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Private equity owned retail seeing most bankruptcies this year: Analyst

Jim Sullivan / BTIG managing director and REITs analyst joins Yahoo Finance and weighs in on the retail and REIT outlook amid Covid-19.

Video Transcript

ADAM SHAPIRO: Just when you thought malls were dead, there was the news that Simon Property Group, along with its partners, has agreed to buy Brooks Brothers for $325 million-- much more going on, though, in commercial real estate. And to help us see what that is, we will come back into the stream Jim Sullivan, BTIG managing director and REITs analyst for us. And this move by Simon Property to become not only the landlord, but actually have a stake in some of the stores, are they going to build out on that? And is this a wise business move for them?

JIM SULLIVAN: Well, I'd say that in terms of whether they're going to build out, time will tell here. But this is only the third deal that they've done since the beginning of 2016. Back then, they acquired with Authentic Brands' Aeropostale. And that transaction has been very, very successful and profitable for Simon. They only invested about $30 million in that transaction. And they've earned back multiples of that between EBITDA earned as well as the value of the holdings they currently have as a result of that transaction.

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Earlier this year, they agreed with Authentic Brands once again to acquire Forever 21. And that transaction is really just getting under way. Obviously, the timing is difficult there. And the Brooks Brothers transaction is the third. They do have also one other transaction, Lucky Brand. So if we put this into context, Simon is investing between Brooks Brothers and Lucky Brand, $50 million.

Simon currently is a company with an enterprise valuation of about $55 billion. So this is a very, very small transaction by the company. And so far, to the extent we've had any time to assess the profitability of what they've done previously with Aero, it's been very successful.

JULIE HYMAN: Jim-- sorry. Sorry, Adam. Jim, when you are looking not only at these transactions, but obviously, in general, the vacancy rate that we're seeing-- and also the non-payment, non-collection. I'm talking about the positioning of malls, not just Simon Property, but the mall REITs across the universe. Simon traditionally has been better positioned because it has the so-called A malls. But is there any defense [INAUDIBLE]

JIM SULLIVAN: Is there any-- sorry, I didn't hear the last part of the question.

JULIE HYMAN: Is there any is there any sort of defense? And does it help them to be a mall owner at a time like this?

JIM SULLIVAN: Oh, absolutely. I think-- you know, we can-- journalists have come to describe the current situation as the retail apocalypse, of course, and, you know, with the shift in some sales to e-commerce. But when you look back at Simon's portfolio over the four years ending December 2019, their occupancy rate in the portfolio declined very slightly, actually, from 96% to 95%. So there's a very small decline over time, although there was a significant amount of retail failure.

So up through the end of last year, they had done a very good job at handling retailer failure and getting back stores. And for the most part, as I said, they only did one transaction during that period of time. And that was the Aeropostale transaction. Now, what's happened this year, of course, is with the pandemic, we're seeing an acceleration of failure by private equity-owned retail, particularly when that private equity-owned retail is thinly capitalized.

Now, that's not the only failure we're seeing in retail, but that's where it's been concentrated as far as the mall owners are concerned. So in the case of Simon, in the report that they delivered this week, you're right. There was non-payment by tenants who are otherwise solvent. Their largest tenant is GAP, and it appears that Simon and GAP are heading to court. Simon has now sued GAP for $100 million of unpaid rent.

And that percentage, i.e. tenants who are in place and that haven't paid their rent, is about 4% or so of their total revenue base. And then there's the bigger-- the bigger problem this quarter has been an acceleration of store closures and unpaid rent in arrears. That's what resulted in what was an 18% decline in net operating income in the second quarter.

This, I think, will be the worst quarter going forward. We're anticipating, as Simon indicated in their call this week, that based on collections that have increased significantly beginning in July as centers opened, that, in fact, the outstanding receivable balance at the end of June will be whittled down as centers reopen and tenans who are going to continue to be in business will pay down their arrears. So we expect that to play out that way. And we expect the second quarter results to be the worst of the year.

KRISTIN MYERS: Jim, it's Kristin here. I know you focus on the retail mall space and hotels, but I wanted to just look a little bit more broadly and even a little bit more tangentially about what you think this post-pandemic landscape is going to look like. I know that you've been chatting a little bit about this. Especially as we see offices shutting down, a lot of businesses and companies consolidating their businesses [INAUDIBLE] aren't going to be ever returning work.

JIM SULLIVAN: Well, I think the office-- you mentioned office, and, of course, that's a major-- that's a major guessing game at the moment. You know, what will the office demand be like in New York City as the lockdown gets lifted and corporations decide just how comfortable they are with having a significant amount of their employee base working from home? I think that's an outstanding question. We don't know what the answer is going to be.

The flip side of that situation, however, is that if office-- if tenants do want to return to the office but they want to do it, say, with 50% of their employee base but they want to have social distancing between those employees for the time being, theoretically, that would lead to a higher amount of square foot per employee. So the impact on office demand in the near term may not be as negative as one would otherwise expect.

However, having said that, we're clearly anticipating that office vacancy rates are going to rise in markets like New York. And we'll get a better read on this, really, in the first quarter. On the other side of the equation, however, when you think of specific tenants, you have Facebook deciding to take an entire new building in midtown-- well, between Penn Station and Hudson Yards in Manhattan west, where they're taking upwards of 800,000 square feet in the Farley Building, which will be sitting on top of an expanded, renovated Penn Station terminus.

So there's plenty of demand in the market for large spaces. But the question is whether that demand is going to be adequate as we go through lease termination in the next year or two. It's a-- you know, the answer, we don't know at this point. And how comfortable will employees be continuing to work from home?

You know, we hear, again, both sides of the equation in talking with-- in talking with our colleagues. But in the financial services business, so far, so good in terms of having the major part of your employee base work from home. So we think it is going to be a hit to vacancy, and probably in the 3% to 5% range in terms of vacancy increase.

ADAM SHAPIRO: Jim Sullivan is BTIG's managing director and a REITs analyst. We appreciate your insight here "On the Move."