Quick, which company has a longer streak of annual dividend increases, PepsiCo or Federal Realty Investment Trust (FRT)? This is an article about the latter, so you could pretty much guess that answer -- but at 52 years, Federal Realty's dividend record puts it in impressive dividend company. However, is that enough to make this retail-focused real estate investment trust (REIT) a buy today?
What it does
Federal Realty has a very specific approach that it has used for decades, but it all boils down to an old real estate maxim: location, location, location. The real estate investment trust only owns 104 properties, which is fairly modest compared to some peers. Moreover, it basically operates in just eight markets. However, its locations are generally in wealthy areas with high barriers to entry for competitors. In other words, it's got assets in markets that retailers want to be in.
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That's the foundation behind the company's incredible 52-year record of annual dividend increases, but it isn't the entire story. The REIT has grocery stores at around two-thirds of its properties, helping to ensure a regular flow of customers. But there's even more beneath that: Roughly 25% of its properties are simply grocery-anchored shopping plazas, 36% are super regional or power center assets (which usually include other major retail anchors), and about 35% are mixed-use. That diversity is important, but it's the last category that is the most interesting.
Federal Realty owns a number of large development projects that include retail, entertainment, work, and living assets. These projects are multi-year in length, providing ongoing capital investment opportunities. And they add diversification to the REIT's revenue stream, since they spread its portfolio into other sectors. Just like your portfolio benefits from diversification, so does Federal Realty's portfolio (more on this in a second). All in all, Federal Realty isn't your typical shopping center REIT, and its dividend history backs that up.
How it's doing today
The problem facing investors right now, however, is trying to gauge the impact of COVID-19. The answer is that it hasn't been pretty. Although only around 20% of Federal Realty's rent roll, 90% or more of apartment and office tenants paid their rent on time in May. On the retail side of things, that number is a dismal 50% or so. The worst offenders are the ones you'd likely expect, including gyms, restaurants, apparel stores, and "experiential" tenants. These groups, unfortunately, account for more than a third of Federal Realty's base rents.
One big piece of the problem here is the effort to contain the spread of the coronavirus, which has included shutting non-essential businesses and asking people to stay home. Having grocery stores as key tenants has been a good thing, since these lessees are paying rent in a timely fashion. The problem is that they are a traffic draw and not a huge top-line contributor. Grocery and drug stores only account for around 10% of base rents. The reopening process will likely lead to improved results, but economic activity needs to pick up for Federal Realty's business to materially improve.
Since there's no clear end to the COVID-19 pandemic in sight, Federal Realty is facing a crisis like it has never seen before. Based on recent years, investors would normally expect a dividend increase in the second half. That may not happen this year. In fact, it's fairly reasonable to wonder if a dividend cut is possible. Put simply, if the REIT is only collecting around half of its retail rents, there's no way it can continue to support the old dividend for very long. Investors should brace themselves for bad news.
But none of this materially changes the core business of owning highly desirable properties in highly desirable markets. Or that the REIT has built in growth opportunities as it builds out its mixed-use properties. In good economies and bad, Federal Realty has proven to be a well run REIT with a shareholder-friendly management team. This recession, which started in February, is different because it is being driven by a global pandemic. Until the health issues are dealt with, Federal Realty will likely struggle. Once COVID-19 is better controlled, however, Federal Realty's strengths are likely to shine again.
To buy or not to buy
For value-focused investors trying to take advantage of the hit retail has taken, Federal Realty is probably a fairly conservative way to increase your exposure to the sector. The stock is never really cheap, but its roughly-5% yield is the highest it has been since the last recession, suggesting it is, relative to its own history, on sale today. You just have to go in with a long-term mindset, understanding that there is a very real risk of a dividend cut. Dividend-focused investors, however, should probably sit on the sidelines while the coronavirus uncertainty lingers, and instead consider a more diversified REIT like W.P. Carey, which has been able to collect nearly all of its rents despite the impact of COVID-19 and sports a 6% yield.
