Over the past year, cracks have emerged in the commercial real estate market, particularly in the office and retail sectors. The problems in the office sector are well-known and driven by the transition to the work-from-home model. Retail is becoming an issue; however, not all retail is equal. Location and type of property matter.
Kimco Realty (KIM -0.22%) is one of the premier retail REITs with a dividend yield of 4.5%. Is this sustainable?
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Kimco Realty has exposure to some of the top markets
Kimco Realty focuses on open-air grocery-anchored shopping centers. The company has 528 properties with 90 million square feet of gross leasable area.
Kimco concentrates on first-ring suburbs in the Coastal and Sun Belt markets. These generally have higher barriers to entry. Kimco's Sun Belt markets have experienced 64% greater population growth than the rest of the country, while Kimco's Coastal markets have 22% higher incomes.
Most real estate investment trusts (REITs) experienced decreasing occupancy rates due to the COVID-19 pandemic. Many smaller retailers and restaurants went out of business, and it has taken time for tenants to return. Kimco's occupancy at the end of 2023's second quarter was 95.8%, still a touch below the pre-pandemic occupancy rate of 96.4%. Rental growth remains robust, with comparable leasing spreads (the difference between expiring and new leases) at 9.9% in the second quarter.
Retail development has been anemic since the Great Recession
The driver of rising rents has been the dearth of retail development following the financial crisis in 2008. Retail real estate development peaked at 13.9 million square feet a quarter in late 2007. Since then, development was generally around 2 million to 4 million square feet per quarter and fell to 775,000 in the first quarter of 2023. As a percentage of existing stock, current development is about half of one percent, the lowest of all commercial real estate sectors.
This dearth of development is driving higher rents in the most attractive markets, which is supporting Kimco's pricing power and growth. Open-air formats are gaining popularity, and about 85% of planned openings are slated for open-air centers. Grocery-anchored centers are higher-performing than non-grocery-anchored centers, with higher retention and income growth.
Kimco's top tenants include TJX Corp, which is the parent company of TJ Maxx and Marshalls; Home Depot; Amazon, which is the Whole Foods brand; Ross Stores; and Albertsons. These retailers are generally quite defensive, meaning that even if the U.S. hits a recession, spending should be less impacted than more discretionary retailers.
Kimco recently upped its guidance for 2023 funds from operations (FFO). REITs generally use FFO to describe earnings in lieu of net income as reported under generally accepted accounting principles (GAAP). This is because depreciation and amortization (D&A) is a large expense under GAAP. Since GAAP is a non-cash charge, net income tends to understate the company's cash flows.
History indicates Kimco might have room to bump the dividend
Kimco is guiding for 2023 FFO per share to come in at between $1.55 and $1.57 per share. This more than amply covers the $0.92 per share in dividend payments each year. Interestingly, prior to the pandemic, Kimco earned $1.44 per share in FFO and paid an annual dividend totaling $1.12 per share.
So historically, the stock has had a much higher payout ratio. This indicates Kimco might have room for a dividend hike. At the midpoint of guidance, Kimco is trading at 13 times this year's FFO per share, which is a reasonable multiple for a high-quality REIT.
