Valuing an underperforming mall, What's In Your Reit?"

Analysis by Kenneth Leonard
Gerson Lehman Group
Ken Leonard Bio
11/14/10

Summary

A recent article in an industry trade journal features a reasonably candid picture of the costs and difficulties of repositioning an underperforming regional mall. I will summarize the article for any of the GLG readers who follow the Mall REIT industry and who may be lulled into a false sense of security about the values of those Mall REITs who are recognized as having a substantial number of underperforming malls in their portfolios.

Analysis

This article states that "there are several hundred malls in the U.S. that are candidates for de-malling". In my opinion this is a very conservative number if one includes those malls that need to be demolished and have the land underneath put to other uses. However, "several hundred" is as good a number as any to work with and assume they are equally distributed among the Mall REITs.

The article goes into some detail about three of the largest and most recent repositioning (de-malling) projects; Villa Italia in Lakewood, Colorado, Bay Shore in Glendale, Wisconsin and Padre Staples in Corpus Christi, Texas. Although the article was a little vague on some of the specific financials, there was enough information to draw the following conclusions:

First and foremost, all three projects at the start of construction, were valued or acquired at only slightly more than the value of the underlying land. While there did not seem to be any major deductions for the cost of demolition, it is very clear that the real value of underperforming malls is NOT in the buildings or leases, it is in the land and zoning that allows for the development of what is essentially a new mall from the ground up. Additionally, when the contribution of the local governments, without which the project could not be built, are factored into the equation, (for such things as infrastructure improvements, garages, roads, etc.), the actual value of the pre-demolished mall is very close to zero. I wonder how many Mall REITs have given their de-malling candidates a zero value on their books?

Next and of almost equal importance, is the time, effort and money it takes to do the "pre-development" work. All three talk about the "several years" of working with the public sector to gain support and public funds for the development, before the first building can be demolished. None of these malls talked about how this very real pre-development cost was accounted for.

Finally, I thought the fact that all three redevelopment projects were shown upon completion, to be slightly less productive on a sales per-square-foot basis, than the original mall. the only thing that seems to save the projects from bankruptcy is the sizable amount of land that was redeveloped for office and residential purposes.

So the next time you see an article in the media that talks about the "hidden value" of underperforming retail assets, you should refer back to the Shopping Centers Today article of October, 2010, titled "Not For The Meek-Hearted.