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 ownership of freestanding properties, wherein both rent and majority of operating expenses for the property are borne by the tenant.
Some of the prominent players in this industry are Simon Property Group (SPG - Free Report) , Federal Realty Investment Trust (FRT - Free Report) and Kimco Realty Corporation (KIM - Free Report) .
Let’s take a look at the industry’s three major themes:
Store Closures, Retailer Bankruptcies Hurting Demand: Mall traffic continues to suffer with e-commerce gaining market share from the brick-and-mortar stores, and store closures and retailer bankruptcies becoming rampant. This has raised concerns over the fate of cash flows of physical stores and landlords as the trend is considerably curtailing demand for the retail real estate space. Also, there is likely to be no respite in the near term as the tepid environment might prevail with dwindling footfall at retail properties amid social-distancing mandates and higher e-commerce adoption due to the coronavirus crisis. Even with an economic recovery, rightsizing of stores and retailers’ bankruptcies will prevail. Moreover, the current business model and economics will no longer be able to support the pre-pandemic rent levels for a number of businesses. Rent collection and deferral issues are likely to be more pronounced for landlords having exposure to non-essential retail tenants. As such, leasing activity is likely to be limited and these will also result in tenants demanding substantial lease concessions.
Structural Changes, Omni-Channel Strategy to Continue: Retail REITs will continue with the transformation measures. Retail landlords were earlier focusing on transforming traditional retail hubs into entertainment destinations and lifestyle resorts. However, the focus has now shifted more toward essential retail and curbside pick-ups in light of the pandemic. Omni-channel will keep being the focal point for retailers. Also, implementation of innovative touchless technology on everything from entrances to order fulfilment will gain traction and provide a competitive edge. The situation has also opened up scope for mall-based distribution hubs as these distribution centers, being situated close to the customers of the retailers, facilitate faster delivery of products as well as aid retailers in improving services, lower costs and make optimum asset utilization. Apart from these, focus on mixed-use development is anticipated to continue, which has gained immense popularity, of late. However, the structural changes involve huge outlay and with continuation of rent collection and deferral woes, profit margins are likely to be affected in the near term.
Reopening of Stores to Improve Rent Collection: Nevertheless, the reopening of the retail sector in several parts of the nation has come as a relief. This is because, with more reopening of stores, tenants stand in a better position to generate revenues and meet their rent payments. Thus, the pressure on retail landlords is likely to reduce and their rent collection figures are expected to improve. Particularly, retail properties having more exposure to essential retail business are well poised to record better cash flows. Apart from these, the reduction in development and redevelopment spending, capital raises through debt offerings together, suspension of dividends and other balance-sheet strengthening efforts are likely to keep supporting the liquidity position of retail REITs.
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 2020 and 2021 moved down 12.9% and 2.8%, 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 declined 21.8% during this period compared with the S&P 500’s rally of 7.5%. During the same time frame, the broader Finance sector has lost 13%.
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 12.29X compared with the S&P 500’s forward 12-month price-to-earnings (P/E) of 21.88X. Moreover, the industry is trading below the Finance sector’s forward 12-month P/E of 16.40X. 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 19.44X, as low as 9.72X, with a median of 14.81X.
In a nutshell, concerns regarding cash flows of retail landlords amid the declining traffic, store closures and retailer bankruptcy filings will prevail in the days to come. However, the reopening of the economy is bringing some confidence back into the retail REIT stocks.
Currently, there are no stocks with a Zacks Rank # 1 (Strong Buy) or 2 (Buy). Nevertheless, as REITs strive to bring their mojo back, we handpick three stocks from the industry carrying a Zacks Rank of 3 (Hold) to watch for.
Agree Realty Corporation (ADC - Free Report) : 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 addition, per the company’s latest press release, as of Jun 22, 2020, the company collected rental receipts from 88% of its portfolio for June. Rent collections for April and May amounted to 91% and 88% of the total portfolio, respectively. The current-year FFO per share consensus estimate of $3.12 indicates an increase of 1.3% year over year. Revenues are expected to grow nearly 23% year on year to $230.5 million in the ongoing year.
Realty Income Corporation (O - Free Report) : The REIT is engaged in the acquisition and management of freestanding commercial properties that generate rental revenues under long-term net lease agreements. High dependence on tenants belonging to service, non-discretionary and low-price retail businesses, which are less susceptible to economic recessions and competition from Internet retailing, provide stable rental revenues. Along with its well-known commercial tenants, investors might love the fact that the firm pays a monthly dividend. Realty Income’s ongoing-year FFO per share consensus estimate of $3.39 suggests a year-over-year increase of 2.1%. Revenues are expected to be up 12.1% year on year to $1.67 billion in 2020.
Regency Centers Corporation (REG - Free Report) : This Jacksonville, FL-based retail REIT is into ownership, operation and development of open-air shopping centers positioned in prosperous and densely populated trade areas. The exposure to shopping centers, with significant grocery component, is driving traffic at the company’s properties amid the pandemic-led choppy retail environment. The consensus estimate of $3.43 for 2020 FFO per share has been unrevised over the past week.
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.