For most of the last decade, Federal Realty's (FRT -1.19%) dividend yield was in the 3% range. Today the real estate investment trust's (REIT's) yield is 4.5% or so. Why exactly has the yield increased so much? Is this a buying opportunity for long-term dividend investors?
Here's what you need to know.
Small but mighty
Federal Realty owns strip malls and mixed-use developments, which generally include retail, office, and apartment assets in a single property. It is a bellwether name in the retail REIT sector but not because of its size. In fact, it has a relatively small portfolio with only around 100 properties. What sets it apart is that, compared to its peers, it has the highest average population within three miles of its properties and the highest average family net worth. This is important because it means Federal Realty owns properties that retailers really want to occupy.
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It also has a long and successful history of development and redevelopment. Basically, it prefers to buy properties that are in need of upgrading. That upgrading process generally leads to higher rents, improved occupancy, and increases the value of a property. After Federal Realty has worked its magic by improving a property, it will consider selling if it gets a good offer and start the process over again. The key is buying the right properties in the right locations. For instance, the REIT used the dislocation caused by the COVID-19 pandemic to enter the Arizona market for the first time.
The company's impressive results most notably include it having the longest streak of annual dividend increases of any publicly traded REIT. At 55 years and counting, Federal Realty is a Dividend King. The last five decades have included some really difficult periods, including the deep economic downturn known as the Great Recession. And the REIT has adeptly survived them all while continuing to reward investors via dividend growth.
The high yield
So far, Federal Realty sounds like a great business, and it is. That said, there's been a general shift away from REITs of late with rising interest rates expanding the options for income investors. For example, you could probably find a bank CD that offered a comparable yield to Federal Realty. That's one possible reason for the price decline (and resulting higher yield), although this is really an industry-wide issue. Still, switching to a multi-year-term CD would mean giving up the potential for dividend growth, which opens investors up to the negative impact of inflation on their income streams.
The other possible reason for the rising yield is that Federal Realty is focused heavily on retail properties. These types of assets can take hits from economic downturns since consumers generally pull back on spending during recessions. There's a very real concern that 2023 could see a recession and that has investors wary of the stock. Federal Realty's stock price is down about 17% over the past year.
That said, Federal Realty's well-positioned portfolio sits largely within wealthy communities. Spending is likely to hold up better in the regions it serves, so this risk may not be as big an issue as some fear. In fact, the company's focus on areas with limited capacity for new construction suggests that a downturn might actually be a net benefit over the long term.
The potential benefit would show up in Federal Realty's ability to redevelop properties. A recession could reduce the cost of construction and even open up more acquisition opportunities (like the Arizona expansion during the last economic downturn).
A great example of this showed up in the company's development outlook. At the end of 2022, management's outlook called for apartments in around six properties. When that development pipeline was updated in the first quarter of 2023, the list increased to 14. These are projects on the drawing board, not ones that are being worked on today. The increase suggests that Federal Realty sees the opportunity for material internal growth if the cost of getting a project done is reasonable. So a downturn could actually be a growth driver in more ways than one.
Reliable rents lead to reliable dividends
Federal Realty's portfolio ended Q1 with a strong occupancy rate of 92.6%. It was able to increase lease rates on expiring and new leases by 11% over previous rates. The portfolio is performing well today. And, given its strong locations, that's likely to remain the long-term trend, even if there are brief periods of weakness, with redevelopment a key long-term growth driver. This Dividend King REIT won't be exciting, but it will likely reward investors each and every quarter for sticking around, just like it has for over five decades. For conservative dividend investors, the relatively high yield today caused by the stock price drop justifies taking a close look.
