Retail real estate stocks soared on Monday on the news that Pfizer's COVID-19 vaccine candidate appears to be more than 90% effective based on preliminary analysis. However, while the prospect that vaccines will conquer the pandemic next year is great news for brick-and-mortar retailers, owners of retail real estate still face significant challenges in the near term.

Fortunately, Simon Property Group's (NYSE: SPG) third-quarter earnings report -- released Monday afternoon -- showed that the largest retail REIT is already starting to bounce back from the worst of the pandemic. That's another dose of good news for shareholders.

One-time items dent key earnings metrics

Simon Property Group's portfolio net operating income (NOI) fell 22.4% year over year last quarter, while comparable NOI fell 24.4%.

Image source: Simon Property Group.

Both metrics deteriorated compared with the second quarter, especially comparable NOI. However, CEO David Simon noted that $270 million of the $338 million year-over-year decline in portfolio NOI was attributable to pandemic-related rent abatements and credit losses. There was also an additional $165 million revenue headwind from the pandemic's impacts on occupancy, percentage rent, and ancillary revenue. These revenue declines were partly offset by about $100 million of cost reductions.

On the bright side, most of the factors weighing on NOI last quarter were either one-time in nature or will fade quickly over the next few quarters. For example, the rent abatements were a short-term measure to help vulnerable tenants -- mainly locally owned shops and restaurants -- stay in business. Credit losses should moderate, as the pace of retail bankruptcy filings is slowing. And while it may take time to backfill spaces that have become vacant because of recent store closures, percentage rent and ancillary revenue will bounce back as mall traffic returns.

Simon's sharp NOI decline last quarter also caused a significant decline in funds from operations (FFO). FFO per share fell to $2.05 from $3.05 a year earlier. This fell short of the analyst consensus of $2.12. However, FFO included a $0.06 per share headwind from litigation expenses, likely related to the company's ongoing dispute with Taubman Centers.

Collections improve, boosting cash flow

While NOI and FFO declined sequentially from the second quarter to the third quarter, cash collections improved significantly in the U.S. market. As of Nov. 6, Simon had still collected just 72% of net billed rents for the second quarter, even after deferring, abating, or writing off 35% of gross contractual rents for the period. By contrast, Simon has collected 85% of net billed rents for Q3, despite a much lower level of rent deferrals, abatements, and write-offs.

In absolute terms, domestic rent collections improved from $763 million in the second quarter to $1.25 billion last quarter. This led to better cash flow. Simon paid a $1.30 per share dividend last quarter -- using over $450 million of cash -- but still managed to reduce its net debt by $174 million sequentially.

At the moment, Simon is still battling with several large national tenants that have been withholding rent as part of a hard-nosed bargaining strategy. It is likely to collect that rent sooner or later, though, as few (if any) of those tenants face near-term bankruptcy risk.

Ready to play offense

Simon Property Group's fortress balance sheet is one of its biggest competitive advantages. The REIT maintains solid A-level credit ratings, allowing it to issue long-term unsecured debt with interest rates in the 3% range last quarter.

With cash flow turning positive again and further improvement on the way as the remaining holdout tenants repay their past-due rent, Simon can pivot to start playing offense again. For example, it is ready to pounce on opportunities to buy high-quality real estate if it becomes available at bargain prices due to the disruption of the pandemic. Simon has also deployed some capital to buy distressed but high-potential retailers out of bankruptcy.

Of course, Simon's recovery from the pandemic won't be instantaneous. But with Simon Property Group stock still trading nearly 50% below its year-ago level, there's plenty of upside here for patient, long-term investors.

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