Brick and mortar retail stores were already undergoing a paradigm shift before the coronavirus pandemic. And with some stores only now beginning to open, while others are potentially facing a second shutdown, the future looks uncertain as cases spike across the country. As a result, mall REITs are facing cash-flow pressures, which are being exacerbated by lower near-term rent collections and the potentially long-lasting impacts of the pandemic on the economy.
Mall REIT property-level fundamentals will remain under pressure from accelerating apparel retailer and department store closures and bankruptcies. Consumers will likely remain wary of visiting enclosed retail establishments, even as social distancing requirements are relaxed, which will present challenges to mall REIT portfolio tenants trying to reopen and restart their physical stores.
April rent collection rates for enclosed mall assets were the lowest of all retail property types, falling to roughly 20 percent to 30 percent. Strip and open-air shopping centers collected about 50 percent to 60 percent of rents, while free-standing locations saw 70 percent or higher in rent collections.
Retail REITs generally have sufficient liquidity to manage through a short period of interrupted rent payments, but the effects of rising vacancy and the anticipated lower-level reset of rental rates will add further strain to mall REITs that have been navigating well through rising capital expense needs and a weakened competitive position.
Lower-tier mall portfolios are at greater risk because of their outsized exposure to struggling anchor and inline tenants. Anchor tenant store closures could spur a wide swath of co-tenancy clause activations, indicating further downside cash flow risk. Capital access for these REITs has evaporated at a critical juncture that requires substantial and sustained investment in mall assets in order to survive.
The high-yield default rate for real estate rose to over 12 percent in 2009, due in part to the bankruptcy filing of General Growth Properties. But the real estate sector has not had any defaults since 2010. Fitch’s 2020 high-yield default rate forecast for real estate is 3 percent, compared with the overall 5 percent to 6 percent expectations.
The coronavirus pandemic is amplifying and accelerating the existential challenges that will reshape the mall sector landscape over the coming decade. Class A malls with higher sales productivity that can transition to entertainment-oriented, mixed-use properties have better medium- and longer-term prospects, but will nevertheless face near-term cash flow pressure. Lower productivity class B and C malls will likely struggle with declining occupancies and cash flows—in some cases for many years—until conversion to an alternate, higher and better use becomes feasible.
Stephen Boyd, CFA, is a senior director in Fitch Ratings’ Corporates group.