By Justin Spittler
A new real estate crisis has begun.
You might find that hard to believe. After all, the government put out all sorts of laws and regulations after the last housing crisis. These measures were supposed to protect us from a repeat of the 2008–2009 financial crisis.
Plus, U.S. housing prices are rising, not falling.
But I’m not talking about the housing market. I’m talking about retail real estate.
On Friday, I told you about a major crisis that’s ripping traditional retailers to pieces.
To recap, Americans aren’t spending money like they did in the old days. They’re going to malls and department stores less often. They’re doing more shopping online.
This is obviously bad news for retail and apparel companies. It’s also killing companies that own and operate retail real estate.
I’ll explain why in today’s Dispatch. I’ll also tell you what real estate stocks to avoid at all costs.
But first, you need to understand why this key pillar of the real estate market is toppling over…
• The United States has too much retail space…
Look at the chart below.
It shows the amount of retail space per person in the United States and six other major countries.
You can see that the U.S. has twice as much retail space per person as Australia. It has more than four times as much retail space as the United Kingdom.
This wouldn’t be a problem if demand for retail space was high. But it’s not. In fact, it’s plummeting.
• America’s biggest retailers are closing stores by the thousands…
As we told you on Friday, U.S. retailers have already announced plans to close 1,500 stores this year.
Major department stores are a big reason for this…
Macy’s, the largest U.S. department store, has plans to close 68 stores.
J.C. Penney, another major department store, plans to shut down 130 to 140 stores in the coming months. Meanwhile, iconic American retailer Sears wants to close 150 stores.
This is a major problem.
• Department stores are what real estate professionals like to call “anchors”…
They occupy more space than any other tenant. They account for a huge chunk of a mall’s rental income. And they drive foot traffic.
In short, department stores are by far a mall’s most important tenants. And they’re very hard to replace if they walk.
This shouldn’t come as a surprise. After all, how many companies need 100,000 square feet of space or multiple floors?
The answer is: not many.
If a mall loses department store tenants, foot traffic could fall off a cliff. Vacancy levels could skyrocket. Rental rates could plunge across the mall.
In other words, losing an anchor tenant is about the worst thing that can happen to a mall.
Just look at what this mall in Richmond, Virginia did when its Macy’s shut down.
The owner built a wall where the store entrance used to be…
And put in a damn vending machine.
• If this trend doesn’t reverse soon, hundreds of U.S. malls will close their doors…
But don’t just take my word for it.
Just look at this chart from Green Street Advisors, a leading real estate research firm.
It shows the number of malls in the United States, ranked by financial strength. The strongest malls are rated A++. The weakest ones are rated D.
Below, you can see that 334 malls are “at high risk of closing.” That’s about a third of the nation’s malls.
• Investors haven’t been taking this threat seriously…
Just look at the chart below.
It shows the performance of the Bloomberg REIT Regional Mall Index since 2007. This index tracks REITs that own and operate malls.
(REIT stands for real estate investment trust. These assets allow everyday investors to invest in large real estate projects. They trade on major exchanges like stocks.)
You can see that Bloomberg’s mall index surged 936% between March 2009 and August 2016. That’s more than four times the S&P 500’s gain over the same period.
Investors dove headfirst into this risky sector for a simple reason.
They’re hungry for income… and REITs pay fat dividends.
According to REIT.com, the average REIT yields 4%. Meanwhile, the S&P 500 yields just 1.9%.
For years, investors ignored the problems in the retail real estate market. But they can no longer ignore those problems.
Since August, the Bloomberg Mall Index has plummeted 27%.
That’s a huge decline for such a short period. But mall REITs are likely headed much lower in the coming months. Some will never bounce back.
• If you own REITs for income, look under their hoods…
Find out if they own malls.
If they do, make sure those properties are high-quality. Steer clear of REITs that own C- and D-rated malls.
Some companies might not disclose this information. But most REITs will say where their properties are located.
Avoid REITs that own retail property in second- or third-tier markets. Malls in these weaker markets are especially vulnerable.
It should only take you a few minutes to perform this research. But this simple step could save you from catastrophic losses in the years to come.
Chart of the Day: The World’s Biggest REIT Is in Free Fall
The world’s biggest REIT is in trouble.
Today’s chart shows the performance of Simon Property Group (SPG). Simon owns or has an ownership interest in 190 million square feet of mall floor space.
You can see its stock has plunged 26% since August. It’s now trading at its lowest level since October 2014.
This is a major warning sign. It tells us the retail crisis is hitting even the most dominant real estate companies on the planet. Keep this in mind if you own any REITs for income.
Delray Beach, Florida
March 13, 2017
We want to hear from you.
If you have a question or comment, please send it to [email protected]. We read every email that comes in, and we'll publish comments, questions, and answers that we think other readers will find useful.