Here’s a simple way to profit from the death of malls

From Justin Brill, Editor, Stansberry Digest:

According to a new Bloomberg report, Wall Street has found its next “Big Short”…

Of course, as regular Digest readers know, this is a reference to the big bets a handful of hedge-fund managers made against the housing market prior to the financial crisis (and later made famous by Michael Lewis’ book and movie The Big Short).

Only this time, the target isn’t housing. It’s shopping malls. From the report

It’s no secret many mall complexes have been struggling for years as Americans do more of their shopping online. But now, they’re catching the eye of hedge-fund types who think some may soon buckle under their debts, much the way many homeowners did nearly a decade ago.

Like the run-up to the housing debacle, a small but growing group of firms are positioning to profit from a collapse that could spur a wave of defaults. Their target: securities backed not by subprime mortgages, but by loans taken out by beleaguered mall and shopping center operators. With bad news piling up for anchor chains like Macy’s and J.C. Penney, bearish bets against commercial mortgage-backed securities are growing.

In recent weeks, firms such as Alder Hill Management – an outfit started by protégés of hedge-fund billionaire David Tepper – have ramped up wagers against the bonds… “These malls are dying, and we see very limited prospect of a turnaround in performance,” according to a January report from Alder Hill, which began shorting the securities. “We expect 2017 to be a tipping point.”

This should sound familiar to Stansberry’s Investment Advisory subscribers…

Porter and his team of analysts detailed the massive headwinds facing malls more than five months ago. In particular, they highlighted three big reasons for bearishness.

First, they also noted the uptick in “anchor” store closures, and warned there would be many more to come. From the September issue of Stansberry’s Investment Advisory

Large department stores like Sears and J.C. Penney have been shutting down their weaker stores for years. That’s not news. But until recently, store closings have plodded along at a moderate pace… But it’s about to get a lot worse.

Last month, Macy’s announced it would close another 15% of all its locations – that’s 100 department stores – which is more than it closed in the last six years combined. Why is this important? First, because it’s Macy’s. Unlike Sears, Macy’s is one of the stronger department-store retailers. When a higher-end retailer like Macy’s shutters stores, it signals an important shift. Second, it indicates that the pace of the closings is accelerating.

The Macy’s announcement isn’t all that surprising given the findings of commercial real estate experts. Four months ago, a report published by the leading commercial real estate research firm Green Street Advisors concluded that retailers would have to close 20% of all anchor space in American malls just to bring productivity back to 2006 levels (as measured by sales per square foot).

Green Street’s research concluded that J.C. Penney and Sears would need to shut down 36% of their stores – a total of 620 of their combined 1,700 stores. Nordstrom, Dillard’s, and Bon-Ton would need to close another 130 stores. When the Wall Street Journal cited this report in an article, the companies – especially Nordstrom – downplayed the “mass closures” strategy. Macy’s, on the other hand, appears to understand the gravity of the situation.

After Macy’s announced its mass closures, shares jumped 17% in a single day. Don’t underestimate the pressure this puts on the other retail CEOs around the country. Wall Street’s message to retail CEOs is clear: close more stores.

And yet, while the market had already “priced in” trouble for retail stocks, it was largely ignoring the risks to mall operators…

Store closures will boost profitability at the aging department-store dinosaurs, but it will devastate the mall operators who depend on their business. Here’s the part that most people don’t understand. The market has already priced in the rough times for America’s large retailers, but it still values the mall operators as if nothing has changed…

Four mall owners appear on our current SIA Black List indicator, which tracks the market’s most expensive stocks worth more than $10 billion that trade at more than 10 times sales. This doesn’t make sense, considering that around 55% of an average mall’s leasable space is dedicated to department-store anchors.

Yes, you would expect mall operators to trade at a premium to retailers, thanks to their higher-yielding dividends… but right now, the market’s view of mall stocks has uncoupled from the struggling retail businesses that support them. This disconnect won’t last forever.

