Regional mall REITs appeared to end the second quarter on a high note, with at least three firms outperforming consensus analyst estimates by a range of $0.03 per share to $0.08 per share. The sector is not out of the woods just yet, however. Falling tenant sales continue to trouble analysts, who expect that the trend will put further pressure on rental rates. And while regional mall REITs, like their shopping center counterparts, have made substantial efforts to clean up their balance sheets in the past six months, some remain over-leveraged.

"It's our position that performance is still going to deteriorate from here for both shopping center guys and regional mall guys, but the malls are probably seeing greater drops in sales than shopping center REITs," says Todd Lukasik, an analyst with Morningstar. "Eventually, we think it's going to pressure rents and overall financial results."

In the second quarter ended Jun. 30, declines in sales per square foot ranged from 5.7 percent on the low end for properties operated by Glimcher Realty Trust (NYSE: GRT), a Columbus, Ohio-based REIT with a 21.7-million-square-foot portfolio, to 11.2 percent on the high end for properties operated by Taubman Centers, Inc. (NYSE: TCO), a Bloomfield Hills, Mich.-based REIT which specializes in luxury centers. Taubman owns 24.8 million square feet of space. Even Simon Property Group (NYSE: SPG), widely considered the outperformer in the regional mall space category, experienced a 10.5 percent decline in sales in the second quarter, to $442 per square foot from $494 per square foot in second quarter of 2008. Given that for the past three years, Simon's sales have reliably trended up by at least 4 percent year-over-year on a quarterly basis, the decline is "a pretty clear sign that things don't appear [poised] to get better anytime soon," according to Michael J. Magerman, senior vice president with Realpoint, LLC, a Horsham, Pa.-based credit rating agency.

Indianapolis-based Simon owns 246 million square feet of retail space, making it the largest retail landlord in the country. On a bright note for the firm, it has been able to continue raising debt and equity. It ended its fiscal second quarter with access to $6.3 billion of cash from debt and equity issuances, as well as proceeds from refinanced mortgages.

For Taubman Centers, falling sales have already left a sizeable impact on its portfolio—in the second quarter of this year, the occupancy rate declined 150 basis points from the second quarter of 2008, to 88.6 percent from 90.1 percent.

Philadelphia-based PREIT (NYSE: PEI), which operates 38 regional malls, and Chattanooga, Tenn.-based CBL & Associates Properties (NYSE: CBL), which has an 83.6-million-square-foot portfolio, also reported occupancy levels below 90 percent. Macerich Co. (NYSE: MAC) chairman and CEO Art Coppola summed up the current state of uncertainty during the company's second quarter earnings call on Aug. 4, saying "We don't know when sales are going to trend back up and how fast and what levels, but business is stable enough that retailers are making new commitments and they're talking about new business."

Santa Monica, Calif.-based Macerich Co., which owns a 76-million-square-foot portfolio, ended the second quarter with occupancy of 90.5 percent, 200 basis points down from 92.5 percent in the second quarter of 2008. Simon reported a 90 basis point drop in occupancy at its regional malls, to 90.9 percent from 91.8 percent.

In fact, there is a bifurcation in the market, with retailers still expressing interest in working with owners of strong centers, but having little incentive to look at lower quality properties or at properties in badly battered areas, says Rich Moore, an analyst with RBC Capital Markets. As a result, he expects that though operating metrics won't improve for some time, companies like Simon and Macerich won't see too much additional deterioration.

However, there are lingering credit concerns in the sector. Moore concedes that most regional mall REITs have been successful in securing debt funding in the second quarter, but they still lack sufficient equity. While Simon has put most of its balance sheet concerns to rest through debt and stock offerings earlier this year, CBL, Macerich and PREIT still trail behind, according to Lukasik. In addition, Moore has expressed some concern about Glimcher. The REIT's debt to total market capitalization ratio declined a mere 50 basis points from the first to the second quarter of this year, to 83.3 percent from 83.8 percent.

"On the balance sheet front, metrics remain very stretched," Moore wrote in a Jul. 22 note. "With only two assets currently unencumbered, the line balance at $376 million and an equity issuance out of the question at the current share price, we consider the line of credit situation precarious at best."