Among the battered real estate industry there are a few REITs that are situated to take advantage of the carnage and profit in the long run.  Simon Property Group (SPG) is going to be poised to snatch up properties at rock bottom prices from sellers who simply want to pay down their enormous debt loads.

With a market cap of $7.59 billion, SPG is the largest public real estate company in the United States.  As of December 31, 2008, SPG owned or held an interest in 324 income-producing properties in the U.S.  It owns, operates and develops its portfolio of properties with an emphasis on high quality retail real estate. SPG operates from five retail platforms: Regional malls, Premium Outlet Centers, The Mills, community/lifestyle centers, and international properties.  As of December 31, 2008, the breakdown of percentage of owned property was: Regional Malls- 58.3%, Premium Outlet Centers- 10.7%, The Mills- 19.6%, Community/lifestyle centers- 9.2%, and other properties- 2.2%.  SPG reported for the full year 2008 that diluted earnings per share decreased $0.08 or 4.1% to $1.87 from $1.95 in 2007.  However, it also reported that consolidated total revenues increased $132.4 million or 3.6%.  This increase in total revenues was mainly due to the full year effects of its 2007 openings and expansions.

The three main reasons why I think Simon will prevail are its consistently high occupancy rates, the poor conditions of competitors such as General Growth Properties (GGP), and strong growth in Funds From Operations (FFO).

Even in the midst of a tough retail environment, SPG has been able to maintain fairly steady occupancy rates.  As you can see, even though all but The Mills are down year-over-year, they are not down nearly as much as some may have thought given the harsh economic climate for over a year now.  Strong occupancy rates were accompanied in 2008 by stable rental rates which helped SPG to generate growth in operating results even with the pressures of the souring economy.

• Regional Malls: 92.4%, down 1.10%
• Premium Outlet Centers: 98.9%, down 0.80%
• The Mills: 94.5%, up 0.40%
• Mills Regional Malls: 87.4%, down 2.10%
• Community/Lifestyle Centers: 90.7%, down 3.40%
• European Shopping Centers: 98.4%, down 0.03%
• International Premium Outlet Centers: 99.9%, down 0.01%

Lots-O-Cash

SPG has a strong balance sheet with a lot of cash.  As of December 31, 2008, it had approximately $774 million in cash.  Going forward, SPG has specifically said it wants to expand within the US and more importantly, grow its international presence.  In 2008, SPG opened three Premium Outlet centers internationally; one each in China, Japan and Italy. REITs such as General Growth became so highly leveraged that it now cannot afford to make its debt payments and has no cash on hand to do so.  Because of this extreme leveraging, it is unable to get financing for more than a few weeks since the risk of not just default, but bankruptcy, is so large.  If negotiations with bondholders and lenders to alter the terms of their bonds and loans does not work, the next best thing for these companies to do is sell assets. Simon has played it safe over the past forty-eight years and has ample cash to acquire assets at depressed prices from companies in dire need of cash.  In addition to cash, it also has approximately $2.4 billion left on a $3.5 billion credit facility.  (A note on the credit facility: Simon has closed a deal and issued 17.25 million shares at $31.50 and issued $650 million in senior notes due in 2019.  It will use some of the proceeds to pay down part of this credit facility.)  With the highest S&P credit rating among regional mall operators of A-, the company has easy access to capital.

Steady FFO Growth

Funds From Operations, or FFO, is a figure used specifically by REITs to define their cash flows from operations.  It takes Net Income, adds back in Depreciation and Amortization and subtracts Gains or Losses from the Sale of Property.  Since GAAP accounting requires Depreciation and Amortization be subtracted out it may reduce true earnings for REITs because the properties that the REIT owns may actually appreciate over time.  It also subtracts out gains or losses on the sale of properties because these are one time charges that are not recurring and do not contribute to the REIT’s ongoing dividend paying capacity. SPG has averaged 10% growth in FFO since 2005.  Going forward, this growth has the risk of decreasing due to the crisis spreading to commercial real estate.  However, since SPG’s specializes in retail I think that the risk is lower.  This may sound crazy, but if it has been able to weather the past twelve months of poor consumer confidence and spending, I think that the future is a bit brighter.  I don’t necessarily need a ratio or a metric to tell me that maybe the light can be seen at the end of the tunnel. Rather, I need only go to my local mall (coincidentally owned by General Growth) and drive around for ten minutes trying to find a parking spot or visit any Simon owned mall in south Florida and do the same thing.  Now, I realize that not everyone is purchasing items, but it is still traffic in the mall and in the stores.  My high school soccer coach always said, “you can’t score unless you shoot the ball.”  Well, you can’t buy things unless you go to the store.  Consumers are out looking for bargains, and by the looks of the things, stores are giving them what they want.

SPG is looking toward the future and management is focusing on being around for another forty-eight years.  The company’s diversified portfolio along with the several items above will help it continue to be the strongest player in the REIT sector.

-Patrick Dougherty

Disclosures:  None