UNITED STATES

US fund managers are betting on high-end malls

Operator Simon Property is top holding in 53 of 71 real estate funds tracked by Lipper as Class A malls defy rise of online retailers

PUBLISHED : Wednesday, 20 May, 2015, 6:00am
UPDATED : Wednesday, 20 May, 2015, 6:00am

Even as the rise of online retailers leads analysts to predict the eventual death of the American shopping mall, real estate fund managers are betting some will prosper - if they can lure the right kind of consumer.

Simon Property Group, the largest high-end mall operator in the country with properties including the Stanford Shopping Centre in Palo Alto, California, and Philadelphia's King of Prussia Mall, is the top holding in 53 of the 71 US real estate funds tracked by Lipper.

The average real estate fund devotes 8.8 per cent of its portfolio to Simon Property, a bigger average bet than the 7.6 per cent that technology funds invest in Apple and almost one percentage point more than the weight of Simon Property in the benchmark S&P US reit index.

Still a symbol of a car-based, middle-class suburban America, shopping malls are increasingly seen as viable only if they attract the affluent.

Fund managers are bullish on so-called Class A malls, anchored by department stores like Bloomingdale's and featuring retailers like Apple, reflecting how better-off consumers have thrived since the end of the financial crisis while middle and lower-income consumers have struggled.

"Class A malls are repositioning themselves to be destinations, with more restaurants, which is making them more resilient to what's going on with the internet," said Rick Romano, a portfolio manager of the US$3.8 billion Prudential Global Real Estate fund, who holds 4.5 per cent of his portfolio in Simon Property, his top holding.

Class A malls were also the only shopping centres able to attract an Apple store, which can post annual sales of more than US$5,000 a square foot - the highest of any US retailer - and boost sales growth for other retailers throughout the mall, Romano said.

As a result, Simon Property has been able to post rent increases of 18.9 per cent for new leases over the past 12 months, according to Paul Morgan, an analyst at MLV & Co.

Simon Property's average rent per square foot - which includes ongoing and new leases - rose 4.5 per cent in the first quarter compared with the year before, or about six times the 0.8 per cent pace of inflation in the country.

Bloomingdale's is the most frequent anchor store at the highest-rated malls in the country, followed by Nordstrom.

What that attempt signifies is that high-quality malls are irreplaceable: difficult to build and difficult to buy
Jason Ko, co-portfolio manager, JP Morgan Realty Income fund

Those Americans in the top 20 per cent of income - or Class A mall shoppers - have seen their household assets jump from about US$15 trillion in 2010 to US$25 trillion last year, according to Green Street Advisors.

Household assets for Class B and lower mall customers rose from about US$7 trillion in 2010 to a little over US$10 trillion last year.

Class B malls are often saddled with struggling department stores such as Sears or JC Penney as anchors, making them less attractive to prospective tenants. Some 24 such malls have closed since 2010, and an additional 60 are on the brink of closure, according to Green Street Advisors.

No reit fund holds Class B or lower mall operators as their largest holding, according to Lipper. JC Penney and Sears are the most frequent anchor stores at Class C and lower malls, according to Green Street.

There are about 1,000 enclosed shopping malls in the country. Foot traffic at malls during the November and December holiday shopping season fell from about 35 billion visits in 2010 to 17.6 billion in 2013, according to an October Cushman and Wakefield report.

Online commerce now accounts for 15 per cent of retail sales - just 5 percentage points less than the percentage of retail sales that come from malls and gaining, according to a report from Green Street Advisors.

Investor demand for high-end malls would rise even if consumer spending overall flattened or started to slow, said Jason Ko, a co-portfolio manager of the US$2.1 billion JP Morgan Realty Income fund, who has 7.8 per cent of his portfolio in Simon Property, his largest position.

They have the largest portfolio of blue-chip tenants, and that's something their competitors have not been able to replicate
Ian Goltra, Forward Funds

Macerich, the third-largest mall owner in the country, rejected a US$16.8 billion takeover offer from Simon Property on April 1, a merger that would give Simon Property an even larger hold of the high-end mall market.

Simon Property was not expected to come back with a higher offer, analysts and fund managers said.

"What that attempt signifies is that high-quality malls are irreplaceable: difficult to build and difficult to buy," Ko said.

Shares of Simon Property are down 5.5 per cent since Macerich rejected its takeover offer, while shares of Macerich have fallen 2.2 per cent over the same time. Over the past 12 months, shares of Simon are up 5.7 per cent, or about 2 percentage points less than the 7.9 per cent gain in the benchmark index.

Simon shares closed on Monday at US$184.78, compared with the average target price of US$217.05 among analysts tracked by Thomson Reuters.

Class B malls, meanwhile, will not only feel the effects of sales declines at JC Penney and Sears, but will see increased competition from so-called power centres - suburban developments that were often next to a major highway and included a Home Depot or Best Buy alongside a traditional strip mall, said Ian Goltra, of Forward Funds.

Goltra has several short positions for Class B mall operators in his funds, yet expects shares of Simon Property to rise, even with its high percentage of fund ownership. He has been adding shares of Simon Property as it has traded in the US$180s, down from a high of US$205.31 on January 28.

"They have the largest portfolio of blue-chip tenants, and that's something their competitors have not been able to replicate," he said.

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