1 December 17, 2018 Deborah Weinswig, CEO and Founder, Coresight Research deborahweinswigcoresight US: 917.65.6790 HK: 852.619.179 CN: 86.186.1420.3016 Copyright © 2018 Coresight Research. All rights reserved. This report provides an overview of the evolution of real estate investment trusts (REITs) in the US and the current REIT landscape, with a focus on retail REITs. 1) Retail REITs have performed well recently, facilitated by wel-managed strategies, despite a particularly dificult retail environment in 2017. 2) Occupancy rate growth for retail REITs betwen 2003 and 2017 was second only to that of industrial REITs, while funds from operations, net operating income (NOI) and same-store NOI also showed steady growth betwen 2000 and 2017. 3) Changing tenant mixes at mall REITs highlight a period of evolution. 4) A shift toward services and experiential retail has prompted diversification away from typical tenants, such as department stores and apparel retailers. 5) Landlords are increasingly looking to food and beverage services as traffic drivers. US Retail REITs Review: A Change in Strategy for Changing Times Deborah Weinswig CEO and Founder Coresight Research deborahweinswigcoresight US: 917.655.6790 HK: 852.6119.1779 CN: 86.186.1420.3016 2 December 17, 2018 Deborah Weinswig, CEO and Founder, Coresight Research deborahweinswigcoresight US: 917.65.6790 HK: 852.619.179 CN: 86.186.1420.3016 Copyright © 2018 Coresight Research. All rights reserved. Table of Contents Introduction . 3 How It All Began . 3 A Slow and Steady Evolution for US REITs . 3 A Chalenging 2017 for US REITs . 3 Retail REITs . 4 Growth in FO and NOI . 6 Dividend Yields . 8 Occupancy . 9 Shoping Center REITs vs. Mall REITs . 10 New Tenants Coming into the Mix . 10 Key Takeaways . 12 3 December 17, 2018 Deborah Weinswig, CEO and Founder, Coresight Research deborahweinswigcoresight US: 917.65.6790 HK: 852.619.179 CN: 86.186.1420.3016 Copyright © 2018 Coresight Research. All rights reserved. Introduction The environment for REITs (companies that own, finance or manage real estate) in the US has changed significantly over the past few years, after being marked by some heady highs in previous decades. This report examines US REITs, with a primary focus on retail REITs. It provides some perspective on the historical factors that led to the current environment and examines the future outlook for US retail REITs. How It All Began REITs in the US date back to 1960, when Congres enacted the Real Estate Investment Trust Act to enable all kinds of investors to acces large-scale, diversified portfolios of income-producing real estate. This legislation gave rise to an investment vehicle that combined aspects of real estate and stock-based investments. Since then, REITs have evolved significantly, and the US model has ben the inspiration for various other REIT models acros the world. A Slow and Steady Evolution for US REITs Although the first REIT was formed in 1961, it tok a while for REITs to catch on and gain acceptance as a sustainable asset class. The 1980s set the tone for the curent industry. During that decade, the real estate market in the US saw a bom folowed by a bust. Property values declined in the later half of the decade, driven by overbuilding and the Tax Reform Act of 1986, which eliminated some key tax advantages to investing in REITs. This decline translated into a great opportunity for REITs, and they began acquiring properties at economical rates, which facilitated their positive market performance. The S for al equity REITs, the rate was lower at 94.3%. Figure 7. Ocupancy Rates for Diferent Sectors, 2032017 (%) Source: Nareit T-Tracker 0.00500.001,000.001,500.002,000.002,500.003,000.003,500.001Q001Q011Q021Q031Q041Q051Q061Q071Q081Q091Q101Q111Q121Q131Q141Q151Q161Q17Shoping Centers Regional Mals Frestanding95.2482.0084.0086.0088.0090.0092.0094.0096.0098.002Q032Q042Q052Q062Q072Q082Q092Q102Q112Q122Q132Q142Q152Q162Q172Q18All Equity REITs Apartments Retail Industrial OfficeThe occupancy rate in REIT-owned malls and shopping centers has been 95% or higher in recent years. Industrial and retail REITs have been the frontruners among all REITs in terms of occupancy. 10 December 17, 2018 Deborah Weinswig, CEO and Founder, Coresight Research deborahweinswigcoresight US: 917.65.6790 HK: 852.619.179 CN: 86.186.1420.3016 Copyright © 2018 Coresight Research. All rights reserved. Shoping Center REITs vs. Mal REITs A shopping center is typically defined as a collection of retail and other commercial establishments that sel merchandise to the public in an enclosed space that is planed, developed, owned and managed as a single property. A mal, on the other hand, can be a shopping mal, a strip mal or a pedestrian stret and need not necessarily be in an enclosed space. From 1994 until 2017, shopping center REITs total returns were about 130 basis points lower per year than the broader REIT average return. This has been a common trend in the shoping center sector and other sectors that have sen above-average capital expenditures. The average anual return of shopping center REITs was 10.9% over the 19942017 period, versus a 12.2% return on the FTSE Nareit All Equity REITs Index. After experiencing a tough 2017, the shopping center REITs grew by more than 13% in terms of total returns over the first quarter of 2018, on the back of an improvement in economic growth. Out of 11 shopping center REITs, five beat adjusted FFO and NOI earnings estimates in the first quarter of 2018, while the other six reached expectations on these metrics. Mal REITs performed wel in terms of total returns in the period right after the 2008 recession, but they have ben underperforming since the beginning of 2016. As measured by total returns, the sector was the second-worst performer among all REITs in 2016 and 2017. In 2018, mal REITs total returns had plunged by more than 12% by mid-May, leaving the sector ahead of only shopping centers among all REIT sectors. Among mal REITs, there has been a discernible diference in the performance of top-tier and lower-tier REITs. Top-tier mal REITs reported strong results for the fourth quarter of 2017 and the first two quarters of 2018, whereas lower-tier mal REITs generated disappointing results over the same period. While the former showed strong fundamentals and positive signs for continued growth, the latter continued to fight for survival. 2017s store closures are stil negatively impacting power center REITs, but grocery-anchored REITs and higher-quality power center REITs are expected to experience continued growth. New Tenants Coming into the Mix One of the ways that retail REITs have countered the chalenging retail environment has been to reexamine and reshape their tenant mixes. Many REITs have welcomed new tenants, to ensure that occupancy rates remain high, and also factored in shopers desire for experiences when choosing tenants. Retail REITs are also investing in making improvements to their properties in order to enhance their appeal to shoppers and visitors. An analysis of how tenant mixes have changed over time provides some interesting insights. The table below looks at the top 10 anchor stores at mal REITs in 206, 201 and 2016. The table shows the number of store locations in mal REITs property portfolios in total, but not those stores square footage. We note that the size of stores difers from tenant to tenant and that changes may have happened over time. Nevertheles, folowing are the key trends: Shoping center REITs grew by more than 13% in terms of total returns over the first quarter of 2018. Mal REITs were the second-worst-performing sector by total returns in 2016 and 2017 and, in 2018, the sectors returns had declined by 12% by mid-May.