Living in the first ring
Federal Realty Investment Trust owns and rents out real estate, and as a REIT, it's required to distribute at least 90% of its taxable income annually to shareholders as dividends. The REIT business structure allows investors to reap the benefits of owning properties without doing all the work that landlords must.
Getting paid is the first rule of the REIT club: The goal of these businesses is to generate rental income that's not only profitable but reliable. In pursuit of that aim, REITs often specialize in real estate niches, and for Federal Realty, the focus is retail properties. More specifically, it concentrates on large, mixed-used, and open-air shopping centers in what it calls "the first ring" -- suburbs just outside major U.S. cities where incomes and foot traffic are high.
Federal Realty's portfolio includes 104 properties near nine major metro areas. Collectively, these properties support 3,100 commercial tenants and 3,400 residential units.
Federal Realty's first ring strategy has allowed it to become a Dividend King, with more than 50 consecutive years of payout hikes, and the 7% compound annual growth rate of that payout is well above historical inflation rates, reflecting true long-term business growth. At today's share prices, investors can get a 4.3% dividend yield too, so the stock offers a nice combination of consistent growth and enough yield for meaningful passive income.
The key business performance metric for a REIT is its funds from operations (FFO) -- essentially, its cash profits. Federal Realty's FFO per share has steadily grown over time, almost always remaining comfortably above the dividend. The only time the company failed to produce enough cash to afford the dividend was early in the COVID-19 pandemic, when many stores temporarily suspended operations.
Federal Realty can tap its balance sheet if there's ever a need to borrow. The company is levered six times debt to EBITDA, (earnings before interest, taxes, depreciation and amortization) which spurred S&P to reduce the company's credit rating in March. However, the REIT remains investment grade, and S&P maintains a stable outlook and expects leverage to come back down over the next 12 to 24 months.
Does the future look bright?
This is all great, but where is Federal Realty headed from here?
To make that prediction, let's start with a look at its tenant base. The company's most prominent tenants are a diverse collection of high-traffic retailers that people frequent during all but the worst economic conditions -- home improvement retailers, discount clothing sellers, and supermarkets.
Secondly, its largest tenant only accounts for 2.7% of total rental income, so Federal Realty isn't relying too much on any single customer. There's inevitably turnover among lessees, but investors don't need to worry as much because tenants will not likely leave this REIT's quality locations en masse.
Third, there's plenty of room for long-term growth. Right now, the company's properties are situated in just nine major metropolitan areas, and its playbook could be applied to new markets if needed.
From an execution standpoint, management says that the business is doing well. Last quarter, it increased its projection for 2022's FFO growth from a 3% to 7% range to a 5% to 9% range.
Nothing is guaranteed, but Federal Realty's financials remain as clean as ever. The company's long history of enduring economic ups and downs should give investors confidence that it will be able to keep rewarding its shareholders well into the future.