2023-12-26 15:19:44 ET
Summary
- Simon is a commercial real estate giant founded in 1960, known for developing and managing retail properties.
- The common shares appear fairly valued, leaving no margin of safety or potential for outsized appreciation, and get a Hold rating.
- The Series J preferreds are trading for a YTC ~60bps tighter than the US5Yr, and a dividend yield spread to the US5Yr ~100bps tighter than the 19-year average, implying ~13% downside.
Summary
Simon Property Group ( SPG ) is one of the world's largest retail REITs with ~165MM sq ft of proportionate GLA, the vast majority in the US. Recent performance has been strong, aided by the impacts of an undersupplied market. This report analyses the common and preferred stock, concluding that neither is attractive for us today based on valuation.
History
Simon, an American commercial real estate giant, was founded in 1960 by brothers Herbert and Melvin Simon. Initially focused on developing and managing retail properties in the Midwest, the company experienced significant growth throughout the 1980s, expanding its portfolio across the United States. This expansion was further propelled when the company went public in 1993, a move that allowed it to raise capital for further development and acquisitions. One of its major acquisitions was Corporate Property Investors in 1998, which added a substantial number of malls to its portfolio.
Entering the 21st century, Simon continued to grow, emphasizing upscale shopping centers and premium outlets. Although the 2007-2008 financial crisis posed challenges, the company navigated these successfully. The 2010s marked a period of international expansion for Simon, as it began acquiring and developing properties in Europe, Asia, and Mexico.
In recent years, Simon has been adapting to the digital era and the rise of e-commerce by integrating digital strategies into its malls. This shift became even more crucial during the COVID-19 pandemic, which severely impacted retail and prompted Simon to focus more on mixed-use developments.
Today, Simon stands as one of the largest REITs in the world. It is renowned for owning, developing, and managing a diverse array of properties, including malls, premium outlets, and lifestyle centers. Under the leadership of David Simon, son of co-founder Melvin Simon, the company has been a leader in transforming the traditional shopping experience.
It has distributed over $40Bn in dividends and produced a total return of more than 2,900%, or a compound annual return in excess of 12%, outperforming the S&P 500.
Portfolio Snapshot
Simon owns interests in 254 retail properties, 215 of which are located in the US, and 24 of which are owned through its 84% non-controlling interest in the Taubman Realty Group ("TRG").
The size, geographic diversification, and complex ownership structure of many of its assets make a comprehensive understanding of the portfolio difficult. To the extent possible, we have tried to present key metrics and our valuation on a proportionate ("prop") basis (i.e., what income and/or value do you have a claim to as a common shareholder).
On a prop basis, Simon owns ~165MM sq ft of gross leaseable area ("GLA"). Substantially all of its prop GLA is located in the US (n.b., ~96%), most of which consists of its domestic Malls and Premium Outlets (n.b., ~52% and ~17% of prop GLA, respectively).
Its international portfolio consists of 39 properties, with Japan, South Korea, and Canada being the 3 most significant geographies collectively representing ~55% of prop GLA (n.b., ~26%, ~17%, and ~13%). The rest of the international portfolio, in descending order of prop GLA contribution, consists of properties in Italy, Mexico, Malaysia, the Netherlands, France, the UK, Thailand, Germany, Spain, and Austria.
Malls typically contain at least one department store anchor or a combination of anchors and big box retailers with a variety of smaller stores connecting the anchors. Additional stores are usually located along the perimeter of the parking area. Its malls are generally enclosed centers and range from ~270k - 2.7MM sq ft of GLA.
Premium Outlets generally contain a variety of designer and manufacturer stores in open-air centers. They range in size from ~150k - 900k sq ft of GLA. They are generally located in close proximity to major metropolitan areas and/or tourist destinations.
The Mills generally range in size from ~1.2MM - 2.4MM sq ft of GLA and are located in major metropolitan areas. They have a combination of traditional malls, outlet centers, big box retailers, and entertainment users.
The lifestyle centers range in size from ~170k - 950k sq ft of GLA. The other retail properties range in size from ~200k - 1.6MM sq ft of GLA and are considered non-core.
In addition to these portfolios, Simon owns ~22% of the listed French retail company Klépierre, and interests in "Other Platform Investments" ("OPI"). OPI includes investments in retail operations (n.b., J.C. Penney and SPARC Group), an intellectual property and licensing venture (n.b., Authentic Brands Group, "ABG"), an e-commerce venture (n.b., Rue Gilt Groupe, or RGG), and Jamestown (n.b., a global real estate investment and management company).
Tenants
Its top 10 anchor and top 10 inline tenants account for ~33% of US GLA and ~17% of US base rent. They have weighted average S&P credit ratings of BBB- and BB+, respectively (n.b., excluding NR tenants). This is about as good as it gets when it comes to retail tenant creditworthiness in a portfolio of this size and scale; however, it is slightly worse than Alpine and CTO , the other 2 retail REITs we've covered recently.
Recent Performance
Below, we see the performance of the key US properties (n.b., ~90% prop GLA). Rent growth across these portfolios averaged a ~3% CAGR, with modest but significant improvements in occupancy.
The portfolio has remained stable over the past two years, with the sale of two domestic Malls and Premium Outlets and the acquisition/completion of two in the international segment.