Next, they warned that even malls that don’t go bust are likely to face huge capital burdens

These “survivors” will be forced to spend millions on redevelopment, and this could devastate shareholders. More from the issue…

The traditional enclosed-mall design is dead. No one has built a new mall in the U.S. in 10 years. These days, developers are only interested in building places like The Grove in Los Angeles, a 575,000-square-foot outdoor marketplace dotted with art-deco style architecture and lots of open spaces. For “traditional” malls to survive, they need to commit to massive capital investments to transform the vacant space left by the disappearing store anchors.

When an anchor store leaves, something else has to replace it. And we must admit, the mall operators – particularly Simon Property Group (SPG) – have done better than we expected filling these retail holes. These redevelopments have included health clubs, call centers, movie theaters, restaurants, and even subdivided inline space. They’ve handled these closures well, at least so far.

One thing that you’ll often notice in these redevelopment efforts is that, in an unexpected twist, America’s shoppers now want their malls to be full of outdoor space… which is ironic, considering the first mall was born when Victor Gruen first enclosed that Minnesota shopping center…

The huge problem mall owners face is that redevelopment efforts are expensive – costing tens of millions of dollars. If the pace of store closures accelerates at the same time the credit cycle tightens, mall operators are going to see many of their properties go bust.

Finally, they warned that the mall market was already showing signs of overheating

In particular, they noted capitalization rates (or “cap rates”) had plunged to worrisome levels

A “cap rate” is essentially the rate of return for real estate based on the income a property is expected to generate. The higher the cap rate, the better the potential return for the investor (disregarding price appreciation/depreciation).

As you can see, cap rates are at extreme lows. In fact, cap rates are at levels not seen since right before the last credit crisis:

Meanwhile, analysts were still largely ignoring “the writing on the wall”…

“Mall bulls” say that things will be just fine… that the demise of the American mall is greatly overstated. After all, occupancy rates are still north of 95%. And real estate investment trusts (REITs) of all kinds continue to enjoy the tailwinds provided by yield-starved investors, who have dumped more than $25 billion into REIT funds since 2010.

But with their largest tenants on the ropes… record redevelopment expenditures on the horizon… and a potential credit crisis looming… it seems like an odd time for mall property values to be pushing record highs.

When you add it all up, the mall owners are a great target for the short portion of your portfolio.

Porter and his team recommended shorting shares of GGP (GGP), the largest U.S. shopping mall owner…

As they noted, GGP – formerly known as General Growth Properties – was in the weakest position of any major publicly traded mall operator

GGP is highly dependent upon the department stores to fill its sprawling properties. Of GGP’s 115 malls, 90% have a Macy’s, J.C. Penney, or Sears as an anchor store. Even worse, 41% of GGP’s malls have all three of these struggling department stores as anchors…

So… department stores are dying, and GGP has the most exposure to these big-box relics. GGP’s underlying business is also weak: It’s not growing revenues. Furthermore, GGP has higher leverage than its closest peers and several problematic properties.

Of the mall owners still sporting expensive valuations, GGP has the wrong tenants, in the wrong types of malls, while sitting in the weakest financial position. It’s the best short candidate in the bunch.

GGP shares have fallen from about $29 at the time of their recommendation to nearly $23 today. Stansberry’s Investment Advisory subscribers are up 18% in about five months as of Friday’s close. 

But Porter and his team believe there is more upside ahead (You can read our educational interview on short-selling stocks right here). They believe shares could ultimately fall to less than $15… representing further gains of 35% or more. And if today’s report is any indication, it may not take long…


Justin Brill

Crux note: In this month’s Investment Advisory, Porter and his team recommended two unique ways to profit in stocks no matter what happens to the broad market. You can access Porter’s latest insights and trading recommendations with a risk-free trial subscription to Stansberry Investment Advisory. Sign up right here. (No long video)

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