Mega-Bears Smell Blood As Mall REITs Tumble

While many have blamed today's spike in yields for the broader underperformance of the REIT sector, which sent the Bloomberg North American REIT index down 1.4%, its biggest one-day drop since December in a widespread selloff across all property sectors with 194 of the 214 stocks in the index lower today, it's more than just the jump in rates that is slamming the rate-sensitive sector.

While longs are grudgingly parting with some of the prized holdings, it is the short sellers that have emerged from hibernation and have smelled blood, first and foremost among mall REITs - the most vulnerable of the lot - and are turning their attention to the struggling chains’ retail landlords. The underlying retail story is familiar, but just in case here is a brief recap from WSJ: shares of retail-focused real-estate investment trusts, which own malls and shopping centers, have slumped since August last year, when Macy’s Inc. announced it would close 100 stores. Sears Holdings and J.C. Penney Co. later said they would close more than 100 stores each.

As a result, a regional-mall REIT index plunged about 22% from late July until March 6, according to data from the National Association of Real Estate Investment Trusts. And as the retail conflagration has spread, so has the shorting: the amount of short interest on retail-focused REITs increased to $7.6 billion as of March 6 from $5.6 billion as of the end of December, according to S3 Partners, a financial analytics firm, the WSJ reports.

S3 also reports that so far shorts against REITs with more class B and C malls, such as CBL & Associates Properties Inc., Pennsylvania Real Estate Investment Trust and Washington Prime Group, have been more profitable. However, increasingly shares of Class A mall REITs, which own the most productive malls in the country, have faced pressure. Short interest on mall giant Simon Property Group jumped to $1.3 billion on March 3 from $916 million at the end of 2016, near its record high. Over the same period, short interest trades in GGP Inc. increased to a record $689 million from $430 million.

Quote BTIG's James Sullivan: "there has been a steady drumbeat of negative reports from anchor retailers in the mall. As a result, when we keep hearing bad news it adds to the impression that there is a problem in the malls.”

Well, there is, because as we reproted yesterday "A Third Of All Shopping Malls Are Projected To Close As 'Space Available' Signs Go Up All Over America" only for years most refused to accept the changing reality of America's traditional "bricks and mortar" industry which has been decimated not only by online retailers such as Amazon but also as a result of ongoing deterioration in the US middle class whose disposable income and spending habits have not kept up with the "recovery."

Other short sellers are focusing on mall debt, which as we also noted yesterday in "The Next Domino To Fall: Commercial Real Estate", is fast becoming a source of potential of distress for capital markets. As the WSJ notes, losses on securitized mortgages tied to retail property rose to $1.7 billion last year from $1.3 billion in 2015, the only property segment that showed an increase in losses, according to Moody’s Investors Service. Kin Lee, senior portfolio manager at Angel Oak Capital Advisors, said his firm, which invests in commercial mortgage-backed securities, is becoming more selective in buying CMBS backed by malls.

“We don’t favor deals that have too much exposure to malls,” said Mr. Lee. “These headlines haven’t been completely new.”

Furthermore, as we warned one month ago in "Are CMBS Ghosts of The Past Reviving?" spreads on BBB-rated retail-heavy CMBS deals are rapidly widening, according to Trepp. Just like 10 years ago, when the "big short" was putting on the RMBX trade, and to a smaller extent, its cousin the CMBX, so now too some are starting to short CMBS through the CMBX, a CDS index which tracks the values of bonds backed by various commercial properties. They are betting against securities backed by malls in weaker locations where stores could close in quick succession, triggering debt defaults.

To be sure, some - like BTIG's Sullivan - argue the mall REITs have been oversold. Defenders note that the department-store closures haven’t hit REIT-owned malls much so far, and mall REITs have been able to backfill other vacancies with new tenants, analysts said. Chicago-based GGP, for instance, has signed new tenants such as Dick’s Sporting Goods Inc., department store Belk Inc. and gym operator Life Time Fitness Inc. to replace Macy’s stores. Only a handful of the planned J.C. Penney closures are expected to occur in REIT-owned malls.

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However, in this particular case, the bulls may be outnumbered, especially if some of the prominent shorts jump in the water smelling the REIT blood. The best example of precisely this is happening, is the latest note from one of the world's most vocal mega-bears, Horseman Capital's Russell Clark, who this week released a note titled "Mall Rats" focusing on, you guessed it, mall REITs:

“Intriguingly we have started to see volumes of real estate transactions for shopping malls fall. This means that the number of transactions to buy or sell properties is beginning to decline. Last time this happened, rents began to fall a year later.

His full note is below:


Shopping mall REITS have been a fantastic investment over the years. Not only have they provided investors with large capital gains, they have also typically offered above market dividend yields. My interpretation of the REIT model is that the operator collects rents from a diverse number of retailers. This is then passed on to the end investors after costs and financing. The REIT manager reduces risk by diversifying the retailers paying rent, and by also spreading the risk geographically. If the REIT manager can acquire more real estate assets at a yield higher than what it needs to pay out as dividend yield, then the REIT can issue more shares and grow indefinitely. Mall REITs have generally done well, except during the financial crisis.

However, it seems to me that North America could well have too many shopping malls. On a per capita basis, the US has twice the space of Australia and 5 times that in the UK.

One source of REITs revenue growth comes from acquiring more malls. Intriguingly we have started to see volumes of real estate transactions for shopping malls fall. This means that the number of transactions to buy or sell properties is beginning to decline. Last time this happened, rents began to fall a year later. Perhaps it’s a sign that buyers believe rents have some downside risk?

Many people in the market are aware of the problems that the large department stores in the US are currently facing, and their resultant plans to retrench. This affects two of the largest shopping mall REITs that have the department stores as tenants. The reality is that the shopping mall REITs charge extremely low rents to the department stores. The large shopping malls use the department stores to lure traffic, and then make their money from higher rents charged to speciality retailers. Often the per square foot rent of the specialty retailer can be 30 times or higher that paid by the anchor tenant. Looking at the top 2 shopping mall operators, they disclose their top rent payers. Recent share prices performance of 8 shared tenants has been poor, and management commentary has seeming implied that they may also be looking to reduce store count.

It should also be pointed out that many tenants have a clause in their lease to reduce rents should an anchor close a store. Thus, even though the loss of rent due to an anchor closing is minimal, the knock-on effect of reduced rents from the remaining tenants is a serious concern for the REITs.

One of the other problems that shopping mall REITs face is that the size that the large department stores take up is more than 400 million square feet. The largest and most successfully specialty retailer is TJ Maxx which currently has 100 million square feet. It is difficult to see any single retailer quickly being able to fill the space made vacant by department store closures.

Back in the lead up to the financial crisis we found that the share prices of REITs and their tenants were very closely related. Recently we have seen tenants share price weaken again, but REITS remain relatively strong.

Investors are advised to exercise caution with the shopping mall REITs