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3 Retail REIT Stocks Set to Escape Pandemic-Led Industry Weakness

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Store closures, retailers’ bankruptcy filings and higher e-commerce adoption, which have been further intensified by the pandemic, will continue to affect cash flows of Zacks REIT and Equity Trust - Retail constituents in the days to come.

Nevertheless, the vaccination drive and stimulus package raise hopes for this industry. Moreover, with focus on tenants from the essential retail and e-commerce resistant sectors, adaptive reuse capabilities and opportunities emanating from consolidations, Simon Property Group (SPG - Free Report) , Agree Realty Corp. (ADC - Free Report) and Urstadt Biddle Properties (UBA - Free Report) are likely to benefit.

About the Industry

The Zacks REIT and Equity Trust - Retail industry represents a group of REITs that are engaged in owning, developing, managing and renting space in a variety of retail real estates. Among these retail real estate assets are regional malls, outlet centers, grocery-anchored shopping centers as well as power centers which include big-box retailers. Furthermore, net lease REITs enjoy the ownership of freestanding properties, wherein both rent and the majority of operating expenses for the properties are borne by tenants.

What’s Shaping the Future of the REIT and Equity Trust - Retail Industry?

Store Closures, Retailer Bankruptcies Hurting Demand: Over the past few years, traffic at retail real estates have suffered with e-commerce capturing market share from the brick-and-mortar stores. This situation has been aggravated by social-distancing measures and higher e-commerce adoption due to the pandemic. Moreover, shifting business strategies of retailers to building up an online presence and shuttering of stores at unprofitable physical locations have been resulting in several store closures. Also, retailers unable to cope with competition have been filing for bankruptcies. These trends have considerably curtailed demand for the retail real estate space and raised concerns over cash flows of physical stores and landlords. Any respite in the foreseeable future is also unlikely with business restructuring to stay afloat, store closures and bankruptcies. Structurally weakening categories appear incapable of battling out pandemic blues. Therefore, an upward pressure may be created on vacancy rates that in turn would lead to a downward pressure on rents.

Downward Pressure on Rents and Collection Woes to Prevail: The current business model and economics will no longer be able to support the pre-pandemic rent levels for a number of businesses. In fact, amid high vacancy, lease transactions in the near term will likely reflect pressure on leasing spreads and concessions. Further, rent collection and deferral issues are likely to be still pronounced for landlords having exposure to non-essential retail tenants, at least in the near term. Malls and urban-core retail assets have been battered the most with occupancy declines and rent slides. As such, rent negotiations and lease restructuring pertaining to COVID-19 will prevail in the near term.

Structural Changes, Omni-Channel Strategy to Remain Key Focus: While earlier the emphasis of retail REITs was on transforming traditional retail hubs into entertainment destinations and lifestyle resorts, the focus has now shifted toward essential retail like groceries and convenience stores, and curbside pick-ups in light of the pandemic. Importantly, omni-channel will remain the focal point for retailers and physical stores will remain a vital sales channel in the long run because though there is convenience in online shopping, it cannot replace the benefits and satisfaction of visiting a brick and mortar store. Apart from serving as showrooms, physical stores also offer a convenient location for pick-up or exchange of goods. Therefore, as retailers turn more toward the omni-channel strategy for higher customer satisfaction and more loyalty, with the aim of generating higher profits, it is logical for them to not only boost their online presence but also maintain brick-and-mortar stores in best locations, raising hopes for retail REITs that focus on such locations. Moreover, as part of the omni-channel strategy, digitally-native brands too are likely to keep boosting their physical presence in the days to come. This is because opening of stores help to them to improve their connection with customers and drive expansion. Therefore, once the concerns of the pandemic end, brick-and-mortar stores will regain their popularity in delivering physical experiences apart from becoming valuable in the fulfillment of digital sales.

Repurposing and Conversions to Pick Up Pace: Importantly, the current situation is prompting adaptive reuse as well as conversions of malls into distribution hubs as these distribution centers, being situated close to the consumers of retailers, facilitate faster delivery of products as well as aid retailers in improving services, lower costs and make optimum asset utilization. Adaptive reuse includes multifamily, hotel, office and medical components and thereby constructs a mixed-use real estate destination. However, the structural changes involve huge outlay, and with continued pressure on rents and vacancy, rent collection and deferral woes, profit margins are likely to be affected in the near term.

