U.S. Retail Environment Weighs on REITs

This article is republished with permission from REITCafe.

Mixed economic news is weighing on retail markets, pushing real estate investment trust (REIT) performance down for 2015. This week, the National Retail Federation announced that back-to-school spending is expected to be down 9.3 percent year over year. This news came on the heels of a report from the U.S. Commerce Department saying retail sales declined 0.3 percent between May and June and rose by only 1 percent in May (down from a previous estimate of 1.2 percent).

Total returns for retail REITs have declined 2.61 percent year-to-date through the middle of July, which compares unfavorably with the FTSE NAREIT All Equity REIT average, which has fallen 1.59 percent. Within the retail sector, regional malls, prized for stability as a core property type, have posted the best year to date returns (–1.92 percent) while shopping centers posted a return of –2.94 percent. Freestanding retail REITs, which have bondlike returns because of the sector’s long-term triple-net lease structure, fared the worst, with a –4.83 percent year-to-date return. These REITs are especially sensitive to interest rates, and performance has been pulled down as the likelihood of higher rates grows.

Retail construction is also restrained, keeping supply and demand fundamentals in check. CBRE reported a first-quarter 2015 retail availability rate of 11.5 percent, unchanged from year-end 2014.

Despite the sector’s challenges, the bailout deal to keep Greece in the Eurozone, and China’s moves to help its faltering stock market, REITs have moved forward in July. U.S. job growth is healthy and oil prices remain low, which puts extra cash in consumers’ pockets. Growth in the Conference Board’s Consumer Confidence Index beat expectations during June and increased during May. Consumers feel good about the economy and the prospects for expansion.

In spite of recent performance, retailers remain attracted to the REIT format. Activist investors are encouraging retailers to spin off their real property assets into REITs. Sears completed its spin-off of Seritage Growth Properties earlier this month, and shares are trading up slightly from their original price. Darden Restaurants, which owns Olive Garden and LongHorn Steakhouse, announced in June plans to spin off some of its properties into a REIT. Macy’s shareholders are also encouraging the company to form a REIT.

Major retail REITs will begin to release second-quarter earnings next week, which will provide greater clarity on recent and expected upcoming performance.

* TREPP-i Survey Loan Spreads levels are based on a survey of balance sheet lenders. For more information, visit Trepp.com.

** - 10 yr. Treasury Yield as of 7/17/2015.