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PREIT: Buy the Transformation

The death of America’s malls might be premature. Actually, let me rephrase that; the death of America’s premier malls might be premature. The truth is that upper-middle-income to upper-income Americans still like to get outside, head down to the mall and go shopping. That fact has propelled many of the country’s top mall operators – like Simon Property Group (SPG ) or Macerich (MAC ) – to new heights.

And Pennsylvania Real Estate Investment Trust (PEI ) (or PREIT as it’s known) could be the next to join them.

PEI is undergoing a transformation to turn itself into a premier player in the mall and lifestyle center sector. Although, it still has a few warts to figure out – which means investors have the chance to buy premier potential at a fraction of the cost of other mall operators.

The Class “C” Problem

For many mall REITs, their problems can be summed up in one word: Amazon (AMZN). As online shopping has disrupted how price-sensitive consumers shop, malls and retailers in less-than-ideal locations continue to see traffic and sales per square foot decline. According to real estate researcher Green Street Advisors, there are more than 200 malls in the United States that are considered “C”, or below, in quality. These are the troubled regional malls in less-than-desirable areas. The ones that are truly at risk of closing.

However, it turns out wealthier shoppers could care less about Amazon.

Class “A” malls in strong regions continue to see rising and high sales per square foot and ongoing traffic from shoppers. For example, Simon’s Lenox Square Mall in Atlanta brings in more than $1,000 in sales per square foot. That compares to the “C” rated Northlake Mall, only 8 miles away, where sales are $240 per square foot. The reason has been a mix of high-end shopping, dining and entertainment that simply isn’t easy to replicate online.

This brings us to PREIT.

A Transformation

Historically, PREIT has been an operator of class “B” and “C” malls in the Northeast. That wasn’t so much a problem during the heydays of shopping malls; but since the Recession, PREIT’s portfolio of malls has been slipping.

To that end, it began to transform itself into a class “A” operator and owner of retail real estate. That meant pruning its portfolio of junk properties by selling 13 malls and adding assets in prime locations like Washington. D.C. – basically focusing solely on the best malls in high income, high barriers to entry super-regional centers.

That process continues today.

PEI has recently announced that it will be looking to sell three of its lowest-performing malls with sales per square foot in the lower $300 range. That would leave PEI with 30 malls in better areas and, ultimately, boost sales figures at the firm.

PEI has also improved the tenant quality of its malls. New building and facility upgrades have meant that its locations can attract a better quality of shopper. With that, Lululemon, H&M and even Whole Foods (WFM) are now tenants at PEI’s malls and surrounding power-center properties.

All of this seems to be working as PEI has seen rising sales per square foot, occupancy rates and rents. PREIT managed to grow its sales from just $240 per square foot to $460. Rents for its malls have nearly doubled since it started its transformation.

A Big Discount to Rivals

While PREIT has been successfully shedding its class “B” and “C” former image, investors are still treating it the same: a victim of declining sales at the hand of online shopping. It’s being simply ignored. Most investors continue to plow their investment dollars into SPG, MAC or other operators of “fortress” and Class “A” malls.

This means PREIT is a discount compared to its rivals.

Currently, PEI shares can be had for a price to funds-from-operation (P/FFO) of just 11.6. Compare this to SPG’s P/FFO of 20, MAC’s P/FFO of 21.19 and General Growth Properties’ (GGP) P/FFO of 19.30. And let’s not forget that PEI currently yields 4%, which is more than any of its rivals.

Now keep in mind REITs like SPG trade at premiums thanks to their huge size and commanding presence in the sector. PREIT is never going to be that big. But it doesn’t have to be in order to be successful. It’s doing a fine job already.

The Bottom Line

The death of retail may be overstated. The Class “A” mall operators are thriving and PREIT is quickly joining their ranks. Its turnaround is working and, yet, it can still be had for a hefty discount versus its peers.