Federal Realty Investment Trust (FRT) increased its dividend in 2020 despite the challenges it faced stemming from the novel coronavirus pandemic and the resulting stay-at-home orders. It was a bold statement that management believed the real estate investment trust (REIT) would survive the pandemic, and perhaps even come out the other side better-positioned than when it entered. All in all, 2021 is likely to be a better year than 2020 in many ways -- but investors still shouldn't go into the new year expecting too much.
A difficult 2020
Federal Realty owns a collection of around 100 shopping centers and mixed-use developments. That's not a huge number of properties, but they are extremely well located in high-income and densely populated areas. Moreover, many of its properties are anchored by necessity tenants, like grocery stores. So even during the economic shutdowns used to slow the spread of the coronavirus, the REIT's properties have opened in some way, and will likely remain open.
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However, a retail center being open for business doesn't mean that all of the property's tenants are paying their rent. During the worst of the pandemic in 2020, Federal Realty's rent collection rate dropped to around 50% or so. By October that was back up to 85% -- which was good to see, but still below normal. So Federal Realty didn't escape the pain in 2020, and in some ways 2021 is starting off on a weak note.
What comes next
Given that rent collections were so weak for a material stretch of 2020, it would be hard for Federal Realty to not see some bounceback in its business in 2021. So long as the United States avoids a repeat of the broad economic lockdowns seen last year, the REIT should be in better shape. The pain from the first round of lockdowns suggests that a more targeted approach will be used in 2021. And, notably, the vaccines now being delivered suggest that the direction of the pandemic will change in a positive way later in the year. That's great news for Federal Realty and its tenants.
However, there's more to the story. Even though Federal Realty's properties are likely to remain vital to the communities they serve, the hit from the coronavirus still has to be dealt with. Indeed, the company's comparable portfolio went from 94.2% leased at the end of the first quarter last year, before the pandemic really got under way, to 92% at the end of the third quarter. That's a small drop given the headwinds the REIT was facing, but the direction is not good. And it will take time to turn things around.
That's not a statement about Federal Realty, it's just how retail properties work. Landlords need to find new tenants and then renovate space so they can occupy it. Neither can be accomplished quickly if you want to do it right and maintain the value of your property. So 2021 will be a transition year that will almost certainly see occupancy levels fall further before they start to recover -- which management very specifically warned about during Federal Realty's third-quarter 2020 earnings call. The nadir is likely to be during the first quarter, and occupancy could dip as low as the mid-to-high-80% range.
The flip side to this story, however, is that Federal Realty is seeing demand for its properties. That includes from retailers with nearby locations that want to upgrade their real estate, even if it means paying higher rents. That's a statement to the strength of this REIT's portfolio, though it doesn't change the fact that it will take time to muddle through this difficult period.
A better, but not great, year
So when you step back, Federal Realty should end up with a better year in 2021 than it had in 2020. In fact, assuming that widespread economic shutdowns are avoided, it would be pretty hard not to achieve that. However, 2021 won't be a return to normal. The REIT still has a lot of work ahead of it to get its properties back on track.
That said, for long-term investors, the roughly 5% yield on offer here (near the high end of the company's yield range over the past decade) could be pretty enticing. You just need to go in knowing that a sustained recovery will take time, and that there could be more bad news early in the year before the business starts to turn for the better.
