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Bear of the Day: Simon Property Group (SPG)

David Borun

The performance of Real Estate Investment Trusts has been a mixed bag lately. On one hand, public companies that own rental properties and are required by law to pay out 90% of their pre-tax income to shareholders have been providing yields that are much more attractive than the rates that can be earned in money-market savings accounts or fixed-income instruments like Treasury bonds.

In normal conditions, REITs tend to trade more like bonds, with prices that rise as interest rates fall.

On the other hand, there’s a very real possibility that REITs that invest in the commercial markets will see widespread tenant lease defaults. As consumers continue to shift their shopping habits to include more online purchases and fewer trips to the mall, an increasing number of large brick-and-mortar retailers have filed for bankruptcy protection.

Traditional retailers closed more than 9,000 locations in the US during 2019 – even before the Coronavirus pandemic struck. Once- mighty retailers like JC Penny (JCP), Nieman Marcus and General Nutrition Centers – as well as at least 12 other companies – have filed for federal protection from creditors as they try to either reorganize or sell their businesses.

Every situation is unique, but in general, landlords wind up in a subordinated position when a tenant files for bankruptcy protection. The rules are complex, but under Chapter 11, the tenant retains flexibility to continue occupying the property for 60 days and in the event of a liquidation, the landlord becomes an unsecured creditor.

Unpaid rent as well as legal fees, property taxes and other expenses add up quickly, so landlords typically have an incentive to come to an agreement with troubled tenants rather than going through the process of eviction – and searching for another tenant who is willing to move into the space.

Generally these events are fairly rare and commercial REITs are adept at mitigating the damage of tenant defaults and protecting their dividends. These are not normal times, however.
Simon Property Group (SPG) is a REIT that specializes in properties leased by restaurants, retail stores and entertainment venues. In happier times, SPG reports solid Funds From Operations and pays a steady dividend. (Funds From Operations is an industry-specific measure that’s a more accurate representation of performance than GAAP earnings because it neutralizes the effects of depreciation.)

At the beginning of 2020 when SPG shares were trading near $145/share, the company’s portfolio of 204 properties allowed them to pay a regular dividend of between 3-5% - a very solid yield. At the more recent share level of around $64/share, the dividend yield is now north of 8% annually.

Paradoxically, that’s not a positive development.

When investors let a company’s shares creep down to levels at which the dividend yield looks juicy, it’s generally because they expect that firm’s ability to keep paying the dividend to be reduced. REIT investors tend to be at the more sophisticated end of the spectrum – often high net-worth individuals and institutional investors who manage large pension programs and university endowments and who seek to achieve consistent results in terms of total return.

This is an opportunity for an average individual to follow the pros. When they leave a high-yielding stock behind, you should probably be wary of it as well.

Simon Property Group is a well-managed and successful REIT and still has a strong balance sheet, but general conditions are simply not in its favor right now. With mall visits, health club workouts and restaurant meals all down significantly right now – and for the foreseeable future – there are much less risky options available for income investors.

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