Pennsylvania REIT Faces Upcoming Maturities as Nearly 19% of Sq Ft Renews by End-2023 Amid Pressure on Rents; At Estimated 2023 EBITDA, PREIT Trading in Line With Peers but Leverage Is Elevated

2021 10-K
Q2’22 Supplemental Financial Information

Facing a credit agreement maturity in December 2023, assuming the company extends maturities by a year, a going-concern warning and recent short-term extensions on $300 million of nonrecourse subsidiary debt, Pennsylvania REIT, or PREIT, faces maturity headwinds as recent rent renewal rates trend lower and the company approaches a wave of lease renewals in 2022 and 2023, with nearly 19% of its owned square footage coming up for renewal in the two-year period.

While the company has expressed confidence that it will be able to exercise a one-year extension of its credit agreements from December 2022 to December 2023, a near-term issue is $300 million of subsidiary debt secured by the company’s Cherry Hill Mall, which matured on Sept. 1 and has been extended in monthly increments, potentially to Nov. 1. Although the debt is issued out of the Cherry Hill subsidiaries and is nonrecourse to PREIT, results are consolidated, and in recent quarters the mall has been the single-largest contributor of net operating income, or NOI, at an estimated $20 million in the last 12 months.

The going-concern notice was triggered by a covenant violation at a joint venture subsidiary, Fashion District Philadelphia, that PREIT is a guarantor on $93.7 million net of debt. If the debt is accelerated, the company said it may not be able to pay and may trigger a cross-default.

As revenue increased in 2021 from 2020, the company has managed free cash flow by limiting capital expenditures to below pre-Covid-19 levels. The company has also been selling noncore, primarily undeveloped assets, to further boost cash flow and liquidity.

Reorg has also estimated PREIT’s 2023 real estate rental income based on recent renewals and the square footage of leases that are due to renew in 2022 and 2023, coming to an illustrative rental income of $289.7 million in 2023 and a Reorg-estimated EBITDA of $145.1 million.

In terms of valuation, looking ahead to 2023 when the extended maturities would come due, PREIT is currently trading at comparable value through its second lien debt on an enterprise value basis consistent with its peers.

Capital Structure

Following its December 2020 emergence from chapter 11, PREIT is one of a handful of companies that Reorg has tracked in Credit Cloud to emerge from chapter 11 since 2020 with more debt than it entered with, primarily due to uptiering unsecured debt to secured debt.

The company’s capital structure as of June 30 is shown below:
 
The company is able to extend its credit agreement facilities by one year from December 2022 to December 2023, subject to compliance with certain conditions. PREIT CFO Mario Ventresca said, “we fully expect to achieve the credit facility extension later this year” during its second-quarter earnings conference call.

The company’s first lien credit agreement, as amended and restated following its emergence, names PREIT Associates LP. and PREIT-RUBIN Inc. as borrowers and PREIT as the parent signatory.

Going-Concern Warning, Recent Short-Term Maturity Extensions

FDP Loan

PREIT first issued a going-concern warning in its 2021 10-K due to performance issues with a loan at one of its unconsolidated subsidiaries, the Fashion District Philadelphia, or FDP, mall. FDP is a 50/50 joint venture with fellow mall REIT, Macerich, which is responsible for general operations of the property. PM Gallery LP is a joint venture entity owned indirectly by PREIT and Macerich and is the borrower of various term loan facilities. The FDP loan agreement matures in January 2023 and is subject to “a full recourse guarantee of 50% of the borrowers’ obligations by PREIT Associates, LP, on a several basis,” according to the company’s 10-K. The FDP loan guarantee was reaffirmed by PREIT Associates LP on Dec. 10, 2020, following the company’s emergence from chapter 11.

However, the FDP loan appears to be structurally junior to other debt, as both the first and second lien credit agreements make reference to guarantor subsidiaries, and PREIT’s plan of reorganization term sheet states that the secured debt is to be guaranteed by “[e]ach owner of a property listed on Exhibit A, and each other Subsidiary of Borrower, other than Excluded Subsidiaries,” while the FDP loan appears to be guaranteed by only PREIT Associates LP.

According to an organizational chart provided by the company during its chapter 11 filing, PREIT Associates LP sits directly below and is 97.5% owned by PREIT, and is the direct or indirect parent company of the company’s other subsidiaries. It is unknown where in the organization structure PM Gallery LP sits, though it seems reasonable to assume that it is an indirect subsidiary of PREIT Associates LP given the guarantee associated with the debt.

While the below is presumed to be accurate as of the company’s November 2020 filing, it is unknown whether the structure of the entities shifted after the company’s emergence from chapter 11.
 
The company adds, “There are also circumstances in which a default of the FDP Term Loan could give rise to an event of default under our Credit Agreements” (emphasis added). PREIT Associates LP and PREIT-RUBIN Inc. are the borrowers of the company’s credit agreement. PREIT as the parent company is also a signatory to the agreement.

As of Dec. 31, 2021, PM Gallery LP did not meet a minimum 10% debt yield covenant, which triggered a cash sweep at the property level.

