Profiting from the Lowly Strip Mall

Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Strip malls--the very name probably makes you think of something undesirable. However, there are an awful lot of strip malls in this country, and investing in them can be quite lucrative. While owning one yourself would probably be a bad idea, investing in a real estate investment trust (REIT) that focuses on this property type can provide consistent dividend income and growth. Companies like Kimco Realty (NYSE: KIM), Regency Centers (NYSE: REG), Federal Realty Investment Trust (NYSE: FRT), Equity One REIT (NYSE: EQY), and monthly dividend payer Whitestone REIT (NYSE: WSR) all provide direct exposure.

Strip malls are an interesting asset class within the property sector. They aren't glamorous, but they get lots of traffic because of the types of stores that are generally in these malls. The lead tenant is often a store that customers have to go to a lot, such as a grocery store. Around this “anchor” is usually a collection of smaller stores that provide products and services that are consumed at the local level. Small restaurants, such as pizza parlors, Chinese, and Japanese places, hair salons, dry cleaners, and card stores are all examples of typical small tenants. While on their own none would be a big draw, all together they create meaningful traffic.

Every Day Items Equals Every Day Visits
So while most people think of a trip to the mall as going to one of the enclosed variety, its far more likely on any given day that a visit to the lowly strip mall will take place rather than a trip to an enclosed destination mall. This is one of the main benefits that comes from owning strip malls. Cost is another one, since strip malls are far cheaper to maintain than a massive enclosed mall. Moreover, no one is expecting anything fancy when they go to a strip mall, so amenities, like play areas and fancy bathrooms, aren't usually an issue, either.

One thing that can hit strip malls hard is economic weakness. When the economy falters, consumers cut back. While this hurts all mall types, the small stores that frequent strip malls generally have a harder time staying afloat than the large tenants that populate most enclosed malls. However, this can create opportunities, too, for intrepid investors.

The market for strip malls is large and fragmented, and there are fairly low barriers to entry. So there are always opportunities for investment, and there are also plenty of strip malls in need of repair. Some companies, like Whitestone REIT, specialize in picking up diamonds in the rough (read more about Whitestone REIT's investment approach), while others, like Federal Realty, only focus on top-notch properties. So there's a fair amount of diversity for investors looking to participate through a REIT. Some names to look at are:

The Big Guy
KIMCO Realty Corp. owns almost 1,000 shopping centers across the country. It is by far one of the largest industry participants. It offers investors a massive amount of market diversification, though growth is likely to be limited because of its size. That said, there are benefits to scale, like the ability to spread costs over a larger base of properties, so slower growth may be a worthwhile trade off. The market, however, is well aware of KIMCO's merits and has placed a premium valuation on the company. Income oriented investors would probably be better served looking at higher-yielding, though potentially more risky, fare.

Of course having a small property portfolio doesn't always lead to a discounted valuation. Federal Realty, for example, owns only a fraction of the properties that KIMCO owns, but has been afforded a premium valuation and, thus, offers just a low yield. In fact, its yield is even lower than KIMCO's. Federal Realty focuses on higher-end properties, so it's premium pricing isn't surprising. That said, it is much more expensive to find and maintain high-end strip malls than it is to deal with less auspicious fare, as more affluent patrons likely provides some protection from the impact of economic weakness. Trade offs abound, but Federal Realty's low dividend yield suggests it's being afforded too high a premium by investors.

High-End Focus
Equity One is another REIT that focuses on higher-end markets, the so-called supply constrained regions. It owns more than 150 properties in key coastal markets like Florida, southern New York, and California. That said, it owns properties all along the eastern United States, and not just in a couple of states. With a recent dividend yield around 4.4%, it is probably a bit too pricey for most income investors to consider. However, 4.4% is in line with KIMCO and still well above the yield offered by Federal Realty.

Another REIT with a 4% or so yield in the strip mall space is Regency Centers. Like Equity One and Federal Realty, it focuses on high-quality, primarily grocery-anchored centers in areas with above average incomes and high population density. It owns more than 200 shopping centers and has interests in nearly 150 more through partnerships. Its portfolio is spread across 24 states, but it has a material presence in California, Florida, and Texas, so it isn't all that much different than Equity One in many respects.

A Rehab Specialist with a Big Yield
Whitestone REIT is the odd man out and is the strip mall REIT with the highest yield. It focuses on what it calls Community Centered Properties, which it defines as “visibly located properties in established or developing culturally diverse neighborhoods.” It generally buys properties that have been neglected in some way and then strives to re-develop them to increase their value. Management pays particular attention to the local communities in its re-development efforts, often focusing on smaller, service-oriented tenants. Its primary markets are Arizona and Texas, though it also has a small presence in Illinois. I

t is very small, owning just a fraction of the properties that the above REITs own. However, its small size allows it to benefit more from acquisitions and provides a more material growth profile. Of course being small comes with risks, too, but the over 9% yield seems to be ample compensation. Another distinguishing factor is that the dividend is paid monthly. For a deeper review of Whitestone, you can read my previous article on the company's strengths and weaknesses.

For investors seeking a high yield, Whitestone is clearly the REIT that should be researched more fully. However, more conservative investors would be wise to keep an eye on this sector. It might be a bit pricey right now, but should some of the above higher-end focused REITs sell off on market weakness, they might be worth a closer look.

ReubenGBrewer has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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