Despite Falling Brick-and-Mortar Sales, Mall REITs' Cash Flows Should Stay Positive

Brick-and-mortar retail saw a dramatic decline in sales in the second quarter of 2020 as the coronavirus pandemic closed most malls and many nonessential businesses. While total retail sales have declined as the U.S. economy enters a recession as a result of the pandemic’s fallout, e-commerce sales growth has taken off as consumers are forced to stay home and shop online.

The fear many investors have is that the change in consumer behavior will be sticky and the loss in sales will further erode brick-and-mortar retail’s share of total sales, which will pressure the mall real estate investment trusts to produce positive cash flows and stay solvent. However, our analysis shows that outside of recessions, e-commerce sales growth follows a predictable, downward-sloping curve over time. Since we believe that the impact of the pandemic will have dissipated at some point in 2021, we expect e-commerce sales growth will return to its prior level of low-double-digit growth in 2022, which should produce very low but positive sales growth for brick-and-mortar retail. The impact on the mall REITs will be severe in 2020 as the companies will have to deal with the drop in sales lowering market rents and thus re-leasing spreads, retailer bankruptcies causing significant occupancy declines, and unpaid rent and rent relief potentially turning into permanent rent concessions to keep existing tenants.