One of the main economic clouds on the horizon involves the commercial real estate sector, which is being negatively impacted by rising interest rates. Commercial real estate investors were lulled into complacency by years of ultra-low interest rates. The COVID-19 pandemic caused tremors in the office real estate market, and retail has been struggling as well.
Simon Property Group (SPG +2.42%), which is a top retail real estate investment trust (REIT), has a 6.6% dividend yield. Do the problems in the commercial real estate market raise a red flag about the dividend?
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Simon Property Group is a premier retail REIT
Simon Property Group is a REIT that develops shopping malls, Premium Outlets, and The Mills. The company owns or has interests in 196 income-producing properties in the U.S., consisting of 93 shopping malls, 69 Premium Outlets, 14 Mills, six lifestyle centers and 14 other income-producing properties. Simon Property also owns an 80% non-controlling interest in Taubman Realty Group and a 22% stake in Klépierre, a French retailer. Simon also owns Premium Outlets and Designer Outlets overseas.
Occupancy is approaching pre-pandemic levels
Simon Property Group has been supported by strong consumer spending and a robust labor market. Occupancy continues to improve, rising to 94.7% at the end of the second quarter, an increase of 80 basis points on a year-over-year basis. Simon is close to recouping its pre-pandemic occupancy of 95.1%. Base minimum rent hit a record in the second quarter, rising 3.1% year over year to $56.27 per square foot.
Simon increased its guidance for 2023 funds from operations (FFO), bumping up the expected range to $11.85-$11.95 per share. REITs tend to use FFO to describe their earnings instead of net income as reported under generally accepted accounting principles. This is because real estate companies have a lot of depreciation and amortization, which is a large non-cash expense.
In other words, it decreases net income, but it doesn't reduce cash. It is an accounting charge. For this reason, REITs use FFO, which excludes depreciation and amortization because it gives the investor a clearer picture of the company's cash flow.
Simon has hiked its dividend twice in the past year
Simon Property Group just bumped its quarterly dividend from $1.80 to $1.85 per share, which is the second increase in the past year. This gives Simon an annual dividend of $7.40 per share. If you look at the payout ratio, which is the dividend divided by FFO per share, Simon has a 62% payout ratio, which is pretty conservative as far as REITs go. Since REITs need to distribute the vast majority of their net income to maintain their tax-exempt status, they tend to have high payout ratios.
At current levels, Simon Property is trading with a 6.6% dividend yield, which is on the high side of its historical range, although interest rates are not really comparable to pre-pandemic levels.
SPG Dividend Yield data by YCharts
Since interest rates are higher today than they were prior to the pandemic and in 2021 and 2022, a higher dividend yield today should be expected. While a rising dividend yield can be considered a red flag in some cases, it isn't in this one because the dividend is well covered.
Simon is trading at 9.5 times this year's guidance for FFO per share, which is reasonable for a high-quality REIT. As long as the economy remains strong, Simon Property should be a stable dividend payer for an income investor.
