Simon Property Group (NYSE:SPG), with its 14% dividend yield, is the leading mall real estate investment trust (REIT), and there's a lot to like about it. However, if you are looking to own a retail-focused landlord today, you should take a step back and examine Federal Realty (NYSE:FRT). The yield isn't as high at just 5.3%, but it has a dividend track record that is industry-leading, and it's better positioned to weather COVID-19 and its aftermath than Simon.
Different ways to play retail
Simon Property Group and Federal Realty are both retail real estate investment trusts. They each focus on wealthy markets with high barriers to entry and dense populations. However, there's a major difference: Simon owns roughly 200 enclosed malls and factory outlet centers. Federal Realty owns roughly 100 shopping centers.
Enclosed malls have been at the epicenter of the so-called "retail apocalypse", the term used to describe the increasing consumer shift toward online shopping. It's a material issue, though perhaps a bit misunderstood and overplayed. A big portion of the problem is that too many retailers haven't kept up with changing consumer habits, and, equally bad, have allowed themselves to get over-leveraged. They are falling by the wayside as the industry shifts and changes. This problem has only been exacerbated by COVID-19, which resulted in the shutdown of non-essential businesses (like malls), putting extreme stress on even the best positioned of Simon's tenants.
Federal Realty largely owns outdoor shopping centers, which generally house retailers that people visit on a regular basis. That list includes necessity businesses like grocery stores, and smaller stores like dry cleaners, restaurants, and hair salons. Although the REIT's tenants weren't all open during the coronavirus shutdowns, many were. In addition, Federal Realty has been expanding in the mixed-use segment for years, which brings together work, living, and retail assets into one place. This niche makes up roughly 35% of its rents, and adds a bit of diversification to its portfolio (for example, it owns roughly 2,700 apartment units).
Right now, both REITs are facing material headwinds, but Federal Realty's necessity-based properties and the diversification offered by its mixed-use assets give it a leg up. However, there's more to the story than just that -- it has also increased its dividend annually for an incredible 52 consecutive years. That doesn't mean it will keep the streak alive through this rough patch, but compare that history to Simon, which cut its dividend during the 2007-to-2009 recession. It's highly likely that the efforts to slow the spread of COVID-19 are going to push the United States into another recession, and Simon has been forced to shut all of its malls. A dividend cut seems highly likely, even if it's only temporary. If you are looking for dividend consistency, Federal Realty's track record wins hands-down.
Then there's the question of the post-shutdown world. As states slowly begin to reopen for business, enclosed malls face a material challenge because they have to convince customers to come back to an enclosed space specifically meant to bring large numbers of people together in one place. These are conditions in which COVID-19 can easily spread. Federal Realty's retail assets are outdoors, and were basically never shut down -- only the non-essential stores within them did. Getting people back probably won't be the same obstacle.
To be fair, Simon is among the best positioned mall REITs, and it is in a strong financial position compared to its peers. It's likely to muddle through this downturn relatively well compared to enclosed mall peers. But Federal Realty currently looks stronger. For example, both have reasonable financial debt to equity ratios, but Federal Realty's comes in at roughly 0.7 times, while Simon, following a material decline in its share price and an increase in debt to consummate an acquisition, sits at roughly 1.6 times. Each solidly covers its interest expenses as well, but Federal Realty comes out on top again with roughly 4 times coverage in the first quarter. The comparable number for Simon in the first quarter (again after an increase in debt) was roughly 2 times.
That said, Federal Realty's funds from operations (FFO) payout ratio was roughly 70% in the first quarter of 2020, the first quarter impacted by the COVID-19 shutdowns. That's a solid number. Simon's payout ratio was roughly 70% in the fourth quarter of 2019, and worsened to 75% in the first quarter of 2020. The second quarter will likely be even worse, and the REIT still has to work back from the closure of its entire mall portfolio. It's highly likely that mall-focused Simon has an extended period of pain ahead of it.
That's not to suggest that Federal Realty won't have to deal with headwinds, but the road ahead is likely to be easier based on the types of assets it owns. Simon, for reference, isn't going to discuss the next dividend until June. The only target it's providing is that it will pay out 100% of its taxable income, a number that, for most REITs, is lower than its FFO. In other words, Simon is leaving room for a cut, although it explicitly wants to avoid joining the growing group of REITs that have slashed their payouts by half or more.
Err on the side of caution
Simon Property Group is not an appropriate fit for risk-averse income investors today. Federal Realty is a much better option for conservative types, even though it has a notably lower yield.
That said, Federal Realty's yield hasn't been as high as it is today since the last recession, so it actually looks like it might be a good time to consider adding it to your portfolio. Granted, Simon's yield is historically high today, too, but the risk profile is very different. And based on history, there's a good chance Simon ends up cutting the payout, at least temporarily. If you are looking at retail REITs, Federal Realty just looks like it's in a better position than Simon to deal with the difficult retail environment today.