Leverage
Simon's debt is fairly well structured. Its prop Net Debt/Gross Asset Value ("ND/GAV") is ~36%, with a ~3.6% weighted average interest rate ("WAIR") and ~7-year weighted average term to maturity ("WATM"). The WATM on the fixed rate debt is ~7.1 years vs ~3.1 years for its variable rate debt.
Despite the ~7-year WATM, ~14% of debt is set to expire in Q4 '23 and FY24. The WAIR for these maturities is ~3.5%, ~200bps below its recent mortgage financing at ~6%. We incorporate an interest mark-to-market adjustment in our valuation to reflect the estimated increase in interest costs necessary to refinance these maturities. We apply the 11x FFO multiple implied by our NAV per share estimate to derive the present value of the incremental interest costs of these maturities. Using this approach, we estimate a ~$2.9 per share impact.
It is also worth noting that Simon has ~$40MM face value of Series J preferred stock outstanding, which we treat as a liability in our valuation but have excluded from the debt analysis above. We discuss our thoughts on the current valuation of the Series J prefs below.
Valuation
Simon currently trades for ~12x LQA and FY23E FFO. It yields ~5.3% following a ~6% dividend hike in Q3. Based on our NAV estimate, it trades at a ~4% premium and ~8.2% implied cap rate.
The balance sheet adjustments we used for our NAV estimate are shown in the table below. Several of the adjustments we made were to reflect Simon's prop share of the portfolio (e.g., removing TRG at equity, as we include it in the investment properties valuation at share). Additionally, we updated the value of its stake in Klépierre, a French REIT, based on its current share price and EURUSD rate. Note that we kept the value of its OPIs at book value for simplicity.
While fundamentals for retail real estate are heavily in Simon's favor for at least the near-term, and likely the medium-term, we do not see the current price as highly compelling. Other retail REITs like Alpine and CTO will benefit from the same favorable market dynamics, are significantly cheaper, and offer greater growth potential. Their portfolios are certainly of lower quality, but that is accounted for in our valuation of those REITs.
Series J Preferred
With the common shares looking fairly priced, we wanted to take a look at the Series J preferred shares. The Series J prefs have a liquidation preference of $50 per share, a redemption date of October 15 '27, and a coupon rate of 8.375%. They currently trade for ~$60 per share, a ~20% premium to liquidation preference and ~7% yield. At first glance, the ~7% yield appears fairly attractive relative to the ~5.3% common stock yield (n.b., ~170bps premium). However, the yield-to-call ("YTC"), representing the IRR one would earn buying the security at the current price, assuming it is redeemed at the liquidation preference, is ~3.3%. This means that the effective yield of the pref is significantly lower than the dividend yield of the common.
The current ~7% yield of the pref is also ~310bps above the current US 5-year treasury yield, ~100bps tighter than the 19-year average (n.b., ~420bps). To trade at the historical yield spread to the US5Y, the pref would have to trade for ~$52 per share (n.b., ~8.1% yield, ~8% YTC, ~4% premium to LP).
Given the above, we give the Series J preferred a Sell rating on its absolute and relative valuation.
Risks/Catalysts
COVID lockdowns were devastating for retail companies and landlords at the time. However, they inspired a lot of uncertainty in developers who were already fairly bearish on retail amidst the " retail apocalypse " narrative. This set up the current landlord-friendly supply environment now that demand has recovered and largely exceeded expectations.
A recent report from Cushman & Wakefield comments on the favorable conditions that exist for retail landlords today:
New retail construction remained subdued in the third quarter, as just under 2 msf of space was delivered nationally. After completions totaled an all-time low of 9.8 msf in 2022, year-to-date deliveries of 6.4 msf three-quarters through 2023 point to a new low this year. With roughly 13.2 msf of retail space currently under construction, the pipeline is improved from a pandemic-era nadir, but higher debt costs and market uncertainty have reduced appetite for construction, both from developers and lenders. Additionally, retail inventory levels will continue to be limited by conversions and redevelopment of existing properties, keeping high-quality space at a premium.
As a result of limited new supply and still solid demand, vacancy rates continued to tighten. The national shopping center vacancy rate fell 40 bps year-over-year (YOY) to 5.4% in the third quarter, marking the lowest rate since the beginning of our data in 2007. The South remains the tightest region with an average vacancy rate of 4.9%; Raleigh/Durham and Nashville were the only markets nationally with sub-3% rates, but there were 10 other markets whose vacancy rate were under 4% in Q3 2023.
Limited availability has given landlords leverage to increase asking rents. Average asking rents in Q3 2023 were $23.68 per square foot (psf), which was 4.5% higher than a year earlier. Rent growth peaked at 5% in 2022 and has been modestly decelerating over the course of this year. Asking rents have risen 16.7% cumulatively from 2019 levels.
As C&W notes, the current environment remains landlord-friendly but has softened recently. This could reverse as we enter a period of softer economic growth or a possible recession. We generally see a margin of safety as the best hedge against generic economic risks, so we don't like Simon at ~$140 per share.
Conclusion
Simon is a well-run retail REIT with a high-quality portfolio. The industry is benefitting from a supply shortage that was exacerbated by COVID lockdowns but may cool if the economic picture worsens. Following a ~17% rally in the past month, we no longer see the shares as attractively priced but could change our mind around ~$110. The Series J preferred stock looks very unappealing to us at ~$60 per share but could be an attractive yield play around ~$52.
For further details see:
Simon Property Group: Simon Says 'Hold'