Mall Valuations Post GGP/BPY

This is my fifth post on high quality mall REIT valuations in less than a year. Going back to my first post on May 4, 2017 ( https://shulmaven.blogspot.com/2017/05/a-new-look-at-mall-reit-valuations.html) I noted that the 4.5% cap rates used by most REIT analysts were way to low and I argued that a 5.65% cap rate was more appropriate. This analysis did not receive much support when Unibail announced its acquisition of Westfield last fall that implied a cap rate for its U.S. assets in the high 4% range.

However, the Brookfield Property Partners (BPY) acquisition of the 64% of the shares of GGP that it did not own at an implied cap rate estimated to be in 5.8%-6% range validated my thesis. The BPY offer was valued at around $22 per GGP share, 19% below the Street consensus net asset value of $27.28. Warning: take Street estimates of NAV with a grain of salt.

If anything I was too optimistic. I argued then that high quality mall cap rates were under stress because the e-commerce challenge would require significantly high capital expenditures, lower future estimates of rent growth and cause a downgrading of approximately 15% of the those malls considered to be high quality over the next five years.  As of today the first two of my assumptions are now the conventional wisdom. I also argued that higher long term interest rates would pressure cap rates.  Since then the 10 year treasury yield has increased from 2.3% to 2.8%.

Yesterday mall stocks tanked on the GGP news. However, today the mall REIT shares are soaring on reports that President Donald Trump is out to get Amazon, their arch nemesis. As of 3:00 PM EDT AMZN was off by 5% and SPG, for example, was up by 3%. In my view today's stock market action is a transitory phenomena and the mall REITs will be revalued to reflect the GGP transaction. Simply put, AMZN ain't going away, Trump or no Trump.

What that means is that once the Street adjusts net asset values to reflect high quality mall cap rates in the high 5% range, the stocks will settle in to trade at about a 10% discount from the new asset values which implies moderately lower share prices. Why? There is still too much uncertainty in the space and in my view long term interest rates will be significantly higher by year end.