PREIT detailed that “[b]ased on the joint venture’s current forecast, management projects that the joint venture will not be able to meet this covenant as the debt yield is projected to be under 9%. To the extent the term loan is not paid down by the joint venture, this term loan could become due and payable during the second half of 2022. The Company guarantees 50% of the joint venture’s obligations under the FDP Loan Agreement and management projects that the Company would not be able to satisfy its obligations if the FDP term loan would become due and payable in 2022.”

PREIT said that it “plans to work with its joint venture partner to satisfy any obligations coming due under the FDP Loan Agreement should it become due and payable.” The company added that “development work at that property is continuing and is expected to stabilize in 2022.”

Based on the company’s disclosure, and the above debt yield target, Reorg estimates that the current debt yield of the FDP property is 5%, based on an estimated $9.7 million gross NOI ($4.9 million net to PREIT) and $194.6 million outstanding on its term loan, or $97.3 million net to PREIT. Getting the term loan to compliance with a 9% debt yield would require the balance to be no more than $107.8 million at the mall’s current NOI and would therefore need to be paid down by $86.8 million total, or $43.4 million to be funded by each PREIT and Macerich, holding NOI constant.

Cherry Hill Mall

Separate from the FDP property, on Sept. 7, the company disclosed that on Aug. 31, it extended two loans that are borrowed at two of its subsidiaries that own the Cherry Hill Mall. Cherry Hill is 100% owned by PREIT. An aggregate of $300 million of loans, split into two separate $150 million promissory notes owed to two lenders, had an original maturity date of Sept. 1, 2022, and were extended by one month to Oct. 1. In conjunction with the extension, the company repaid $1 million of the outstanding balance.

The extension agreement allows the company to further extend the note maturities to Nov. 1 if the company repays an additional $500,000 of the principal balance and a 0.1% extension fee.

The borrowers of the promissory notes are PR Cherry Hill STW LLC and Cherry Hill Center LLC. It does not appear that PREIT is a guarantor or party to the notes. According to the promissory notes, the notes are secured by a mortgage on the property. The note states, “If an Event of Default has occurred, Holder may exercise any and all Remedies, and shall have full recourse to the Secured Property and to any other collateral.”

Cherry Hill Mall is one of PREIT’s core properties and in recent quarters has been one of the highest contributors to the company’s NOI. In the second quarter, the mall contributed 13.6% of PREIT’s consolidated NOI, more than any other mall. Reorg estimates that Cherry Hill contributed $20.1 million of NOI in the LTM period, based on PREIT’s segment disclosure and company-reported consolidated NOI.

Summary Financials

PREIT’s revenue had declined annually from 2017 until 2020, when in a Covid-19-induced recovery, the decline abruptly reversed. While 2021 full-year revenue and base rent increased relative to 2020, it remains below 2019 levels.
 
Likewise with revenue, EBITDA declined from 2017 to 2020, prior to reversing in 2021. However, the company’s cash interest expense has not materially changed. PREIT filed for chapter 11 in November 2020 and emerged a month later with more debt than it entered with, as discussed earlier in this article.

The company’s cash interest expense on an LTM basis is lower versus 2020 but higher versus 2019.
 
The company’s cash flow has improved off of a sharp decrease in capital expenditures. From 2017 to 2019, the company’s annual spending on capex ranged from $181.1 million to $248.7 million, before falling drastically in 2020 coinciding with the onset of the Covid-19 pandemic, which reduced the company’s revenue and cash flow from operations.

It is unknown how long the company can continue to maintain such a reduced level of capex while maintaining the quality of its asset base. Below, we show the component breakdown of capex. While the reduction in investment in new buildings, assumed to be included in additions to construction in progress, may stay muted as the company does not seem to be currently focused on growth, investments in improvements may have to rise closer to historical levels to maintain the quality and desirability of the company’s properties.

Management has not given any capex guidance on earning calls or in prepared remarks in recent quarters.
 
Recent Rent Trends, Impact of Asset Sales

PREIT discloses average rent per square foot on an annual basis. Average rents are disclosed on a size of contract basis and by tenant type. Figures for the past five years are shown below, but what is noteworthy is that for each of the past five years, the under 10,000 sq. ft. rental rates have declined or, at best, stayed constant. Rates for over 10,000 sq. ft. leases have stayed substantially flat, though this may be due to the generally longer tenor of anchor tenant leases rather than a reflection of changes in market rents.
 
PREIT also discloses the change in rents with respect to renewals that are signed in each period. In the most recent three years, the renewal rate for leases under 10,000 sq. ft. has declined each year, and for leases over 10,000 sq. ft., it has increased in two of the most recent three years.
 
In 2021, PREIT executed renewals on approximately 788,000 sq. ft. of leases, or about 5% of its total owned square footage. Annualizing the first half of rental income of 2022 implies a full-year run rate of $285.1 million, or a decline of 3.8% from 2021. It is not possible to directly compare leasing results with company results, as PREIT does not disclose which malls or clients are responsible for the new contracts.

