Mall REITs Store Value

It may be time to shop for mall REITs.

Fears about consumer spending have unjustly hurt mall owners this year, causing the sector to lag the overall performance of real estate investment trusts. That could signal a buying opportunity, so long as holiday retail sales aren't disastrous.

The misconception about mall owners like Simon Property Group(SPG Quote) is that their earnings are driven by consumer sentiment and consumer sales, says Deutsche Bank analyst Lou Taylor. However, only 2% of the companies' revenue actually comes from percentage rent that is tied directly to retailer sales, he says.

The bulk of mall REITs' profits come from long-term leases, which average about 10 years. The industry currently is benefiting from strong leasing and high occupancy rates because retailers have increased store openings and taken up space in quality malls.

"You need a prolonged drought [in consumer spending] to really hurt malls," says Mike Kirby, director of research with Green Street Advisors.

Nonetheless, investors seem worried about mall REITs. Year to date, shares of regional mall operators are up 15%, while the total NAREIT Equity Index (which excludes mortgage REITs) is up 27%.

"Class A" mall operators, which tend to be newer and located in regions where affluent customers reside, could be among the most undervalued. Class A malls are those that typically have more than $450 per square foot of tenant sales, whereas Class B malls tend to be older and have about $350 per square foot in sales.

Green Street Advisors says Class A mall operators such as General Growth Properties(GGP Quote) and Taubman Centers(TCO Quote) are both trading at 13% discounts to their net asset values (which roughly equal what the real estate would fetch on the private market).

"It's an overall fear of the consumer, and that's being reflected in the mall prices," says Jeung Hyun, a principal with Adelante Capital Management, which invests in the sector.

Nonetheless, Hyun says mall owners have good growth prospects and that their current stock prices are inexpensive. He says investors can reasonably expect 3% same-store net operating income growth at the quality names in the sector.

Shopping for Value Mall owners are cheap compared with other top-tier commercial property REITs
REIT	Sector	Price-to-FFO Multiple*
General Growth Properties (GGP)	Mall	14
Simon Property Group (SPG)	Mall	16
Macerich (MAC)	Mall	16
Taubman Centers (TCO)	Mall	17
Archstone-Smith (ASN)	Apartment	23
Avalonbay (AVB)	Apartment	26
SL Green (SLG)	Office	22
Vornado (VNO)	Office	21
*Based on 2007 analyst estimates

"The sentiment is bad. Reality is good," says Dean Frankel, a portfolio manager with Urdang Securities Management, which owns mall REITs.

The sector continues to put up good earnings numbers, and new rents are being priced at healthy premiums to old leases, Frankel says.