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) 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) and Taubman Centers ( TCO - Get Report) 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.

If the economy weakens, Frankel expects landlords to see some occupancy deterioration, but the drop won't be large enough to meaningfully affect fundamentals.

Although retail sales don't immediately have an on impact mall landlords, they can hurt the sector if sales continues to slide over time. Continued sales declines could force mall-based retailers like Gap ( GPS - Get Report) to open fewer stores. Since about 10% to 15% of mall landlords' space opens up each year, then the REITs could face occupancy issues in a downturn, and that affects the pricing of new rents.

The fourth quarter will hold a clue to retailers' health, since more than half of their annual profits come in the holiday period. Last week, retailers generally reported strong sales for September as lower gas prices and fall weather helped consumers boost their back-to-school spending.

Though fundamentals are stronger than investors seem to believe, malls are expected to lag other commercial property sectors in earnings growth next year.

Frankel says the mall sector will have 8% growth in "core" funds from operations next year (he strips out one-time charges and benefits from lease terminations). That compares with 20% FFO growth from hotel stocks, and 9% growth in apartments. Funds from operations is a common REIT performance metric that excludes the effects of depreciation on net income.

Most mall companies also have healthy development pipelines, which add value but could hurt near-term earnings.

Frankel suggests investors focus on the top-tier names in the sector such as Simon, General Growth, Taubman and Macerich ( MAC - Get Report), which all operate Class A malls.

Frankel recommends avoiding owners of older Class B malls, such as CBL ( CBL - Get Report), Glimcher ( GRT) and Pennsylvania REIT ( PEI - Get Report). Since Class B malls are in secondary markets, they'll be most affected in an economic slowdown.