'Counterintuitive' Strength In Brick-And-Mortar Lifts Outlook For Retail REITs

Despite high interest rates and slowing consumer spending, publicly traded retail owners have reported surging occupancy, allowing them to raise rents and boost their outlook for the rest of the year.

Major retail REITs are coming off a strong third quarter, with executives expressing a general sense of optimism as retailers are willing to pay more for the space amid record-low levels of available square footage nationally.

“We're waiting for shoes to drop, but we haven't seen it,” Simon Property Group CEO David Simon said on his company's earnings call last week.

Many of the major retail REITs reported strong earnings and leasing activity for the quarter. The same companies that were hemorrhaging tenants during the depths of the pandemic are now raising rents as their centers increasingly fill up.

“There's been a retail apocalypse. There's been the Covid pandemic. There have been all things we've faced in terms of challenges. And we feel right now we're in a really good spot to, hopefully, be the bright spot of commercial real estate,” Kimco Realty Corp. CEO Conor Flynn said during his company's third-quarter earnings call. 

Mall giant Simon reported a net profit of $594M in the third quarter, a 10.2% increase over the same period last year, while its occupancy rose from 94.5% in Q3 last year to 95.2%. It increased its expected earnings for the full year by 10 cents a share.

Shopping center owner Kimco posted a $112M profit, a big jump from the $51.6M in net income reported in the third quarter of 2022. It reported occupancy of 95.3%, up 120 basis points year-over-year.

Owners are still working through the impact of the wave of major bankruptcies that hit earlier this year, including Bed Bath & Beyond and David’s Bridal. Still, they have found ample demand for those spaces — Kimco executives said all 14 of the vacant Bed Bath & Beyond boxes in its portfolio have either been leased or are in negotiations with new tenants.

Federal Realty Investment Trust reported a dip in occupancy as a result of vacated Bed Bath & Beyond stores, but strong leasing across its portfolio prompted it to raise its earnings guidance for the rest of the year.

Smaller tenants have also kept up their activity at shopping centers — Brixmor Property Trust reported small-shop occupancy hitting a record 89.8%, and Kimco's small-shop occupancy also reached its all-time high of 91.1%, it reported.

"We continue to think that the small shop occupancy is going to be a bright spot for us as we've just reached all-time highs and we're continuing to think there's more to push there," Flynn said on the call.

Mall owner The Macerich Co. reported a net loss of $271.9M for the quarter, attributed to impairment charges associated with the expected sales of its stakes in Country Club Plaza in Kansas City and Fashion Outlets of Niagara in Buffalo, New York, according to reports. The loss shows that while leasing and revenue are holding up, retail REITs aren't immune from the decline in property values and investor demand.

But despite the loss, Macerich's occupancy rose from 92.1% in Q3 last year to 93.4% in the three months ending in September, and its average base rent rose 2.8% year-over-year.

Macerich Senior Executive Vice President Doug Healey said the pandemic flushed out the struggling retailers, leaving those in business in a much stronger position and wanting to grow.

“It is sort of counterintuitive that given what’s going on in the macroeconomic environment and the slowdown in sales that we’re still seeing the demand that we’re seeing,” Healey said during Macerich’s earnings call. “We have a very healthy retailer environment out there, and they’re really taking advantage of some opportunities to take down some real good space and some real good properties.” 

The national retail vacancy rate hit a historic low of 5.4% in the third quarter, a 40 basis point drop from the same period in 2022, according to a recent Cushman & Wakefield report, giving landlords leverage to raise rental rates. Kimco and Brixmor reported new leases were being signed at 35% and 52.7% markups over the prior tenants, for example.

Piper Sandler & Co. Managing Director Alexander Goldfarb said retail real estate is emerging from the pandemic stronger, with a consumer base who wants to shop at brick-and-mortar stores again, as unemployment in the U.S. remains at historic lows.

"That's why today, Bed Bath & Beyond is like, who cares?" Goldfarb said. "These spaces are being taken by new retailers."

On top of that, the pullback on construction lending for anything commercial real estate is helping to tamp down new retail supply, Goldfarb said. While interest rates might be making life painful for commercial real estate, the broader economy is still strong, with unemployment below 4%.

“If we had 10% unemployment and strong job losses, you and I would be having a different discussion,” Goldfarb said. 

But there are potential headwinds for retail. REIT executives acknowledged that inflation and interest rates are still affecting their margins. 

U.S. consumer credit card debt has surpassed $1T, which some experts say could be a worrying portent of shoppers being able to spend money with retailers, CNN recently reported. And after a more-than-three-year pause, student loan payments have restarted, biting further into many shoppers' incomes.

"Higher interest rates, inflation clearly is affecting a good portion of the consumer out there," Simon said. "The good news is you’ve got employment and you’ve got wage growth that is counterbalancing that. But they’re definitely being more cautious."