Shares of Federal Realty Investment Trust (FRT) are down 30% so far in 2020. That's terrible -- but they are also down nearly 50% from their 2016 highs, so pandemic-hit 2020 is just a continuation of a longer trend. With the stock near 10-year lows, is Federal Realty a buy, or should investors stay away?
An incredible record
The first thing that investors need to know about Federal Realty is that this real estate investment trust (REIT) has a dividend history that is nothing short of spectacular. Its dividend record puts it into Dividend Aristocrat land, a designation that starts at a "mere" 25 consecutive annual dividend increases. Federal Realty's dividend streak is up to 53 consecutive years, a record that few companies, let alone REITs, can match. That included an increase in 2020, a period that forced many REITs to trim their distributions.
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The key takeaway from this history is that Federal Realty puts investors front and center -- and, just as important, it doesn't think short-term. That's why the dividend was increased in the third quarter, despite the headwinds facing the retail sector the REIT is focused on. Indeed, retail is the big story here. Prior to 2020, the so-called "retail apocalypse" was weighing on the stock. Essentially, retailers that weren't keeping up with customer trends, including but not limited to online shopping, ended up struggling. Those with heavy leverage were going out of business.
And then, in 2020, what was really a slow-moving issue (despite the hyperbolic name) sped up. Years worth of store closures were fast-forwarded by the economic shutdowns being used to slow the spread of the coronavirus, people working from home, and general social distancing. The retail apocalypse suddenly lived up to its name. It has not been easy for Federal Realty, which only managed to collect 85% of its rent in the third quarter. But that was actually an improvement over the 54% rate it managed in May.
Why so positive?
With that backdrop, it makes sense that the stock is trading near 10-year lows. And it would be reasonable for investors to wonder why management announced a dividend increase in October. The answer goes back to an old real estate maxim: location, location, location.
Federal Realty owns a portfolio of roughly 100 properties. That's actually pretty small relative to some of its peers. The key difference here is that Federal Realty is focused on quality over quantity. Its properties are located in markets with high barriers to entry, with wealthy and dense populations. And it has a long and successful history of investing in its assets to keep them desirable. Notably, it owns both traditional shopping centers and mixed-use developments, which are generally built in stages over time. So there's "built-in" growth in the business.
That said, the really exciting thing here is what's going on in the background. Even during the worst of the pandemic downturn in the second quarter, Federal Realty was still able to ink 50 new leases. Where it was replacing old tenants it was able to increase rents by 11%. Leasing activity was already back to more normal levels by the third quarter, though rent rates were basically flat. However, there's a deeper level here that needs to be examined.
In Federal Realty's third-quarter 2020 earnings conference call, the CFO noted that the REIT had inked a deal to replace a Bed Bath & Beyond store that was closing with a TJX Companies-owned Marshalls store. Good news, of course. But even better when you consider that the Marshalls is moving from a lesser retail property nearby so it can upgrade its location -- and it was willing to pay more rent to get into a Federal Realty asset. That's just one example of a trend that Federal Realty is seeing in its portfolio as strong retailers look to take advantage of the current industry dislocation to improve their long-term positioning.
In other words, the REIT's portfolio really hasn't lost any of its allure for retailers. And as strong and desirable retailers increasingly locate in Federal Realty assets, consumers will likely follow along in a virtuous cycle.
More pain, and then gain
When all is said and done, 2020 will be a pretty terrible year for Federal Realty. And 2021 will probably be better, but still not great, as it takes time to bring new tenants into a property. There's a very real reason why the stock is trading near 10-year lows.
But for investors willing to think long-term and looking to focus on quality over quantity, this Dividend Aristocrat and its 4.8% yield are worth a very close look. You'll need to be able to stomach some uncertainty in the near-term, but if history is any guide, the long-term success this REIT has achieved is far from over thanks to its location, location, location.
