAC): REIT Investors Skip the Office and Go the Mall

April 14, 2024
REIT Analyst van Dijkum recommends Simon Property Group (NYSE:SPG) and Macerich (NYSE:MAC)

Floris van Dijkum, Managing Director and Senior Research Analyst, Compass Point Research & Trading

In a recent interview with The Wall Street Transcript, Compass Point Research & Trading Analyst Floris van Dijkum offered recommendations across REIT subsectors, with the exception of office.

Mr. van Dijkum is a Managing Director and Senior Research Analyst at Compass Point. He joined Compass Point in June 2019, bringing 30+ years of real estate investment, research and banking experience.

Prior to joining Compass Point, he started the REIT research effort at Boenning & Scattergood. Before that, he started the global REIT investment platform at BlackRock, where he served as COO and was responsible for a quarter of the U.S. portfolio.

Mr. van Dijkum began the interview with a discussion of valuations in the REIT sector today.

“Based on consensus estimates, the overall REIT sector trades at a 1.9% discount to NAV, and based on earnings, REITs trade at 17.5 times 2024 FFO. That FFO multiple has increased marginally over the past month as investors have gotten more comfortable on the U.S. economic outlook. REITs on average deliver a 4% dividend yield.

However, not all sectors are valued equally. The property sectors that I cover are currently valued well below the overall REIT sector average. In particular, the retail sectors of malls and shopping centers trade at 28% and 24% discounted multiples, while hotels trade at a 45% lower multiple, despite the fundamentals for these sectors being probably the best they’ve been in nearly a decade.”

He was negative, however, on the fundamentals in the office sector.

“Office will be a challenged sector for the medium term, in our opinion. We currently have no ‘buy’ recommendations in the office space.

In the office sector, post-COVID, the work-from-home concept has really impacted office demand. McKinsey has published a study that expects 18% to 25% lower office usage as more work is done from home. Office usage, according to Kastle Systems, which tracks swipes at buildings, is 50% of what it was pre-COVID. Some markets are getting back to 60% to 70%, but in most national office markets, on average, office usage is still significantly down.

As companies realize they need less office space, they’re going to lease less space. If you look at the U.S. office market, the availability of office space in the country is around 20% — and we think this availability rate is going to go higher.

A lot of companies are currently leasing space they don’t use, so when those leases expire, they’re going to take approximately 20% less space. We think 20% is a good benchmark for what the space reduction needs are going to be going forward for companies.”

In contrast, Mr. van Dijkum was bullish on the mall sector.

“I remain completely out of consensus, and I have been for a couple of years, in that I am a bull on the mall sector. Malls are the best performing REIT segment over the last three years. They outperformed the REIT Index every single year, and have the best total return over the last three years.

Our mall owners still continue to screen incredibly attractively, because they’re undervalued, and part of that is because the national media has been slow to recognize that the A mall business, we think, is one of the best real estate sectors around.

There continues to be negative supply growth, and coming out of COVID, the retailers realized they actually need to operate in store. As retailers seek space where they achieve some of their highest sales productivity, they have leased space and are continuing to lease space in the mall.

The demand for space in the malls — and it’s not just the A-rated malls, it’s also the B-rated malls, but the A malls are seeing a disproportionate amount of demand — means that landlords have pricing power. Occupancy rates continue to trend higher, and we think they can go back to prior peak levels and beyond.

However, we are not there yet. Moreover, rent spreads are double-digit and will probably continue to trend higher going forward, as well.

Couple that with the fact that the mall business has 3% annual fixed rent bumps in all of the lease contracts, it means you’re going to see some very strong NOI growth over the next two to three years, well beyond the 3% cruising speed.

We think malls, A-rated malls in particular, are going to grow by 4% to 5% a year for the next couple of years. And actually, we see no signs of that ending, because there’s less mall space in the country every year.

The luxury brands are expanding outside of their coastal major market focus to throughout the U.S. Luxury brands tend to only operate in two locations, street retail in urban settings and the A malls, and so the A malls are huge beneficiaries.

We’ve written that 5% of Simon’s (NYSE:SPG) shop space in its mall portfolio is taken up by luxury, and that’s going to grow to up to 10%. And it exceeds 20% in 25 of Simon’s best malls.

Luxury tenant sales productivity is multiples of other retailer sales. The average A mall sales are about $700 a foot in our mall database; an A mall is any mall that has tenant sales over $500 a square foot. Open air shopping center sales are, we estimate, around $250 per square foot. So, the average mall sales are nearly three times the average open air sales.

So, from a retailer’s perspective, your sales tend to be much better operating in an A mall than in a typical open air center. And then look at luxury — luxury average sales are north of $1,500, oftentimes north of $2,000 a square foot.

What does that mean for mall landlords? That means that with an occupancy cost of 10% to 12%, mall owners can charge triple-digit rents. Simon’s average rents are $55 a square foot, but luxury is going to pay $150 to $200 per square foot in the mall, so a landlord essentially triples the typical rent.

Of course, only a select number of malls in the U.S. are suitable for these tenants, with Simon owning 40 and Macerich (NYSE:MAC) owning 12, based on our estimates.

We published an analysis on what the impact is should luxury do just 25% of its potential expansion in Simon’s and Macerich’s portfolios, and the numbers are significant. We have estimated that Simon’s total NOI — over $5.5 billion per year — could increase by 9%, and Macerich’s NOI could increase by 14%. Macerich is a smaller portfolio, so it’s more impactful for Macerich than it is for Simon.

These are massive numbers that are not being reflected in the current valuations. The mall sector trades at 12.4 times 2024 FFO, and 11.9 times based on 2025 FFO, and the REIT sector trades at 17.5 times.

The underlying earnings growth in the mall sector is massive, even though the headline earnings growth this year is going to be low because of refinancing of maturing debt. And, by the way, higher interest costs is an issue that the whole REIT sector is dealing with. The average REIT growth in terms of FFO per share is 2.5%. We believe the mall valuation discrepancy screens very attractive.”

You can learn about Mr. van Dijkum’s other top real estate picks by reading the entire 4,303 word interview in The Wall Street Transcript.