Near-Term Outlook for Retail REIT Stocks Appears Bright

Real estate investment trusts (REITs) that are engaged in owning, developing, managing and renting space in a variety of retail real estates are categorized as Retail REIT. These retail real estate assets include regional malls, outlet centers, grocery-anchored shopping centers, as well as power centers which include big-box retailers. In addition, net lease REITs enjoy ownership of freestanding properties, wherein both rent and majority of operating expenses for the property are borne by the tenant.

Strength of the economy, together with the job-market environment, plays a key role in shaping up the retail REIT industry’s performance, as these determine consumers’ spending capacity for buying retail goods and services. Moreover, as purchase of retail goods and services takes place through multiple channels, it plays a crucial part in determining the demand for the retail real estate space.

So here we go through the major themes in the industry:

Healthy U.S. Economy: The domestic economy has been resilient and hiring continues to be strong. This is boosting consumer confidence and indicates decent consumer spending in the months ahead. This is anticipated to send across positive ripple effects across the industry.

Omni Channel Strategy: Admittedly, e-commerce is gaining market share from the traditional brick-and-mortar stores and forcing retailers to reconsider their physical footprint and focus more on investing in online platforms. Though this has raised concerns over the fate of physical stores and landlords’ cash flows, the latest trends indicate that despite the rising popularity of e-commerce, omni-channel will keep being the focal point for retailers, while physical stores will remain an integral and effective sales channel. This is because, despite choosing online retailing options, consumers prefer exploring the option of visiting physical stores as well.

In addition, options like free shipping and returns offered with online sales, have led to e-commerce becoming an expensive platform, affecting retailers’ profit margin. This has prompted them to focus more on in-store pick up of online purchases (such as BOPS - buy-online, pick up in-store, and BOSS - buy-online ship-to-store). Retail real estate landlords are also embracing digitally native brands and offering incentives, helping them open, operate and scale stores as a complement to e-commerce. Therefore, retailers that focus on omni-channel model will likely navigate well through the retail apocalypse and REITs that support their real estate needs will benefit.

Structural Changes to Continue: With changing consumer preferences, right-sizing of footprints and store closures would continue, while the ones unable to cope with competition will resort to bankruptcy filing. These will lead to tenants demanding substantial lease concessions. Nevertheless, to counter these challenges and in a bid to lure customers, retail REITs are expected to continue with the transformation initiatives of their traditional retail hubs into entertainment destinations and lifestyle resorts. The REITs are likely to avoid high dependence on apparel and accessories and rather focus on expansion of dining options, opening movie theaters, as well as offer recreational facilities and fitness centers. Additionally, focus on mixed-use development is likely to continue, which has gained immense popularity, of late, although with huge outlay for refurbishments, growth in profit margins of retail REITs in the near term might be affected.

Zacks Industry Rank Indicates Bright Prospects

The Zacks REIT and Equity Trust - Retail industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #100, which places it at the top 39% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bright near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of positive funds from operations (FFO) per share outlook for the constituent companies in aggregate.

Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Leads on Stock Market Performance

The REIT and Equity Trust - Retail Industry has outperformed the broader Zacks Finance sector, as well as the Zacks S&P 500 composite in a year’s time.

The industry has gained 5% during this period compared to the S&P 500’s fall of 1%. During the same time frame, the broader Finance sector has declined 4.8%.

One Year Price Performance

Industry’s Current Valuation

On the basis of forward 12-month price-to-FFO (funds from operations) ratio, which is a commonly used multiple for valuing Retail REITs, we see that the industry is currently trading at 14.54X compared to the S&P 500’s forward 12-month price-to-earnings (P/E) of 16.01X. However, the industry is trading above the Finance sector’s forward 12-month P/E of 13.18X. This is shown in the chart below.

Forward 12 Month Price-to-FFO (P/FFO) Ratio

Over the last five years, the industry has traded as high as 19.44X, as low as 12.57X, with a median of 15.73X.

Bottom Line

In a nutshell, with a stellar job market and a resilient domestic economy, consumer confidence is likely to remain upbeat and offer scope for growth to the retail REIT industry. Particularly, retail REITs’ concerted efforts to boost productivity of retail assets by trying to grab attention from new and productive tenants, and disposing the non-productive ones are commendable, though substantial outlays will continue to dent any near-term gains.

Nevertheless, as REITs strive to bring their mojo back, we handpick two stocks from the industry with a Zacks Rank of 2 (Buy) that will add Midas touch to your portfolio and another that should be retained for its superior operating platform.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Acadia Realty Trust (AKR): The REIT is focused on building a core real estate portfolio with significant concentrations of assets in the dynamic urban and street-retail corridors of the nation. Additionally, it aims for profitable opportunistic and value-add investments through its series of discretionary and institutional funds. The stock holds a Zacks Rank of 2, at present.  The Zacks Consensus Estimate for the ongoing year’s FFO per share has been revised marginally upward over the last 90 days. The company is also expected to witness nearly 3.6% year-over-year FFO per share growth in 2020.

STORE Capital Corporation (STOR): This net-lease REIT based in Scottsdale, AZ, is engaged in the acquisition, investment and management of Single Tenant Operational Real Estate (STORE properties). This Zacks #2 Ranked company’s current-year FFO per share consensus estimate of $1.89 has been revised marginally north, in two months’ time. In addition, its 2020 FFO per share will likely witness year-over-year improvement of 6.4%.

Simon Property Group, Inc. (SPG): This retail REIT is a global leader in the ownership of premier shopping, dining, entertainment and mixed-use destinations. It currently carries a Zacks Rank #3 (Hold). The REIT is anticipated to benefit from new development, redevelopment, expansion and acquisition efforts. The Zacks Consensus Estimate for the 2019 FFO per share is projected to be up roughly 2.1% and 3.3%, respectively, in 2019 and 2020.

Note: Funds from operations (FFO) is a widely used metric to gauge the performance of REITs rather than net income as it indicates cash flow from their operations. FFO is obtained after adding depreciation and amortization to earnings and subtracting the gains on sales.

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