Every commercial real estate investor has their own unique investment preferences.  For example, some investors may like apartment buildings while others like office buildings.  In addition, some may prefer to purchase a property directly while others may prefer an indirect approach through a private equity firm or REIT.

Fortunately, there are a large number of investment options and products to accommodate investor needs and preferences.  One such option is a “Mall REIT.”  The purpose of this article is to describe what a Mall REIT is, the pros and cons of investing in one, and available alternatives.  It makes sense to start by breaking this term into its discrete parts.

What is a “Mall”?

According to the International Council of Shopping Centers (ICSC), an industry trade group, a “mall” is a specialized type of shopping center that sells general merchandise and/or fashion oriented offerings.  It is characterized by an enclosed structure with inward facing stores connected by a common walkway.  Parking surrounds the outside perimeter.

While this is the technical definition, we are all familiar with the typical shopping mall.  They have a handful of anchor department stores and a diversified retail offering from clothing, to electronics and jewelry. 

Malls are commercial properties with a big price tag and they are a specialized type of investment that are typically only affordable for the largest investors and firms.  One such type of firm is a Real Estate Investment Trust or “REIT.”

What is a REIT?

A Real Estate Investment Trust or “REIT” is a specialized type of investment firm that offers a tax advantaged structure as long as they payout a certain percentage of their earnings as dividends to investors (per IRS rules).  REITS can be publicly or privately traded and individuals can purchase shares in them for investment purposes.  In return for their share ownership, investors are entitled to a portion of the income and cash flow produced by the properties that the REIT owns.

Investors can purchase REIT shares in all assets classes, including shopping malls.  In fact, one of the largest shopping mall owners is a REIT called the Simon Property Group, which owns or manages 191 million SF of retail space, including shopping malls.

Why to Invest in Shopping Malls 

Again, a shopping mall REIT is one of many different commercial real estate asset class options.  They make a good investment for the following reasons:

• Liquidity:  Publicly traded REIT shares can be bought and sold like stocks or a mutual fund, which provides investors with the type of liquidity not normally available in a real estate investment.
• Diversification:  Depending on the size of the mall, there are dozens or hundreds of tenants.  And, a REIT may own dozens of malls.  As a result, a REIT share can provide a high level of diversification, also not normally available in real estate investments.  Strong diversification can protect against market volatility.
• Income:  REIT shares provide investors with passive income through high dividends, which gives them a good dividend yield and makes them a beneficial addition to any investment portfolio.  When income is combined with price appreciation, total returns can be strong.

However, REIT investing is not for everyone.  

Who Should Invest in a Mall REIT?

Again, every investor has different asset class/property type preferences and their own return objectives.  But, Mall REITs tend to be a good fit for investors who are seeking the above benefits of liquidity, diversification, and income in addition to the tax advantages of investing in an equity REIT.

However, investors should be aware of the risks of doing so and consider them carefully before committing any capital to an investment.  In addition, they should carefully consider the following operational metrics.

Mall REIT Operational Metrics to Look For

Because every property type is unique, they each have a set of operational metrics that indicate whether or not the property is financially healthy.  In the case of a Mall REIT, investors should look for:

Funds From Operations (FFO)

This is a figure used by REITs to calculate the cash flow earned from operating activities.  It is calculated by adding depreciation, amortization, and losses on the sale of assets and then subtracting gains on sale and interest income.  It is usually quoted on a per share basis.  The REIT should be profitable.

Net Asset Value (NAV)

Net Asset Value describes the sum total of the REIT’s assets less their liabilities.  If the result is divided by the total number of REIT shares outstanding, the value can be a useful guide for the true value of a REIT share.  On a relative basis, the NAV and the share price of a REIT should be similar.

Cap Rate

Cap Rate is a financial metric used to assess the value of a property.  It is calculated as Net Operating Income (NOI) divided by price or value of the property.  As a general rule of thumb, the lower the cap rate, the more valuable the property.

Best Types of Shopping Malls for REIT Investment

Even within the Mall REIT category, there are a number of shopping mall types into which an individual investor can allocate capital.  They include:

• Super Regional Malls:  These are very large scale shopping malls, often with 1M+ SF of Gross Leasable Area.  They may have 3+ anchor tenants and dozens or even 100+ retailers who occupy the space.  They cover a trade area of 5-25 miles and their offerings range from department stores to specialty retailers.
• Regional Malls:  Similar to super-regional malls, but smaller.  They may have 400,000 – 800,000 SF of gross leasable area and cover a smaller trade area of 5-15 miles.  Typically, they have 2+ anchor tenants and 40-80 non-anchor tenants.
• Factory Outlet:  Even smaller in size, a factory outlet center is 50,000 – 400,000 SF in size and it is where manufacturers and retailers sell brand name goods at a discount.  They can have 10-50 tenants and serve a trade area of 25 – 75 miles. 

Each of these types have their own unique benefits and risks that can drive potential returns.

Risks of Investing in a Mall REIT

For individual investors considering a Mall REIT investment, the single biggest risk factor is the ongoing rise of E-Commerce.  Digital native retailers continue to eat into the market share of established brands and, in many cases, provide a superior shopping experience to a customer in the comfort of their own home.  As these sales continue to shift online, they come at the expense of physical retailers, many of which are shopping mall tenants.  Additional risks include:

• Interest Rate Risk:  Shopping mall purchases are financed with debt, some of which has a variable interest rate.  In a rising rate environment, the property’s ordinary income can be impacted, which leaves less money available to distribute to shareholders, lowering the overall annual return.
• Taxes:  A REIT is a tax advantaged structure which benefits shareholders in the form of decreased taxable income.  Tax laws can change at any time, which can negate some of these benefits.
• Liquidity Risk:  The biggest gains in real estate investment come in the form of capital appreciation, but this can’t be realized until the property is sold.  In certain markets, this may be harder than others.  As shopping malls fade in relevance, liquidity risk grows.
• Market Risk:  Every real estate market is different.  The supply and demand characteristics have a major role in the success of a mall REIT investment.  Fast growing markets with strong demand will prosper, while shrinking markets can compound mall REIT risk.

For these reasons, we believe that a mall REIT is likely not the best investment choice for most individual investors.  There are more attractive alternatives.

Why The Single Deal Private Equity Structure is a Better Alternative

For an individual interested in real estate investing, the structure of a retail REIT is such that they have little to no control over what specific property their money is used to purchase.  Instead, their money goes into a blind “pool” of investment capital and the manager decides which properties to allocate it to.  While this may lead to a more diversified portfolio, we believe that investors want to know exactly where their money is going. 

In a single deal syndication, investors know exactly what their money is going to be used for.  As such, they can perform their own due diligence on the market, tenant(s), local trends, ingress/egress, and physical condition of the asset.  If they so choose, they could also perform their own site visit to see the property for themselves.

Finally, the single deal structure can also allow the investor to create their own strategy for portfolio diversification by choosing which deals to invest in and which to pass on.  For example, we believe that many malls – and the retailers that inhabit them – are fading in relevance and their long term investment prognosis is trending negative.  But, grocery stores aren’t going anywhere.  This is why we continue to bring high quality, high occupancy, grocery store anchored retail center deals to our investors and encourage them to perform their own due diligence prior to investing.

Interested In Learning More?

First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. We leverage our decades of expertise and our available liquidity to find world-class, multi-tenanted assets below intrinsic value. In doing so, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.

If you are an Accredited Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.