Simon Property Group (SPG)

by | Jan 1, 2022 | Companies, Episodes | 0 comments

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One of Simon Property Group’s malls.  Image Source: Simon Property Group

    Simon Property Group is one of the largest mall operators in the United States.

History of Simon Property Group

      • Simon Property Group is the largest REIT and largest mall operator in America
      • Founded by brothers Melvin and Herbert Simon in 1960 in Indianapolis as Melvin Simon and Associates.
      • It eventually became the publicly traded Simon Property Group in 1993.
      • SPG owns and operates malls.  Where did malls come from and what is their significance?
      • Ever since commerce has existed, merchants have needed a place to set up shop.  One example are the bazaars that have existed in the Middle East for centuries…and even millenia.  Evidence of places of trade existing go back to 3000 B.C.!
      • The first precursor to what we know as a mall today started at a place called The Arcade, in Providence, Rhode Island in 1828.  
      • As the suburbs in America grew throughout the 1900s (especially after WWII), larger shopping centers were created outside of city centers.  They gradually got bigger and bigger, and were designed to accommodate people traveling by car.
      • The first enclosed shopping mall didn’t really appear until the 1950s.  New features such as air conditioning and restaurants were added.
      • Mall growth generally continued deep into the 20th century, even into the 1990s.  By the early 2000s though, the “dead mall” phenomenon started to become an emerging trend.  In 2007 no new malls were built, and a new one wasn’t built after that until 2012.  This makes sense for a few reasons:
        • The global recession happened in 2008, causing credit to dry up for large, commercial construction projects
        • Specialty stores and traditional retail stores (especially anchor stores) were becoming increasingly irrelevant as more and more purchases of consumer goods shifted online.
          • Every mall has a few “anchor” tenants, that exist as the major draw for people to come into a mall.  These tenants take up a disproportionate amount of square footage, make up more of the sales for a mall, and in turn provide more rents to the mall owner (like SPG).  Which store are you more likely to go to more frequently?  Macy’s or Bath & Body Works?
          • Anchor tenants are typically placed as far apart as possible from each other in order maximize traffic flow throughout the entire retail space.

Business Overview – What is a REIT?

      • SPG is organized as a REIT, or Real Estate Investment Trust.  This is a type of security that, though it trades on the public markets just like regular common stock, operates a bit differently.
      • REITs are legally bound to derive the vast majority of their income from real property (could be owned directly, could be a stake in a partnership or joint venture, could be in the form of a mortgage on property).
      • REITs do not pay corporate taxes, and thus as “pass through” entities.  In the U.S., REITs must pay out at least 90% of their taxable income to shareholders (different laws in other countries).  An effect of this is that in order to fund growth, REITs often look to the debt markets and credit markets.  Also because of this structure, the company can pay out more money to the owners, but the flip side is that you and I would pay ordinary income taxes on these dividends.  Let’s take a moment to look at a hypothetical scenario between a common stock and a REIT.
        • Common stock: Let’s say a company makes $2.00/share in net income.  It then decides to distribute $1.00 of that as dividends.  Those dividends are already taxed at the corporate level, so we can assume that if they weren’t taxed they would be around $1.26 (take a 21% tax off of the corporate profits that would be going to dividends to get $1.00).  Then, let’s assume that you as the investor hold the shares long enough to get the dividends counted as “qualified” (60 days for common stock – some special tax rules apply here).  Let’s say that based on your tax bracket, you get charged 15% in taxes on qualified dividends.  So that $1.00 now turns into $0.85.  $1.26 at the corporate level then gets converted to $0.85 after both you and the company pay taxes (and yes…this is double taxation).
        • REITs: REITs are different!  Let’s say the company distributes $1.26 in pre-tax profit as dividends.  Since it is a pass through entity you get all $1.26 showing up in your brokerage account.  Now, you have to pay taxes on this amount.  Here’s where it gets tricky. 
        • Because you are a unitholder and not a shareholder, this $1.26 is split into two parts: one is called a return of capital and the other is your portion of the earnings.  The portion of the earnings is just as it sounds – your share of the cash flows just like a regular dividend.  The return of capital is considered to be you getting part of your initial investment back by the IRS.  This is because REITs have a lot of depreciation and other expenses that they have to account for on their books.  So for this portion of your income, it’s not considered taxable.
        • So you’re paying dividend taxes on a portion of the income you receive, but not all of it.  This is great because it lowers the effective taxes you have to pay on this high yield.  There is a cost to this however, quite literally.  When you get a portion of your income given to you as a return of capital, your cost basis on the investment is lowered.  That means if you paid $20/share for your shares initially, over time as you get dividends from the REIT, your cost basis will decline gradually to $19, $18, etc.  So, when you eventually sell the stock (hopefully for a gain) you’re going to have to pay more in capital gains taxes because your cost basis was lowered.  
        • At this point you may be wondering – ok, well what happens if I hold onto a REIT for a long time, and it pays me so much income that my cost basis gets brought down to $0?  Great question.  At this point, any subsequent return is considered as a capital gain by the IRS.
        • Let’s get back to the example.  Say you have this $1.26 and half of it is given as a return of capital, while the other half is taxed as qualified dividends.  If you do the math, in this scenario you end up with about $1.16 after taxes.  Not bad compared to $0.85!  Note that your cost basis is getting lowered here as well in the REIT scenario, so that has to be considered.

