Mall REITs - Under Threat From The Lockdown Flight To Online Shopping

Summary

• Clearly, online retail taking a larger share of total retail spend is bad news for REITs that specialise in mall real estate.
• We see this very clearly in the U.K. The question is, how far might it go in the U.S?
• The answer is that the U.K. has gone twice as far as the U.S already - so there could be a lot of pain still in store.

What kills malls

What kills the current technology for doing anything at all is the widespread adoption of newer and different one to do the same thing. Well, there's an insight you'd never have been able to come up with, eh?

But taking this slightly seriously, we've had within living memory two such big changes in retail technology. Back a century and more we had a third, the Sears catalogue and the idea that retail prices were retail prices - the store sells at the one price, not what they think this particular customer might be willing to pay.

The two recent ones are that move from High Steet (but that's English English, Main Street in American) stores to out of town and Big Box retail. This pretty much killed off the centre of town mixed shopping area where people bought things that were actually needed. Some of those areas still exist selling candles and the like, but significant volumes of retail are now in those out of town shopping precincts and malls.

Except for the bit that has moved on to the next tech, online shopping. The question becomes well, how far is this going to go? Our interest is in what is the property valuation going to be for those who own those out of town properties and real estate?

The British experience

I've talked about this several times before here. One example, another. The basic point being that the retail estate was built to the size of handline 100% of retail spending. OK, not exactly, there's always been some mail order, but close enough. Now, some portion of that retail spending isn't running through the retail estate. That's great for companies like Tritax Big Box (BBOX:LN) who build the warehouses to service the new retail methods, but that's not what interests today.

Rather, we're seeing that those who own the malls and out of town shopping centres of today are having their knees cut out from underneath them. Intu (OTCPK:CCRGF) for example, although there are others. Entirely decent management, the business plan was fine, but that change in habits killed the assumptions being worked to. Gearing and asset valuation falls mean that Intu, as the one example, is on its last legs at very best.

Everything in an economy happens at the margin. It's not necessary for oil demand to stop to change the price, it just has to fall. It's not necessary for malls to have no paying tenants for the value to fall to near or actually zero - just fewer paying tenants than will cover the running and financing costs.

The UK, roughly and around and about, has 20% of all retail sales happening online. It also has about 20% of retail space empty. That's enough to be causing these serious financial problems for the real estate owners.

So, what about the US?

This is something that surprises me:

(Ecommerce as a percentage of retail sales from Tamebay)

Those are slightly old figures, 2018, and we'll get to up to date ones in a moment.

But this does surprise. That the UK is so far along the road as compared to the US.

More up to date figures

We have those from the sales figures. For the UK:

Online sales as a proportion of all retailing reached a record high of 22.3% in March 2020 as consumers switched to online purchasing following the pandemic.

OK, pandemic affected and all that but it was around 20% before that. And for the US:

The first quarter 2020 e-commerce estimate increased 14.5 percent (±1.8%) from the first quarter of 2019 while total retail sales increased 2.8 percent (±0.4%) in the same period. E-commerce sales in the first quarter of 2020 accounted for 11.5 percent of total sales.

OK, growing fast and there's some difference between those two US estimates. But it's clear that the US is behind the UK in this eating of retail by online.

Quite why, well, that surprises. Having lived in both countries - lived, not just visited - it might be that the move from Main Street happened earlier in the US so more of total sales are in the out of town and mall sites. Sales being more difficult to disrupt there. But that's only a speculation.

The actual point here

The US has less ecommerce penetration than the UK. There's a level of ecommerce penetration that causes significant to terminal pain to the real estate companies that own the retail estate. The UK has definitely passed this; the US, perhaps not yet.

My view

I'm a big believer in trying to learn the lessons the world is trying to tell us. And here, I think it's that yep, we're in the middle of a technological change. That's going to make redundant some portion of the infrastructure required by the older method. We would expect online eating retail sales to impact upon retail real estate values. My argument here is that the UK has gone through that event horizon, and I'm not sure that the US has. Or to be more accurate, the US hasn't yet in those prime properties that have been so hit in the UK. There's an awful lot of pain already in second and third tier properties.

The investor view

I am therefore hugely suspicious of the entire sector. The whole REITs based upon retail property thing. Just because I think that what has happened in the UK is going to happen in the US. There's a level of online shopping that is just an irritant, there's one that becomes finances threatening. The UK's already passed the line into that second and I worry that the US is about to.

Please note these stocks are just examples of my point, they are not either the only stocks nor do I say these will specifically be impacted. But Simon Property (NYSE:SPG), Macerich (NYSE:MAC), Washington Prime, these are the sorts of companies in the sector I would be worrying about.

They're all obviously depressed at present as a result of the lockdown, and I expect that lockdown to accelerate the retail shake out in favour of online as well. They're also, for the moment, good income stocks. But over the next few years I'd be worrying about significant capital impacts.

No, this isn't to say to sell and certainly not to short. Rather, such good income generating stocks are no longer to be left in the back portfolio to carry on sending out dividends. Positions, holdings, are going to need to be actively managed by us investors. For there is the possibility that companies in this sector will fall off the cliff, as Intu has done in the UK and for the same reasons.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.