Vaccination Drive, Macroeconomic Gains to Drive Recovery: Situations have improved compared to the onset of the pandemic and rent collections are improving. Specifically, retail properties having more exposure to essential retail businesses are well navigating the blues. However, the rate of recovery is likely to gain pace with widespread vaccinations, realization of the full impact of the fiscal stimulus and faster economic recovery. Although the initial months of the current year have posed challenges, the back half might witness some improvement with vaccines becoming widely available. This would help normal activities to resume and workers to return to offices, and go out for lunch and shopping around their work place. Moreover, retail REITs will continue benefiting from the Fed’s low-rate stance because REITs depend on debt for business. Thus, these companies benefit from lower borrowing costs in a low-rate environment. Also, with borrowing costs remaining low, credit-related retail spending usually remains strong, indicating better prospects for retail real estate landlords. However, the ones with better balance-sheet strength are likely to withstand the coronavirus blues. Further, consolidation in the industry can open up chances for the survivors to grow their market share and capitalize on the recovery.

Zacks Industry Rank Indicates Bleak Prospects

The Zacks REIT and Equity Trust - Retail industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #198, which places it at the bottom 22% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bleak near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of the negative funds from operations (FFO) per share outlook for the constituent companies in aggregate. Looking at the aggregate FFO per share estimate revisions, it appears that analysts are losing confidence in this group’s growth potential. Over the past year, the industry’s FFO per share estimate for 2021 and 2022 moved 14.5% and 2.6% south, respectively.

Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Lags on Stock Market Performance

The REIT and Equity Trust - Retail Industry has underperformed the broader Zacks Finance sector, as well as the S&P 500 composite in a year’s time.

The industry has gained 54.1% during this period compared with the S&P 500’s rally of 67.9%. During the same time frame, the broader Finance sector increased 62.6%.

One-Year Price Performance

Industry’s Current Valuation

On the basis of forward 12-month price-to-FFO (funds from operations) ratio, which is a commonly used multiple for valuing Retail REITs, we see that the industry is currently trading at 16.85X compared with the S&P 500’s forward 12-month price-to-earnings (P/E) of 22.54X. Moreover, the industry is trading below the Finance sector’s forward 12-month P/E of 17.45X. This is shown in the chart below.

Forward 12 Month Price-to-FFO (P/FFO) Ratio

Over the last five years, the industry has traded as high as 19.41X, as low as 9.68X, with a median of 14.72X.

3 Retail REIT Stocks Trying to Survive the Industry Challenges

Simon Property Group: This retail REIT is a behemoth in its industry and enjoys a portfolio of premium retail assets in the United States and abroad. Amid the choppiness in the retail real estate space, adoption of an omni-channel strategy and successful tie-ups with premium retailers have been driving the company. It is also tapping growth opportunities by assisting digital brands to enhance their brick-and-mortar presence. Additionally, Simon Property is exploring the mixed-use development option, which has gained immense popularity in recent years among those who prefer to live, work and play in the same area. Moreover, solid balance-sheet strength and available capital resources, Simon Property Group looks poised to remain afloat and bank on opportunities emanating from market dislocations.

Simon Property Group currently carries a Zacks Rank #3 (Hold). Over the past month, the Zacks Consensus Estimate for FFO per share for 2021 witnessed upward revision of nearly 1% to $9.66, reflecting analysts’ bullish outlook. The stock has also rallied 33.5% over the past three months.

  You can see the complete list of today’s Zacks #1 Rank stocks here.

Agree Realty Corporation: This retail REIT is based in Bloomfield Hills, MI, and is into acquisition and development of properties net leased to industry-leading retail tenants in e-commerce and recession resistant sectors. The Zacks #3 Ranked company received February rent payments from more than 99% of its portfolio as of Mar 1, 2021. Encouragingly, February was the sixth consecutive month that the company received at least 99% of all contractual monthly rental obligations. Further, its 2021 guidance for acquisition volume ranges from $800 million to $1.0 billion of high-quality retail net lease properties.

The Zacks Consensus Estimate for this year’s FFO per share has been revised marginally upward to $3.47 over the past week, indicating a year-on-year improvement of 7.4%.The stock has appreciated 17.8% over the past year.

Urstadt Biddle Properties Inc.: This REIT owns or has equity interests in 81 properties containing approximately 5.2 million square feet of space. Their core properties consist principally of community shopping centers located in the northeast. The company enjoys concentration on quality suburban markets outside New York City. In fact, it has emerged as a well known grocery anchored shopping center REIT in the suburban NY Metro Area. Suburban revival due to the pandemic is benefitting its communities. It has a strong tenant base with focus on grocery anchored & Internet resistant tenants. It has paid 204 consecutive quarters of uninterrupted dividends to its shareholders since its inception. Urstadt Biddle currently carries a Zacks Rank of 2 (Buy).

Over the past week, the Zacks Consensus Estimate for FFO per share for fiscal 2021 witnessed upward revisions of 3.1%, calling for an 11.8% increase year on year. The stock has also rallied 24.2% over the past three months.

Note: Funds from operations (FFO) is a widely used metric to gauge the performance of REITs rather than net income as it indicates cash flow from their operations. FFO is obtained after adding depreciation and amortization to earnings and subtracting the gains on sales.

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