In today's market for real estate investment trusts, or REITs, it's pretty much required that you'll have to pay up for the high-quality companies that have a history of delivering results. Paying up means accepting a smaller yield than has been historically available and likely a lower total return than has historically been available as well. Federal Realty Investment Trust (NYSE: FRT ) , which reported its fourth-quarter and full-year earnings earlier this week, is no exception.
Federal Realty's four largest markets for its retail space are the Washington, D.C., New York City, and Philadelphia metro areas, plus California. Among the company's largest tenants are grocery store operator Ahold (NYSE: AHO ) , clothing retailer Gap (NYSE: GPS ) , drugstore chain CVS (NYSE: CVS ) , and office-supply superstore Staples (Nasdaq: SPLS ) .
For the year, the company improved on last year's $2.85 per diluted share in funds from operations (FFO) by 7.4% to $3.06. The gains came largely from increasing the occupancy in its portfolio of properties and redeveloping some of its existing properties. It is the redevelopment properties that interest me the most. In its supplemental material (available on its website), the company lists 18 properties that are opportunities for redevelopment, including 11 that should stabilize in 2006 and 2007 with an average return on investment across all of the properties of 12%.
Federal Realty remains conservatively leveraged, and its dividend is well funded by FFO even after adjusting for maintenance capital expenditures. With a stable group of tenants, a debt-to-total market capitalization ratio of approximately 30%, and only 12% of its debt variable in nature, the business is fairly predictable. The company has also awarded shareholders with two special dividends in the past year on top of the $2.22 annual dividends that have been paid out.
The only thing that's not to love about Federal Realty Trust is its valuation. The company trades at 23 times its trailing FFO and at a 19% premium to the net asset value (NAV) estimate of $58.85 per share listed on reitcafe.com. Neither measure of valuation indicates an affordable stock. That said, it is normal for high-quality REITs such as Federal Realty to trade at slight premiums to their NAV, and I do like the company's strategy for continued growth. Investors should simply realize that the growth doesn't come on the cheap.
The question with paying up for quality is whether you'll beat the market as measured by the S&P 500 and whether you'll beat REITs as a whole. A number of REIT investors that I have talked to are comfortable with this situation and believe that the best of breed will still reward investors in the long run. I don't find the valuations in the market so unreasonable that such statements will prove untrue over three to five years or more, but I do think that investors expecting smooth sailing might be in for a surprise or two along the way.
The question for many investors considering the traditional high-quality REITs is whether a potential total annual return of 6%-8% over a long period of time is acceptable. For those who find such a scenario acceptable, a number of high-quality REITs should be able to deliver that level of return in the long term. For investors looking for dividends and a higher total return, I think it makes sense to balance investments in REITs with dividend-payers from other industries that aren't quite as popular at the moment.
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