Real Estate Investment Trusts, or REITs, are a great way for long-term income investors to gain exposure to real estate without the hassle that comes with actually owning, maintaining, and managing rental properties.


In fact, REITs, if carefully chosen, can help you achieve the ultimate form of financial freedom; being able to live off pure dividend income during retirement, including early retirement.


Of course with so many REITs out there investors can have a tough time choosing where to invest their hard earned money.


Let’s take a look at one of the largest blue chip REITs, Simon Property Group (SPG), and see if now, thanks to the recent REIT correction, this mall owner deserves a core spot in a diversified portfolio such as our Conservative Retirees dividend portfolio.


Business Description

Simon Property Group is America’s largest mall owner (and the largest REIT by market cap), with 218 properties across the North America, Europe, and Asia. As seen below, malls account for half of the company’s assets, and premium outlets contribute another 31%. Most of the business is domestic with international assets accounting for just 8% of the total.


Simon Property Group SPG Dividend

Source: Simon Property Group Investor Presentation


By geography, Florida (14.7% of net operating income), California (12.8%), and Texas (10.4%) are the biggest contributors, but the business is well-diversified.


Simon Property Group SPG Dividend


The REIT’s historical success has been due to management’s disciplined approach to slow but steady growth. Specifically, Simon Property Group focuses exclusively on high-end and ultra premium luxury properties (such as its “Mills properties”), with good diversification across the U.S. as well as with tenants.


As you can see, Simon Property Group’s largest tenant accounts for just 3.4% of its total rent for U.S. properties. The malls the company owns property in are also reasonably diversified by anchor tenants with Macy’s representing the biggest share of square footage (12.8% of the total).


This helps protect Simon Property Group from being overly exposed to the fate of any single retailer, which is important because retail is a notoriously tough business with a low survival rate for many companies (consumers are fickle).


Simon Property Group SPG Dividend

Source: Simon Property Group Earnings Presentation


Business Analysis

While lower quality retailers, such as those found in grade B and C malls have suffered in recent years, Simon Property Group’s exclusive focus on the high end of the market has helped it to continue growing despite the rise of e-commerce giants such as Amazon (AMZN).


Even more impressive is the fact that management, led by CEO David Simon (Harvard business review called him one of the world’s greatest CEOs in 2013), has been able to generate improving profitability and returns on invested capital in an environment where low interest rates have sent commercial real estate prices soaring.


With 31 years of industry experience, including being with Simon Property Group since its 1993 IPO, Mr. Simon has proven to be one of the industry’s best capital allocators, generating 3,000% total returns over the past 23 years (five times better than the S&P 500).


Part of that is the REIT’s ability to locate attractive acquisition opportunities, which prove highly accretive to funds from operation per share (the equivalent of a REIT’s cash flow and what pays the dividend). Since Simon Property Group’s IPO in the early 1990s, the company has made over $40 billion of acquisitions, resulting in tremendous growth.


Simon Property Group SPG Dividend


But Simon Property’s true competitive advantage lies not just in acquiring top quality malls in fast-growing regions. The key to staying ahead of industry headwinds (e.g. rising online shopping) and generating consistent growth throughout various interest rate and economic growth cycles is to focus on the quality of the customer experience within each mall.


For example, Simon Property Group has invested heavily into revitalization efforts of its properties ($3 billion in just the last five years). This helps to attract not just more shoppers, but customers with higher incomes that in turn attract superior anchor tenants such as Neiman Marcus, Bloomingdale’s, Lord & Taylor, and Saks Fifth Avenue. Take a look at the $300 million transformation the company made to its shopping center in Long Island.


Simon Property Group SPG Dividend


The high end nature of its malls allows Simon Property Group to exert enviable pricing power, as represented by this year’s 4.5% increase in base rent it is charging its tenants in 2016. Yet despite the steep rent hike, occupancy at its properties remains at all-time highs (96.3%).


Better still, Simon Property Group’s vast diversification and long-term leases mean that it never faces a steep lease expiration cliff. As seen below, no single calendar year sees more than 8.6% of the company’s gross annual rental revenues expire. This staggering protects Simon Property Group from having to renew a large chunk of its leases or find many new clients in a down market. Occupancy rates and rent prices can remain more stable over time.


Simon Property Group SPG Dividend


These factors combine to give Simon Property Group strong cash flow predictability ,which allows for some of the strongest and most consistent dividend growth in the REIT industry in recent years. From 2010 through 2015, Simon Property Group’s free cash flow and dividends per share compounded by 10.1% and 18.4%, respectively.


Simon Property Group SPG Dividend


Key Risks

There are two main risk factors to consider with Simon Property Group. The first is the continuing growth of e-commerce and online retailing. Up until now, management has used its decades long expertise in premium retail to prevent this growing threat from harming its growth capabilities.


However, there is no guarantee that the company will be able to continue to do so. After all, at the end of the day if rivals like Amazon can deliver what shoppers want more conveniently, and at a better value than mall-based retailers, even luxury mall stores may end up falling into secular decline.


Then there is the risk of rising interest rates, which have risen by about 0.7% since the surprise results of the November 8th election.


This has been due to markets pricing in growing inflation from a combination of rising oil prices and a Trump stimulus package of tax cuts and infrastructure spending. While such a package is thought to be likely to spur economic growth (based on the market’s knee-jerk reaction at least),

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