VNQ - Tanger Factory Outlet: 5 Reasons Why You Should Sell This REIT

Summary

• Tanger Factory Outlet Centers is a very popular REIT on Seeking Alpha.
• But I actually think that it is one of the least attractive at the moment.
• I explain 5 reasons why and present a better alternative.

Tanger Factory Outlet ( SKT ) is one of the most popular REITs ( VNQ ) among individual investors and it is easy to understand why:

• It owns outlet centers that you might have visited.
• It pays a generous 5% dividend yield.
• It is priced at a relatively low valuation of just 10x FFO.
• It has an investment-grade-rated balance sheet.
• And it is growing rapidly right now as we emerge from the pandemic.

But despite all of that, I am not buying it and I think that it is actually one of the least attractive REITs in today's market.

Here are 5 reasons why:

Reason #1: Outlet Centers are Losing in Appeal

I fear that outlet centers as a retail concept have the most to lose in the coming decade.

The growth of e-commerce companies like Amazon ( AMZN ) and discount retailers like TJ Maxx ( TJX ) present a particularly significant thread to outlet centers because:

• They are located in more remote locations where people have to drive to.
• They focus very heavily on fashion.
• Their layouts are difficult to adapt to other uses such as entertainment, services, and other non-retail uses.

So far, people were willing to drive 30 minutes to get to the nearest outlet center because they could get better deals, but this 30-minute drive is becoming longer and longer in the day and age of same-day delivery.

Now you can get comparable deals online and so competing just on prices isn't enough anymore.

Convenience is becoming increasingly important and retailers like TJ Maxx understand that. They are replicating the "treasure hunt" feeling that you get at outlets and they are bringing it closer to you to provide more convenience.

This is a big problem for outlets... and it is already reflected in SKT's results.

Its outlets saw their sales per square foot drop quite significantly in real terms in 2022, despite the fact that it was still benefiting from the recovery of the pandemic.

On the other hand, the class A malls of Simon Property Group ( SPG ) actually grew their sales per square foot by 14% in 2022 and reached new all-time highs.

This shows you that there is a growing divergence in performance between outlet centers and Class A malls.

Class A malls are doing a lot better because they are better located and their layouts are more flexible, which allows them to adapt to this changing world. Today, malls are not just shopping destinations anymore. They are becoming mixed-use destinations with lots of entertainment, services, and even non-retail uses such as WeWork ( WE ) co-working offices and this is what allows them to thrive even despite the growth of Amazon, TJ Maxx, and others.

Outlet centers need to adapt, but they are having a harder time because of their unique layouts and worse locations.

Reason #2: Significant Near-Term Lease Expirations

We are approaching a recession, potentially a severe one, and SKT has more than half of its leases expiring in the next 3 years:

If the sales at its properties were growing rapidly, I would feel confident about releasing prospects. But given that its properties struggled to grow sales in real terms in a good market, I fear that sales could deteriorate as times get tough, potentially leading to rent cuts and lower occupancy.

Reason #3: It is Just Short of Losing Its Investment Grade Status

SKT's troubles began already before the pandemic. Outlet centers have felt the growing competition of online and discount retailers for a while already.

Then came the pandemic and this caused SKT's balance sheet to deteriorate quite a bit.

Its credit rating has already been downgraded and today, it is just shy of losing its investment grade rating.

It has a BBB- rating, which is just above junk.

Reason #4: Rising Interest Rates

I think that most REITs aren't materially impacted by rising interest rates.

That's because they use little debt and have long debt maturities.

SKT's balance sheet is also quite good in that sense. It has no major maturities until 2026 and by then, interest rates will likely have dropped lower.

But SKT is exposed to rising interest rates in two different ways.

Firstly, many of its tenants are overleveraged retailers that were having difficulties already prior to the historic surge in interest rates. It could lead to more lease defaults, especially if we go into a recession.

Secondly, it will make any potential external growth projects less feasible. Historically, SKT has achieved a lot of its growth by building new outlet centers, but with interest rates where they are today, developing new properties will be a lot riskier and less lucrative.

Reason #5: More Expensive Than Higher-Quality Peer

Finally, and perhaps most importantly, SKT is today priced at a higher valuation than Simon Property Group ( SPG ), which makes no sense given that SPG is actually a higher-quality company.

We think that it should be the opposite. SPG should trade at a large premium relative to SKT because:

• It owns Class A malls that are doing far better than outlet centers.
• It has a much stronger A-rated balance sheet.
• It has better growth prospects and it is more resilient to the growth of Amazon.

So here you need to ask yourself:

I think that SPG offers far better risk-to-reward and so that's what we have decided to buy at High Yield Landlord.

Bottom Line

I would sell SKT if I owned it today.

Real estate is all about location... location... location, and outlet centers happen to be poorly located (relatively speaking) and will have a hard time adapting due to their unique layouts.

In the near term, we could also face a severe recession and more than half of its leases will expire in the coming years.

SKT is also at risk of seeing its credit rating downgraded to junk, and its tenants are particularly heavily impacted by the rising interest rates.

Finally, SKT is more expensive than its higher-quality peer.

With that in mind, I see no reason for owning SKT.

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