Business Overview – SPG

 

      • Let’s get back to SPG.  Simon Property Group develops and manages premier commercial real estate, specifically malls.  The definition of a “mall” is changing somewhat, but this broadly includes shopping, dining, restaurants, other entertainment categories.  There are also “mixed use” properties.  For example, apartments or condos can share the same building as a row of restaurants, shops, or fitness centers
      • They own 204 income-producing properties in the United States.  Over half of these are malls of some type, 69 are Premium Outlets, and there are a small number of other types of retail properties.
      • They also have ownership interests in 29 properties throughout Asia, Europe, and Canada.  This includes an approximate 22% ownership stake in Paris-based real estate company Klépierre (they are publicly traded).
      • Going through their list of properties, I realize that I have shopped at or been in several of their properties over the years.  They are pretty nice malls and tend to have a wide selection of stores.  They have properties spread across the States, but I noticed particular trends of more properties in certain areas, like Texas and Florida.  This isn’t surprising because these are very “consumer friendly” states (I have lived in both).
      • Simon now uses bluetooth technology at its properties, so as shoppers stroll into a store they can get notifications about deals tailored to that particular property
      • They are also rolling out marketing campaigns specific to Simon, with management realizing that they want to create their own brand identity in addition to their tenants’ brands.
      • Across their portfolio, the occupancy rate is around 95% (pre-COVID), which is very good and indicates their properties are in high demand.
      • In spite of the “dying mall” overall trend, SPG is still building new properties and pursuing redevelopments.  In 2018 they opened Denver Premium Outlets in Denver, CO (cost $128 MM).  In 2019 they started construction on a premium outlet in Tulsa, OK that is expected to open in 2021.
      • There is also lots of planned development activity in international markets.  This is happening in countries like Japan, Spain, Mexico, France, England, South Korea, and Canada.  Typically what Simon does is create a joint venture so it owns 20-90% of the project.

Financials

 

2012

2019

CAGR (%) / Comments

Sales

4.8

5.7

2%

Depreciation and Amortization

1.2

1.3

Funds From Operations

2.4

4.2

8.3% 

Diluted FFO Per Share

$7.98

$12.04

6%

Cash

1.1

670 MM

Long Term Debt

23

24

8.8% of total debt was floating rate in 2012.  By 2019 this decreased to 3.5% of the debt.

Operating Cash Flow

2.5

3.8

6%

Investing Cash Flow

(3.5)

(1.0)

Financing Cash Flow

1.4

2.5

Virtually all dividends, though there are some share buybacks.  Debt position relatively stable in 2017, 2018, 2019.

