The Federal Reserve's spate of aggressive rate hikes has had all sorts of effects on the broader U.S. economy, including putting real estate investment trusts (REITs) in the discount bin. As a general rule, real estate investment trusts don't react well to rate hikes because they use a lot of debt to finance their operations and rising rates increase their borrowing costs. The market knows this and tends to sell off its holdings in REITs when rates start rising.
The REIT sell-off invariably results in rising dividend yields because of the relationship between yields and stock prices. But yields can rise for other reasons too. Simon Property Group (SPG 0.05%) is trading with a 6.6% dividend yield. Why is its yield so high?
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Premier mall operator takes an indirect hit from SVB Financial crisis
Simon Property Group operates multiple shopping malls, Premium Outlets, and The Mills. The company owns or has interest in 196 properties in the United States. Internationally, Simon Property owns 34 Premium Outlets and Designer Outlets. Simon Property Group also holds an 80% non-controlling interest in Taubman Realty Group and a minority stake in French retailer Kleppiere.
Since the beginning of the year, Simon Property Group stock is trading down some 10% while the S&P 500 is up about 7%. The underperformance began around the time that SVB Financial's Silicon Valley Bank failed. Until then, Simon more or less was matching the S&P 500. The Silicon Valley Bank situation stoked fears of tighter credit, which would translate into higher borrowing costs for REITs across the board. During the first quarter, the company issued $1.3 billion worth of 20-year bonds at an average rate of 5.67%, which is a highly attractive rate.
In addition, the Fed's tightening began to affect consumer spending. Investors are worried that falling consumer spending will negatively affect leasing demand. So far this year Simon is seeing strong demand, saying on its earnings conference call that sales per square foot hit another record level. The company is seeing strong demand from its luxury retailers and its restaurant tenants.
Simon Property Group's dividend yield is toward the high end of its recent range. Much of the increase corresponds with the beginning of the Federal Reserve's tightening cycle.
SPG Dividend Yield data by YCharts
Strong labor market allows Simon to up forecasts and keep hiking its dividend
While rising rates are a concern, the labor market remains the best the country has seen in a half-century, with unemployment at 3.4%. This should be supportive of consumer spending going forward. Simon Property seems sanguine about the future given that it hiked its quarterly dividend by 9% to $1.85 per share.
On the first-quarter call, Simon Property Group upped its full-year 2023 forecast. The company now sees funds from operations (FFO) coming in between $11.80 and $11.95 per share. REITs generally use funds from operations to report earnings because net income under generally accepted accounting principles (GAAP) requires depreciation and amortization (D&A) to be deducted from net income. Since D&A is a noncash charge, net income tends to understate the cash flows of the company. As a result, REITs tend to report earnings in FFO per share.
At current levels, Simon Property is trading at price-to-FFO ratio of just under 9 times. This is a highly attractive ratio for a market leader like Simon. The company's FFO forecast easily covers the $7.40 annual dividend. Given that the company just hiked its dividend and is seeing strong sales from its tenants, the market's fears seem to be overblown.
