Real estate experts continue to warn and worry about the distressed values in the commercial property market. Overbuilding during the easy-money days before the credit crunch and the Great Recession's upward push on vacancy rates have sparked a rash of dire outlooks both for the commercial real estate sector and the broader U.S. economy.
But that hasn't stopped shares of real estate investment trusts (REITs) from rallying strongly since their lows in March 2009. A group that has been stellar performers are the REITs that own mall properties, such as Simon Property Group (SPG), which develops and manages retail real estate, primarily regional malls, outlet centers and community shopping areas.
One of the world's largest owners of shopping centers, Simon is now highly favored by some investors who see it as the big winner in the commercial property market. And Wall Street is starting to be upbeat on Simon, whose stock has jumped to $84.47 a share on April 1, from $69 on Feb. 4. It had plunged to a 52-week low of $29 on Mar. 30, 2009.
Trading Below Its Replacement Cost
Mall REITs as a group have climbed an average 15.8% since February, helped in part by the bidding war for the ailing General Growth Properties (GGP), which filed for bankruptcy court protection in April 2009, making it the largest real estate bankruptcy in the U.S. Simon offered to buy General Growth on Feb. 16, 2010, and since then, Simon, which owns or holds an interest in 321 income-producing properties in 41 states and Puerto Rico, has bounced up more than 8%.
"With its vast property assets, robust cash flow and strong balance sheet, with cash of about $4.3 billion, Simon continues to trade below its replacement cost – a vital metric in valuing a real estate company," says Jeung S. Hyun, a principal and portfolio manager at Adelante Capital Management, which owns shares. Adelante is a boutique investment manager that specializes in real estate securities.
The best way to invest in REITs, says Hyun, is to select companies trading at or below the private market value of their underlying real estate assets. Simon is one of the best operators in the industry, he adds, which showed its mettle and foresight by managing to scale back its leverage, or debt burden, to its lowest level as the econony tumbled into recession last year.
Tug of War for General Growth
Simon and Brookfield Asset Management are the major competitors in bidding for General Growth. If Simon ends up acquiring General Growth, it would combine the two largest regional mall operators in the U.S. -- which should significantly boost Simon's worth, says Hyun. Analysts figure that with General Growth's real estate assets, Simon would capture some 30% of the mall business.
Simon has offered $10 billion for General Growth, which has rejected the offer as too low. To thwart Simon's bid, General Growth announced plans to split itself in two and remain independent. It wouild would allow Brookfield to invest $2.6 billion to become its biggest shareholder. So far, no one is sure how the situation will end.
Analyst Robert McMillan of Standard & Poor's reiterated his strong-buy recommendation on Simon on Mar. 26 and raised his 12-month target for the stock to $99 a share from $87. "We believe the recent strength in retail sales suggests that retailer sentiment will improve further, bolstering increased demand for new as well as existing space in Simon's shopping center portfolio," says McMillan.
He forecasts Simon will post funds from operations of $5.76 a share for 2010 and $6.11 for 2011, reflecting his expectations of better occupancy and pricing trends over the next 12 to 18 months. "Simon's established relationships with numerous retailers will allow Simon to continue to generate solid growth over the long term," says McMillan. The giant retailer Gap (GPS) is Simon's largest tenant, accounting for 2.9% of its annual rental revenues.
Generally Considered Toxic
Analyst Carol L. Kemple of investment firm Morgan Joseph figures that when retailers start expanding again and open more stores, they'll want to be in Simon's "class A" malls and should be willing to pay more to be where the most shopping traffic is. Kemple notes that Simon's top 10 tenants account for 13.5% of its total yearly rental revenues. The analyst rates Simon as a long-term buy.
In a way, Simon is one of the most attractive asset plays in an industry where properties are generally regarded as toxic. But Jeffrey Spector, analyst at Bank of America Merrill Lynch says Simon's diversified portfolio has consistently generated above-average growth and operating cash flow. "In addition, Simon's management and balance sheet are among the best in the industry," says Spector, who rates the stock a buy. Although he remains cautious on the retail outlook through 2010, Spector says Simon's "outlet-center business continues to be robust, providing operating flexibility and growth opportunities."
Although Wall Street remains down on real estate and housing, it isn't much worried about Simon. Eleven of the 22 analysts who track it recommend buying the stock, with only one advocating a sell, and six rating it a hold.
Some Big Buyers
It's understandable that a large number of big institutional investors sold shares and took profits as of Dec. 31, 2009, since the stock had made a big leap by then from its lows in March 2009. They, of course, missed the stock's further upswing since February.
However, some big investors bought more shares as of Dec. 31, 2009, including Vanguard Group, Simon's largest stakeholder with 8.35%, which purchased 799,060 shares; Goldman Sachs Group, which acquired 1.98 million shares that upped its stake to 2%; and Heitman Real Estate, which bought 2.78 million shares, pulling up its ownership to 1.9%.
For investors who believe that housing and real estate have seen their lows, and that the economic recovery is gaining traction, a bet on Simon Property's continued upward mobility may be a way to shelter against possible headwinds.
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