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Retail REITs: Trouble Ahead

Occupancy income and rents are improving but consumer confidence and Wal-Mart's grocery expansion could point to trouble ahead for retail-focused real estate investment trusts.



) -- Industry trends in the retail-focused real estate investment trust sector have been improving, but trouble may yet be on the horizon.

Real estate investment trusts in the retail sector have suffered in recent years as consumers' cutbacks in discretionary spending led to softer demand for retail space. Many retail-focused REITS suffered through tenant bankruptcies and store closings, and some reduced the rents they charged to keep retailers.

While firms such as

Developers Diversified Realty



CBL & Associates Properties

(CBL) - Get CBL & Associates Properties, Inc. Report


Simon Property Group

(SPG) - Get Simon Property Group, Inc. Report

have reported improving occupancy and rental trends in their recent quarterly reports, there remains a few key obstacles for REITs that rent space to retailers. Perhaps the most important is consumer confidence.

The Thomson Reuters/University of Michigan index of consumer sentiment rose to 68.9 in August, from an eight-month low of 67.8 in July, but the uptick was less than expected. Soft consumer confidence often leads to pullbacks in consumer spending which is widely considered to account for 70% of the U.S. economy.

High rates of joblessness could mean the recent recovery in the REIT-retail sector was simply an anomaly, and not indicative of fundamental strengthening, according to equity research shop Stock Call.

Excluding auto and gasoline sales,

U.S. retail sales fell 0.1% in July

, though overall retail sales rose 0.4% last month after falling the previous two months.

Retail behemoth

Wal-Mart Stores

(WMT) - Get Walmart Inc. Report

also poses a potential threat to retail REITs, the research firm noted.

Wal-Mart has been expanding into the grocery business

, posing a threat to grocery store chains like


(KR) - Get Kroger Co. (KR) Report




. Grocery stores are generally the primary traffic anchors for retail developments and strip malls, Stock Call pointed out, and Wal-Mart's growing grocery business could steal grocery shopper traffic away from higher-priced chains.

"While two companies in this

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retail-focused REIT sector have Wal-Mart as a tenant, Wal-Mart owns the vast majority of its own stores meaning the REIT-Retail sector could see a significantly negative impact if Wal-Mart's expansion proves successful."

Even so, Stock Call said recent financial reports from retail-focused REITs showed that "occupancy and tenant net operating incomes have been trending upward toward pre-recession levels."

It was a welcome trend after high vacancy rates and softer rental demands kept much of the sector under tight pressure for some time.

Strengthening average rents have moved the needle higher in terms of industry fundamentals, Stock Call said, pointing to a recovery of sorts.

Developers Diversified Realty, a mall and shopping center owner, recently narrowed its quarterly losses thanks in large part to improved business activity, higher demand and increased occupancy. The REIT booked a funds from operations loss of $32.8 million, or 13 cents per share, compared with a year-earlier loss of $166.5 million, or $1.15 per share.

FFO is a performance figure generally used by REITs to define cash flow from operations. The performance metric removes the profit-reducing non-cash effect of depreciation.

CBL & Associates Properties, also a retail-focused REIT, posted a 15% rise in quarterly FFO to $68.4 million, or 49 cents per share. It also said occupancy increased by 160 basis points in the period.

Simon Property Group, the largest U.S. mall owner, recently reported higher-than-expected quarterly FFO of $487.7 million, or $1.38 per share, a 55.8% increase from the year-earlier period. Results were driven by lower expenses and higher occupancy at its malls and outlet centers.

Shares of

Apollo Commercial Real Estate Finance

(ARI) - Get Apollo Commercial Real Estate Finance, Inc. Report

were upgraded Monday to outperform, from market perform, by FBR Capital, citing the company's recent success getting attractive returns on its loan portfolio. The REIT recently grew quarterly earnings by nearly 40% year-over-year,

Shares of Developers Diversified fell 2.2% Monday, while CBL lost 1.1% and Simon Property 0.8%. Apollo gained 0.8%.

-- Written by Miriam Marcus Reimer in New York.

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