While holiday retail sales have an immediate and obvious impact on retailers, they also affect retail real estate investment trusts (REITs), the companies that own the regional malls and shopping centers where retailers operate. In fact, the amount of money Americans spend during the holidays can have both a short- and long-term impact on retail REITs.
Although retail REITs have moved away from leases that are based on percentage rent — a rental amount determined by a retailer's sales per square foot — analysts note that holiday sales could cause seasonal movement of retail REIT stocks throughout November, December and January. In the long-term, holiday sales affect the bottom line through occupancy and rental rates shifts.
“The impact of holiday sales on retail REITs might not be as obvious as it is for retailers, but it still exists,” says Rich Moore, a REIT analyst with RBC Capital Markets. “Retail REIT executives are constantly talking with their tenants, and they have a good idea of what those tenants expect from this year's holiday season. It certainly influences the way they go about their business.”
“Average” Holiday Season
The National Retail Federation (NRF) says the 2011 holiday season can be summed up in one word: average. Holiday retail sales (defined as retail industry sales during the months of November and December) are expected to increase 2.8 percent to $465.6 billion.
While that growth is far lower than the 5.2 percent increase retailers experienced last year — growth that outperformed most analysts' expectations — it is slightly higher than the 10-year average holiday sales increase of 2.6 percent. And, according to the American Express Spending & Saving Tracker, Americans will spend an average of $831 on gifts this season, $121 more than last year.
“From what I'm hearing from retailers, the expectations are for holiday sales to be marginally positive,” says Paul W. Freddo, senior executive vice president of leasing and development for DDR Inc. (NYSE: DDR), one of the largest retail REITs in the nation. “Back-to-school sales are a great indicator of holiday sales, and August and September sales were up roughly 5 percent. Furthermore, the vast majority of prime retailers, of our prime retailers, have been increasing earnings guidance. WalMart, TJX, PetSmart, Kohl's, Bed Bath & Beyond, Ross, Dick Sporting Goods and Kroger are just a handful of our top tenants that have increased earnings guidance in 2011.”
Holiday sales expectations this year are drastically different than those immediately following the credit crisis in mid-2008, for example. During that holiday season, sales were dismal — down 4.4 percent compared to the year before, according to the NRF. Even worse, retailers were stuck with too much inventory and forced to heavily discount merchandise just to get it out of stores and warehouses. The market responded quickly and negatively to retail stocks: consider the Gap. On Dec. 24, 2008, the apparel retailer's stock closed at $12.97 — a significant decrease from 2007's Christmas Eve price of $21.72.
“Today, retailers are in a much better position to sell inventory at close to full price as they continue to manage their businesses effectively,” Freddo noted during the DDR's third quarter 2011 earnings call, adding that demand for quality real estate remains “robust.”
During the third quarter 2011, for example, DDR completed 516 leases for more than 2.5 million square feet at a leasing spread of 7 percent (the leasing spread is the percentage increase in rental rates over expiring leases). As a result, the REIT's portfolio was 93.1 percent leased at the end of the third quarter, a 110-basis point increase over the third quarter 2010. Specifically, DDR signed 220 new leases for 973,000 square feet with a positive leasing spread of 16 percent and 296 renewals for 1.6 million square feet with a positive spread of 6 percent.
While holiday retail sales don't have an immediate impact on retail REIT occupancy and rental rates, they certainly have the ability to impact the sector's stock prices. In previous years, investors have responded to positive holiday sales figures by buying retail REIT stocks, creating a bump in pricing. Conversely, poor holiday sales activity compelled investors to offload retail REIT stocks, causing prices to plummet, Moore recalls.
According to NAREIT, the trade organization that represents U.S.-based REITs, there are 28 retail REITs with a combined market cap of $106.4 billion. In 2010 and so far this year, retail REITs have outperformed the whole REIT sector.
Retail REITs have achieved a year-to-date return of 11.63 percent as of Oct. 31, 2011, compared to 7.36 percent for all equity REITs. In 2010, retail REITs posted a total return of 33.41 percent compared to 27.95 percent for all equity REITs.
While the short-term impact of holiday sales is limited to stock performance, the long-term effect can be traced directly to retail REIT cash flow, analysts agree. “Holiday sales are going to affect store openings and closings, which have a direct impact on occupancy and rental rates,” explains Alexander Goldfarb, managing director of Sandler O'Neill + Partners L.P.
Consider this: A strong holiday shopping season not only translates into greater profits for retailers, it also gives retailers a shot of confidence to expand their store base and to renew leases.
RBC Capital Markets' most recent retail demand survey found that retailers plan to open 72,271 stores over the next 24 months, up 3.2 percent from December 2010. Moreover, landlord respondents said tenants are transitioning from short-term leases to more traditional long-term leases.
The extended duration of leases and the willingness of retailers to commit to more traditional leasing terms suggest that retailers have become comfortable with existing plans in the current economy, Moore points out.
“The holidays will be the biggest contributor to sales, and the more profitable these guys are, the more stores they want to open, and as sales go higher, landlords can raise their rents more,” Moore says. “I think there's a 90 percent probability that we're going to see growth this holiday season — in fact, I don't see much downside — and that's one of the reasons why we think 2012 is going to be a good year for retail REITs.”