According to Mark Twain, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”
This applies to all aspects of life, of course, and particularly to investing. Yet, the converse is also true: what makes for great investment returns is something that everybody knows for sure that just ain’t so.
One thing investors seem to “know for sure” is that shopping malls and shopping mall REITs are dead. The rise of Amazon and the ease of buying over the Internet in the mid-2010s led to a steady decline in mall traffic, followed by the complete shutdown of malls during the pandemic. Investors view malls, and mall-based real estate companies, as fading, debt-burdened embers.
But, borrowing again from Twain, “this just ain’t so.” No doubt the old concept of the mall has evaporated: store after store whose primary appeal was the lack of alternative ways to buy merchandise. Today, consumers can shop online for anything. They don’t want to spend their free time wandering through malls.
[text_ad]
Ironically, the pandemic was a major positive for malls – it forced them to immediately and directly address their fading relevance. Today, well-run malls focus on stores that offer consumers what they increasingly want: tasty restaurants and fun entertainment for socializing with friends, the convenience to quickly buy/pick up/return their quality and nationally branded merchandise, and better outcomes by physically testing merchandise before buying it.
Retailers are also getting savvier. They are learning that customers like brick-and-mortar stores if they are well-located, well-stocked and provide a quality shopping experience. Years of gathering data on their customers allow retailers to do exactly that. Warby Parker, for example, originally an online-only company, is aggressively expanding into physical stores emphasizing locations where they already have concentrations of customers. And, they are finding that a physical store boosts online sales in those markets, as well. The one-two combination of a robust online effort and an appealing physical store builds impressive customer loyalty and promotes repeat buying.
Interestingly, Irish retailer Primark is expanding across the United States without an online buying option, as they have found that their in-store, value-oriented merchandising can’t be replicated digitally. Leading retail and technology analysis firm Coresight Research has all but said that the golden age of the digitally native store has passed.
Despite the return of the mall, investors seem to be ignoring mall real estate investment trusts, or REITs. One such shopping mall REIT is Kite Realty Group Trust (KRG), a midcap ($4.5 billion) company based in Indianapolis. This company has 181 properties located primarily in Sun Belt states, which generally have favorable population growth. Its mostly open-air malls are well-suited for customer convenience and have lower operating costs than other formats. Kite’s properties feature a diversified (the largest tenant, TJX Companies, comprises only 2.5% of total base rents) roster of well-known and high-quality retailers like Best Buy, Ross Stores, PetSmart and Target. Helping drive traffic: over 75% of its rents are produced from malls with a grocery component. Restaurants like Chipotle, Starbucks and Crumble Cookies, along with niche retailers like Yeti, Warby Parker, Nike and Sephora, generate further customer pull-in.
Kite’s success creates a fly-wheel effect: the more customers it draws in, the more attractive its properties become to high-value retailers. This helps them draw in even more high-value retailers, which drives more traffic. It also helps Kite boost its rental prices. The company’s average rent is 12% higher than in 2019, and strong new leasing activity is supporting higher rates from new renters. Nearly 95% of its space is leased.
The company is well-managed, led by John Kite, the chairman and CEO who formed Kite from predecessor companies in 2004. Operating margins and other metrics are above most of its peers. The combination of quality properties and capable management is helping the shopping mall REIT generate strong profits and drive same-property net operating income up at a 2-3% pace. Adding to its quality reputation: the integration of its 2021 all-stock acquisition of Retail Properties of America, which nearly doubled the company’s size, is going well.
Financially, Kite is strong. Its balance sheet is sturdy enough to earn its debt an investment-grade credit rating. Nearly 90% of its debt is at fixed interest rates, which provides some shelter in the rising rate environment. Its low 4.4% weighted average interest rate is below the general inflation rate, earning Kite an implied arbitrage profit on its properties. Favorable as well is that its debt matures relatively evenly over the next seven years, reducing the risk of oversized refinancings in any one year.
Kite’s shares look undervalued. On estimated 2023 funds from operations, or FFO (a metric similar to price/earnings), shares of the shopping mall REIT trade at a relatively modest 10.8x. The dividend looks readily sustainable and provides a 4.7% yield.
Contrarian investors may want to consider putting shares of Kite Realty Group in their baskets before others do their shopping.
Cabot Value Investor and the Cabot Turnaround Letter offer stock ideas, commentary on the markets and other topics relevant to contrarian and value investors, all supported by our rigorous and disciplined methodology, research and analysis. Let us help you sort through the market to find the best contrarian and value stocks.
[author_ad]