Dividends

$4.10 (1.2)

$8.30

(2.9)

10% per share growth, 13% payment volume growth

Shares Outstanding

303 MM

306 MM

-%

 

Valuation and Closing Thoughts

 

    • There are two things that are great about Simon.
      • 1) It owns some of the highest quality commercial real estate in America (and some abroad).  By high quality I mean high sales per square foot.
      • 2) It pays out a fat dividend yield.
    • Let’s take a moment to consider the risks.  The first and biggest one is the most obvious – the decline of malls in America, which is no doubt accelerated by the impact of COVID-19.
      • Honestly, I am not too worried about COVID-19 permanently decreasing foot traffic at malls.  People are constrained from spending because they are effectively forced to – no other option but to buy things online.  I’ll revisit this statement in a moment.
      • That being said, there is definitely a secular trend toward a greater percentage of shopping moving online, which is undeniable.  In 2010 only 4% of U.S. retails sales were online, whereas as of Q1 2020, nearly 12% was online.
      • As long term investors, there are few questions to ask here.  First, will the growth of online shopping permanently erode physical retail sales?  I think the answer is yes and no.  Yes in the sense that lower quality retail locations will be wiped out, as they simply have no reason to exist.  Who would ever go to a run down mall to buy a pair of shoes when you could just buy it on your phone at home?  The answer I think is also no in the sense that I do not believe we will ever become a society where people never buy things in person.  I don’t know what the ratio will stabilize at, but I believe it will stabilize.  It might be 50/50 online to physical, 80/20, or something else.  I don’t know.  But being able to touch and see products in front of you does have some appeal (at least for now – just wait until augmented reality becomes a bigger deal, but that’s a topic for another podcast).  What is probably more important here is the focus on customer experience, which leads to the next question.
    • What Wall Street has been asking is some variation of: will the growth of online shopping eliminate the appeal of malls?  Fundamentally, I think this is the wrong question.  The question I want to ask is: will the growth of online shopping eliminate the appeal of high-end physical gathering spaces.  Now, I think that is a much better question because I think it gets to the heart of the matter.  
    • Malls are simply large buildings with lots of space in them.  There’s landscaping, basic infrastructure like heating and cooling, and parking lots.  But really, they act as a place for people to gather.  This sense of physical community is inherent in human nature.  Let’s think back to the first bazaars that existed millenia ago.  The bazaars eventually disappeared, but the marketplace didn’t.  In fact, marketplaces around the world have simply transformed into different forms of gathering places.
    • SPG is sitting on a lot of real estate, and they work very hard to make it attractive to customers.  Even if Macy’s, Dick’s Sporting Goods, and others don’t survive, they can find new tenants for different types of businesses (or other up and coming retailers).  As long as there is a desire for people to physically gather places, there is a potential for Simon to transform its asset base into whatever people want.
    • The trick with this though is that it takes a lot of money to do this, and a lot of experimentation.  
    • One thing that we do have to watch out for is the debt load, but it seems that SPG’s management has been relatively prudent since the debt has not increased much in recent years and 
    • Another thing of note is insider buying.  There have been many directors of the company buying stock lately.  David Simon, the CEO, purchased 150,000 shares on March 17th, at a pretty low price of $60.827 per share (that’s $9.1 MM).  This is meaningful because he owns over 950,000 shares, so this purchase increased his ownership by over 18%.
    • I don’t have much experience with REITs yet but this company has certainly been interesting to research.  SPG has already been working to transform its properties, and it has a great record of high tenant occupancy, which is key to reliable cash flow.
    • Right now the shares are trading around $62/share.  They did cut their dividend for the second quarter but didn’t eliminate it – now management is saying they expect to pay at least $6.00/share in 2020.  That’s a 10% dividend yield, and probably higher if things go well in 2021.
    • Over 97% of their properties reopened for business when July began, but with the resurgence of the virus there is definitely uncertainty here.
    • They purchased Aeropostale and Forever 21, who both went into bankruptcy in recent months.  There is a potential they could acquire J.C. Penney.  This is a sign of strength to me…they are the ones writing the big checks while other companies are forced to capitulate and sell for less than intrinsic value.  This is what Buffett and Munger do.
    • IF there is a solid recovery and tenants that can’t pay are replaced with tenants that can, I think there is a good opportunity here.  The cash flow is strong, the occupancy is high, the balance sheet is reasonable…they can weather the storm.  It will be interesting to see where things go from here.

 

 

Want to listen to another episode or check out another company?  Check out the full archive here.

Alex Mason

Hi, I'm Alex and I'm an individual investor and podcaster who's curious about the world, especially when it comes to long term investing in the stock market. I'm always looking for better ways to analyze businesses and add more mental models to my brain's tool belt.

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