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On May 17, we downgraded our long-term recommendation on the retail real estate investment trust, Simon Property Group Inc. (SPG - Analyst Report), to Neutral from Outperform. The recommendation was lowered to reflect the gradual fall in consumer spending leading to pressure on revenue growth in the near term.

Why the Downgrade?

Though Simon Property beat the Zacks Consensus Estimate on revenues and FFO (funds from operations) in the first quarter of 2013, we anticipate the current unsettled economic environment to remain a cause of concern in the near term. At such times consumers become cautious and their spending decreases. This affects the sales volume of retailers, which in turn, weighs upon rent increment. Moreover, tenant bankruptcy increases leading to a fall in occupancy.

Further, Simon Property’s significant development pipeline increases the operational risks in the current unsettled market, exposing the company to rising construction costs, entitlement delays, and lease-up risks. In addition, excess retail space in a number of its markets and the rise in consumer purchases through catalogs and the Internet could hurt the demand for its properties.

However, Simon Property’s geographic and product diversity provides a significant competitive edge. Also, the company has a strong balance sheet with adequate liquidity.  Yet we believe that these positives have already been factored at the current valuation.

Nevertheless, Simon Property’s first-quarter 2013 FFO beat the Zacks Consensus Estimate by an average surprise of 1.99%. The results were primarily driven by an increase in overage revenues and occupancy. Additionally, rise in tenant sales per square foot was the other highlights.

Moreover, following the release of first-quarter results, the Zacks Consensus Estimate for 2013 marginally moved up (by 0.3%) to $8.61 per share. The Zacks Consensus Estimate for 2014 has, however, nudged up nearly 0.9% to $9.33 per share. The stock now has a Zacks Rank #3 (Hold).

Stocks That Warrant a Look

Better performing REITs include Macerich Co. (MAC - Analyst Report), Equity One Inc (EQY - Snapshot Report) and Kite Realty Group Trust (KRG - Snapshot Report), all of which carry a Zacks Rank #2 (Buy).

Note: FFO, a widely accepted and reported measure of the performance of REITs is derived by adding depreciation, amortization and other non-cash expenses to net income.

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