The falling share price of retail property owner Washington Prime (NYSE: WPG) has driven its yield north of 20%. At that level, many investors in the real estate investment trust (REIT) were clearly anticipating a dividend cut when the company reported quarterly results last week.

It didn’t happen.

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Washington Prime reaffirmed its current policy of distributing $0.25 per share each quarter. It earned $0.31 per share in funds from operation (FFO) and expects to generate between $1.16 and $1.24 for the full year — providing a coverage ratio of 116% to 124% on the $1.00 per share annual distribution.

So the dividend is still safe, at least for now.

There is a widespread perception (driven by a steady drumbeat of dour media coverage) that brick-and-mortar shopping is dead. Storefronts everywhere are being boarded up and the nation’s shopping centers will soon be abandoned ghost towns.

It’s certainly true that many of the weaker malls and strip centers have already succumbed to the wave of retail bankruptcies and store closures. And there are other half-empty, moribund properties on life support. But let’s not get carried away.

The Truth About Retail (And WPG)
Americans love to shop — and 90 cents from every retail dollar is spent in physical stores.

Washington Prime owns dozens of tier one malls that are teeming with affluent customers. These stores are generating $399 in annual sales per square foot, fairly strong productivity. While the loss of several big anchor tenants like Toys R Us has stung, core portfolio occupancy rates remain healthy at 93.3% — versus 93.7% a year ago.

That figure doesn’t include the weaker second-tier properties, but they account for a small fraction (less than 10%) of net income.

The retail shakeout isn’t over — more stores will close. But many are in the oversaturated apparel category with little to differentiate themselves. We don’t need ten of them in the same mall. That’s why Washington Prime is incentivizing its leasing agents to diversify and bring in new types of tenants: fitness centers, professional offices, restaurants, entertainment centers.

The unique goods and services of these “lifestyle” tenants give shoppers more reasons to visit, which in turn benefits other neighboring renters. They are also less vulnerable to online competition.

Washington Prime signed new and renewal leases on 1.4 million square feet of space last quarter. Contrary to what the stock charts might indicate, that’s an increase of 20% from a year ago. And more than half of that space was in the lifestyle category.

Better still, leasing spreads (which measure incoming rent from new leases versus what was paid on old leases for the same space) increased by more than 13%. This figure might conceal leasing concessions that are common practice, such as tenant-improvement allowances. Still, rising spreads are encouraging, nonetheless.

That certainly doesn’t mean there aren’t challenges. There are 22 vacant department stores in the portfolio (although new renters have been found for half). And net operating income (NOI) is projected to fall between 1% and 3% this year.

But the biggest problem is negative investor sentiment, reinforced by headline-grabbing doom-and-gloom journalists.

To be clear, e-commerce isn’t going away and will likely continue to take a larger slice of the pie. But the fastest-growing segment (five times faster than online retail overall) is buy-online-pickup-in-store (BOPIS), where customers still visit the physical locations to collect their merchandise.

Risks To Consider
Here’s what has me worried, though. There isn’t much of a cushion in the event certain operating metrics deteriorate further. As it stands, dividends are eating up most of the firm’s cash flow, leaving little for required maintenance expenditures. They run about $65 million annually or $0.30 per share.

And redevelopment costs to breathe new life into tired properties are high — over $100 million this year alone.

With all this in mind, I think management needs to cut its distribution. While that would certainly drive many investors to the exits and temporarily hurt the shares, what matters most is the long-term health of the business and its future cash flow potential.

Cutting the distribution in half would preserve more than $100 million per year, funds that could be rediverted to accelerate redevelopment efforts and lead to higher rental rates. And few would complain of “only” a 10% yield.

Action to Take
Washington Prime continues to diligently convert tired malls into vibrant “town centers.” That process takes time. But management is executing well, and the company maintains a stout, investment-grade balance sheet. Given the stiff headwinds, I am telling my High-Yield Investing subscribers that this stock is a “hold” right now. I need to see more evidence of progress in a turnaround before rating it as a “buy.” But the stock could easily deliver triple-digit gains once turnaround efforts begin to yield tangible results.

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