PREIT is currently in and about to enter two of its highest contract expiry years in the foreseeable future. According to the company’s 10-K, approximately 920,000 sq. ft. of rental agreements expire during 2022, and 1.9 million sq. ft. of contracts expire in 2023. This amounts to 6.1% and 12.5% of PREIT’s owned square footage, respectively. The company has 15.1 million of owned square footage, consisting of 11.4 million at its consolidated properties and 3.6 million at its unconsolidated, or not wholly owned, properties.

PREIT does not have a significant amount of customer concentration. As of Dec. 31, 2021, the company’s largest individual tenant was Macy’s, which represented about 15.1% of its total gross leasable area. Its second-largest tenant was Copper Retail JV LLC, or J.C. Penney, representing 9.4% of total gross leasable area.

To improve liquidity and pay down debt, PREIT has been selling assets, which consist predominantly of undeveloped parcels of land. So far in 2022, the company has netted $28.1 million in proceeds from asset sales. In July, it signed a purchase and sale agreement for its Exton Square Mall, at a price of $28.8 million. In its second-quarter earnings release, the company said that it “has several others in the final stages of negotiation for a total of over $200 million of potential incremental asset sales pending.”

PREIT’s restructuring term sheet includes various asset sale and debt paydown provisions as well as consent from lenders in the case of certain properties. For simplicity, sales of properties that produce net operating income generally will have to apply all proceeds to repay secured debt.

During PREIT’s chapter 11 process, the company disclosed an asset sale schedule. In November 2020, the company envisioned selling an aggregate of $95 million of assets between the first quarter of 2021 and the first quarter of 2022.
  Of PREIT’s malls, Exton Square is one of its lower contributing properties to the company’s results. Since the first quarter of 2021, the mall has contributed less than 1% of PREIT’s net operating income on a quarterly basis, and at the end of the second quarter it was 52% occupied, while nearly all of PREIT’s properties had occupancy rates of 85% or higher, and the company as a whole said its leased occupancy was 93% as of June 30. As a point of comparison, total leased occupancy as of Dec. 31, 2019, was 93.5%, showing that occupancy has substantially recovered to pre-Covid-19 levels.

Revenue Forecast Until Year-End 2023

In building an illustrative 2023 forecast, Reorg has made a few simplifying assumptions. Property operating expenses as well as depreciation and amortization for fiscal years 2022 and 2023 are assumed to be equal to the annualized actual expenses incurred in the first half of 2022. Both of these assumptions seem reasonable, as depreciation has been on a slight downward trend in recent years. Property operating expenses have been slightly higher in 2022 compared with 2021, which seems reasonable given general inflation in wages, utilities and other costs.

SG&A expenses are assumed to be $46 million per year, which is the midpoint of 2021 reported expenses and $42.5 million, the annualized amount based on the first half of 2022, and similar to what the company reported in 2019.

Revenue is the primary influence in the forecast. As discussed above, average gross rent per square foot has been declining since 2017, and correspondingly, total revenue has been in general decline, with the exception of the increase from 2020 to 2021. Reorg has built a forecast based on the square footage of leases that renewed during 2021 and are expected to renew in 2022 and 2023.

Based on the percentage of square footage that renewed in 2021, we have assumed no change in rental revenue for the rentals that did not expire and applied a reduction in rent that is scheduled to expire in 2022 and 2023. Approximately 75% of the square footage due to expire in 2022 and 2023 is attributable to non-anchor, or leases smaller than 10,000 sq. ft., and 25% is attributable to anchor leases, or larger than 10,000 sq. ft.

Based on the company’s disclosed renewal rates in 2020 and 2021, we have assumed small leases will renew 8% lower, and large leases will renew at unchanged rates. Based on 2021 real estate revenue of $295.9 million, this implies a gradual reduction in real estate revenue for each of the next two years.
 
As shown in an earlier section of this article, in 2021 Reorg’s adjusted EBITDA for PREIT was $151.1 million, consisting of $119 million at consolidated properties and $32.2 million from unconsolidated properties.

Given the revenue and expense estimates detailed above, and assuming an unchanged contribution from unconsolidated properties for simiplication, Reorg estimates that PREIT’s 2023 EBITDA could be approximately $145 million.
 
Peer Valuation Comparison

In order to approximate the relative and potential value of PREIT, Reorg has compared the company’s illustrative 2023 EV/EBITDA multiple with some of its publicly traded peers, including Simon Property Group, Macerich and CBL & Associates Properties. To show the estimate of PREIT’s value during the year it will need to refinance its debt, we have used the above 2023e Reorg EBITDA, while for its peers, last-12-month NOI is used instead.

Based on the book value of the various companies’ debt, and market capitalization of equity as of Sept. 19, PREIT’s enterprise value to net operating income is slightly lower than its peers, but not too dissimilar. Net operating income has been used as the metric for each peer, as disclosed in each company’s quarterly financial filings.

Using Reorg’s estimated 2023 EBITDA, PREIT is trading at comparable through its second lien debt, excluding the company’s preferred stock, on an enterprise value basis.
 
--Jeremy Sherby