Federal Realty (FRT -0.37%) is focused on the three most important things in real estate -- location, location, and location. That's a bit of a joke, but the sentiment is very real. Unlike many of its peers, this real estate investment trust (REIT) stresses quality over quantity. And the impact of recent retail bankruptcies highlight just how important this focus happens to be.
Bigger isn't always better
Most of Federal Realty's most prominent strip mall peers own several hundred properties. Federal Realty only owns about 100. The real difference here shows up when you compare the average population within three miles of a Federal Realty property and the average family income.
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To put some numbers on that, on average there are 170,000 households within a three-mile radius of a Federal property, and the average family income sits at $151,000. The company likes to point out that this equates to $10 billion in spending power. That combination of population and wealth is greater than that of any of its strip mall peers. Simply put, Federal Realty owns properties in the places where retailers want to put their stores.
That sounds like a good selling point for the stock, but there's more to it than just averages. Notably, the retail-focused REIT still has to deal with the retail market as it waxes and wanes over time. However, its top-notch locations give it an edge. For example, during the coronavirus pandemic when retailers were shutting locations, Federal Realty was fielding calls from other retailers for the spaces being vacated. Many of those inbound calls were from retailers with nearby locations that wanted to upgrade to a Federal Realty property.
The Bed Bath & Beyond opportunity
Although a clear sign of Federal Realty's strong locations, the coronavirus was an unusual event causing enormous stress in the retail industry. What isn't that uncommon is for a tenant to go bankrupt. There's really no way to avoid this on occasion. And there is almost always some near-term pain involved. That makes sense, since a tenant that was paying rent stops paying when they go bust.
The bankruptcy process can be slow, too, so often a landlord won't be able to do anything with the space for longer than it would like. And then when it does officially get the space back, it will probably need to put some cash into the property to attract a new tenant. In other words, in addition to the loss of rent there is also likely to be a short-term increase in costs.
If you have well-located properties like Federal Realty, though, there can be a notable benefit to getting space back. Very often a bankruptcy situation will involve a tenant that has been in a property for a fairly long time. That suggests that the rent the tenant is paying will be below current market rents. In the case of Federal Realty, because its properties are so well located, troubled tenants will probably try to close other locations first. That stretches out the process of dealing with a bankruptcy. The benefit in all of this is that once the property is returned to Federal Realty it can turn around and bring the rent up to the current market standard.
Don't underestimate how important this can be. During Federal Realty's second-quarter 2022 earnings conference call, Chief Executive Officer Don Wood spoke specifically about Bed Bath & Beyond. He noted that the company has nine locations with the bankrupt retailer. It got one back in the second quarter and was quickly able to sign a lease with Burlington Stores (BURL 3.17%) that came with a 57% rent increase.
That's a great outcome, and a very quick resolution of the problem. It isn't realistic to think that every location affected by a bankruptcy will come out so well (or resolve so quickly). But on the whole, because of Federal Realty's strong properties, this is the general direction that investors should expect. And while bankruptcies might lead to some weakening of near-term financial results, they will more than likely lead to a much stronger long-term performance for Federal Realty.
Some pain and lots of gain
Federal Realty can't avoid the pain from retail bankruptcies. But investors need to understand that there can be a long-term benefit when an REIT with good locations gets space back. Federal Realty's ability to jack up rents on vacated Bed Bath & Beyond properties by as much as 57% is just one example of the good that can come out of bad news. In other words, the near-term pain from a bankruptcy can actually lead to the long-term benefit of higher rental revenue. Higher rental revenue, in turn, will lead to even more dividend growth for this Dividend King REIT.
