Real estate investment trusts (REITs) are fertile ground for income investors. This is because REITs operate using a business model that allows them to avoid paying corporate income tax as long as they distribute 90% of their income as dividends to shareholders (who then take on some of the tax burden).
The key to REIT investing is to analyze whether the dividend is sustainable for the company you are interested in. Sustainability is a function mainly of earnings, but debt maturities matter as well.
Tanger Factory Outlet Centers (SKT 0.73%) stock is trading up 29% year to date and has a 4.3% dividend yield. Is this retail REIT's dividend sustainable?
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One of the biggest outlet mall operators
Tanger Factory Outlet Centers is one of the biggest outlet operators in the United States. At the end of 2022, the company operated 29 outlet centers with 11.4 million square feet of gross leasable area. The outlet centers contain 2,200 stores representing 600 different brands. Tanger also has one outlet center under construction.
The outlet center concept involves retailers selling branded merchandise at a significant discount to department stores and full-price channels. In order to avoid cannibalization, the outlet centers are usually located at a significant distance from shopping malls. The outlet centers are usually located just off the interstate near fast-growing suburbs. Tanger operates in 18 states and has the most square feet in South Carolina, New York, and Georgia.
Consumer spending is supported by a strong labor market
Tanger's fortunes are going to be at least somewhat dependent on the state of the U.S. consumer. Despite the Federal Reserve hiking the Fed funds rate dramatically in the past year, the labor market remains exceptionally strong, and workers are getting raises. This bodes well for consumer spending as long as the U.S. doesn't enter a recession. Tanger's stores generally sell discretionary items. If consumer spending declines, many full-price shoppers might eschew the mall for Tanger's outlet centers.
Tanger is guiding for 2023 funds from operations (FFO) per share to come in between $1.82 and $1.90. REITs tend to use FFO to describe earnings because net income as calculated under generally accepted accounting principles (GAAP) tends to understate the actual cash-flow-generating capacity of the company. For this reason, REITs might look expensive on a price-to-earnings basis because analysts typically value them based on price-to-FFO.
Tanger stock trades at a cheap multiple and the dividend is well covered
Based on Tanger's guidance, the company is trading at 12.4 times guided 2023 FFO per share, which is a reasonable multiple for a market-leading REIT. Tanger's annual per-share dividend is $0.98, which is well covered by Tanger's FFO guidance. Based on the midpoint of guidance, Tanger's payout ratio (the dividend divided by earnings) is 53%, which is low for a REIT. This means Tanger has room to hike the dividend. In fact, Tanger has hiked its dividend in the last three out of four quarters.
Tanger Factory Outlet Centers is a good candidate for income investors because it is trading at a reasonable multiple, and earnings (at least as measured by FFO) are almost twice the dividend. In addition, the company has been increasing its dividend. Tanger has a yield that is attractive and the stock is performing well year to date, making it a good candidate for an income investor's portfolio.
