It's no secret that the retail industry is struggling to adapt to the rise of e-commerce. Thanks to Amazon.com and other e-retailers, many once-great brick-and-mortar retailers have shut their doors for good, others have announced store closures, and many more are struggling to survive.
As you might expect, many retail real estate companies are struggling as well. Shopping center real estate investment trusts, or REITs, especially those that had lots of exposure to companies like Toys R Us, HHGregg, and more, have seen profits plummet.
Two exceptions to this trend are Realty Income (NYSE: O) and Simon Property Group (NYSE: SPG), both of which are retail REITs that are performing quite well, but with different strategies.
Image source: Getty Images.
Two very different ways of fighting back against retail headwinds
Realty Income has a rather simple model. The company acquires top-notch, freestanding single-tenant retail properties in excellent locations, and then leases them to tenants. Based on the most recent results, you'd never know that retail was in trouble. The company's earnings grew by more than 5% year over year, it acquired 238 new properties, and S&P actually raised its credit rating to an A-, which is among the best in the REIT world.
There are two main reasons why Realty Income hasn't felt the wrath of the "retail apocalypse" much at all. First, the company intentionally targets properties occupied by tenants that are recession-resistant and not prone to online competitors. Think of convenience stores with gas stations -- there's really no online-based substitute. The same can be said for dollar stores, warehouse clubs, and casual restaurants.
Second, Realty Income's tenants are on long-term leases (15-year initial terms are typical), and the tenants are responsible for taxes, insurance, and maintenance expenses. All Realty Income has to do is get a tenant in place and collect a growing stream of income for years.
On the other hand, Simon Property Group owns a portfolio of shopping malls and outlet centers. And Simon's way of fighting back against retail headwinds is to create the best experiential centers for shoppers. The company incorporates new and innovative dining options and other attractions into its properties to give shoppers a reason to utilize them.
Plus, Simon is actively transitioning many of its properties into mixed-use centers, incorporating non-retail elements such as apartments, hotels, and office space into them. These give a built-in source of traffic, and with a bunch of vacant (or soon-to-be-vacant) Sears spaces at its malls, there's a lot of opportunity to redevelop and increase revenue.
Dividends: It's not just about yield
Both of these stocks are high-yielders, which isn't too surprising since REITs are required to pay most of their taxable income as dividends. Realty Income yields 4.1% as of this writing, while Simon's dividend yield is a slightly higher 4.5%.
The biggest differentiator is consistency, and that's where Realty Income really shines. The company has made 582 consecutive monthly dividend payments and has increased the payout in 85 consecutive quarters. Since its 1994 NYSE listing, Realty Income's dividend has increased at an annualized rate of 4.6%. It's tough to find another stock anywhere in the market with a better all-around dividend track record.
To be fair, Simon doesn't have a bad dividend record by any definition of the term. In fact, since 1994, Simon's dividend has actually grown more than Realty Income's. However, the path wasn't straight up.
To be clear, no stock capable of market-beating returns (which both of these are) is without risk. REITs in general can be rather sensitive to interest rates, with higher rates putting pressure on REIT prices. The 10-year Treasury yield is a good REIT indicator, and if it spikes, I'd expect both of these companies to take a hit.
In addition, there's obvious tenant-related risk -- if one or more of these companies' tenants go bankrupt, it could cause profits to shrink. Neither is particularly dependent on any single tenant, but with the recent wave of retail bankruptcies, this is certainly a risk to keep in mind.
With Simon, there's a fair amount of execution risk as well. The investment thesis when it comes to Simon is predicated on the company being able to successfully redevelop a substantial amount of real estate -- such as spaces formerly occupied by Sears. If Simon can do this as planned (which I believe it will), investors could be rewarded, but there's no guarantee that the company's repositioning efforts will be as smooth as expected.
Realty Income is the more "expensive" of the two stocks by a wide margin. The stock trades for $67.37 as I'm typing this, and the company's expected 2018 year-end FFO (the REIT version of earnings) is $3.195 per share at the midpoint. This translates to a price-to-FFO multiple of 21.1.
On the other hand, Simon Property Group trades for $181.55 per share and is expected to report FFO of $12.11, for a P/FFO of just 15.
The bottom line
In a nutshell, although these are both ways to invest in retail real estate, this isn't exactly an apples-to-apples comparison.
Realty Income is the clear choice if you want lower volatility, stable and predictable income, and generally fewer surprises along the way. On the other hand, Simon Property Group is an excellent way to invest in the transformation of the shopping mall business model over the coming years and could handsomely reward investors once the dust settles in the retail industry. However, it's fair to say that Simon is likely to be the more volatile of the two along the way.
I tend to gravitate toward the steady and predictable end of the spectrum, which is why Realty Income is a staple in my own portfolio. Having said that, I don't think buy-and-hold investors will go wrong with either company over the coming decades.
More From The Motley Fool
- 10 Best Stocks to Buy Today
- 3 Stocks That Are Absurdly Cheap Right Now
- 5 Warren Buffett Principles to Remember in a Volatile Stock Market
- The $16,728 Social Security Bonus You Cannot Afford to Miss
- The Must-Read Trump Quote on Social Security
- 10 Reasons Why I'm Selling All of My Apple Stock
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Matthew Frankel, CFP owns shares of Realty Income. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.