In the eyes of the market, Dividend King Federal Realty Trust (FRT) has lost much of its luster in the COVID-19 pandemic. Despite an astounding 53-year dividend growth streak, the stock has shed 43% of its value this year. The REIT owns and manages well-located mixed-use real estate and high-end open air shopping centers in major (mostly coastal) metropolitan markets across the United States. The focus on quality also extends to FRT’s balance sheet, as it is one of only six REITs that has earned an “A” credit rating.
I first bought FRT shares early this year after selling my rapidly appreciated shares of Taubman Centers (TCO) after the Simon Property Group (SPG) buyout agreement. After feeling very happy with myself for locking in a ~50% gain, it didn’t take long to see most of that value plummet in my FRT position.
Today, I am more bullish than ever on FRT — not because the company faces no short-term headwinds or risks. It does. Substantial ones. But I’m bullish on it because the REIT has the quality of assets and financials to weather the storm, and because the stock price exhibits too much fear and not enough greed. After FRT escapes the ravages of COVID-19 with dividend intact and continuing to grow, which I believe it will, investor greed will undoubtedly return.
That makes now a great time to buy this 5.8%-yielding landlord.
Assembly Row, Somerville, MA; Image Source
The Real Estate Portfolio
FRT’s handful of mixed-use properties like Assembly Row in the Boston MSA and Santana Row in San Jose are very much urban, city-center type properties. A disproportionate share of FRT’s business (about one-third of rent) is in these developments that are packed with high-end retailers, restaurants, hotels, offices, and apartments.
But in the Q2 presentation, FRT specifies that its shopping center properties, of which there are far more in number, are primarily located in “first ring” suburbs, which are the closest, richest, and densest housing centers to cities’ central business districts. They are not right in the heart of urban areas, but neither are they “way out” in the suburbs either. These often have public transit access but are also drivable.
Source: Q2 Presentation
This could be something of a sweet spot in the latter stages of the pandemic and beyond. Retailers, restaurants, and theaters in many areas are being allowed to reopen and will continue to do so as the country navigates out of the Covid era. And they are not located right in the downtown areas that have emptied out as people work from home.
On the other hand, they are still quite densely populated areas. On a weighted average basis, there are 162,000 people living within a three-mile radius around FRT’s centers. And as residents of this well-located “first ring” around the city, these are necessarily higher income people. Within that three-mile radius, the average household income is $127,000.
Federal Plaza, Rockville, MD; Image Source
At the same time, there are high barriers to entry for new retail developments in these dense areas. The square footage of retail space there is lower than the national average, which insulates FRT somewhat from the United States’ oversupply of retail real estate. What’s more, 24% of FRT’s centers are grocery-anchored and another ~50% have a grocery or essential goods component, which should ensure continued foot traffic even while the pandemic persists.
There’s a reason that centers cluster multiple tenants together under the same roof or across the same parking lot. There are network effects and scale advantages, not just for the real estate developer but also for the tenants. Retailers like to fill the smaller spaces of heavily trafficked centers. That is already happening with FRT. In Q2, the REIT signed 50 new leases at an average spread of 11% over the previous rent from their respective spaces. This is very encouraging to see given that FRT already has some of the highest retail rents per square foot in the nation.
Tenants are using COVID-19 as an opportunity to strategically reposition themselves in higher quality centers in order to take advantage of network effects.
Plaza El Segundo, Los Angeles MSA; Image Source
This is especially true of restaurants that have been looking to find centers with outdoor seating space, of which FRT has plenty. Many restaurant operators have been moving out of urban centers and into first tier suburban areas in order to capture the best of both worlds — being near the city center but also being drivable for suburban residents.
The 15% of FRT’s portfolio that is leased to restaurant tenants is split evenly between quick-service (fast food) and full service / casual dining. And, interestingly, despite FRT’s higher end inclination when it comes to its real estate, its apparel tenant exposure is also split evenly between full price retailers and discount retailers.
Source: Q2 Presentation
Movie theaters make up about 2% of rent, while full-price retailers make up 8% and fitness makes up 4%. These three tenant types performed the weakest in terms of rent collection. Full service restaurants, likewise, have performed poorly, as restrictions in New England and California have been stricter than in many other states.
Linden Square, Wellesley, MA; Image Source
According to a September presentation at Bank of America Securities, rent collection for Q2 has now reached 68%, much higher than the initially reported 57% for April and 54% for May. Another 10% of scheduled rent for Q2 has been deferred, with an average payback period of 9 months. For the month of July, that percentage bumped up to 76%. In August, it crept up to 80%.
Management estimates that their corporate-level break-even rent collection rate is roughly 60%.
CEO Don Wood estimates that roughly 20-22% of FRT’s tenant base was significantly impacted by Covid, but its diversification in residential and office spaces helped. Around 95-96% of residential rents were collected, and nearly 90% of office rents came in as well. Though occupancy currently sits in the low 90s%, management expects it to reach its trough for this recession sometime in the first half of 2021 in the upper 80s%.
The good news is that Wood is optimistic about FRT’s ability to bounce back. He says that “of all the things I’m worried about, and there are plenty of them, [it] is not finding tenants to effectively fill what we believe is the best quality portfolio in the country.”
The Shops At Sunset Place, Miami, FL; Image Source
Moreover, FRT’s balance sheet remains solid, and liquidity is aplenty. Net debt to EBITDA had reached 6.5x at the end of Q2, but fixed charge coverage remained strong at 3.6x. And thanks to the REIT’s A credit rating, its cost of debt is very low at a weighted average interest rate of 3.53% and an average maturity of 9 years. FRT does have a modest debt hurdle of $340 million to be refinanced next year, but with ultra-low interest rates it should not be difficult to roll that over at attractive rates. This May, FRT issued $400 million of 1-year notes at an effective rate under 2% and $300 million of 4-year notes at an effective rate under 3%.
FRT had almost $2 billion of liquidity at the end of June, with $980 million of that in cash.
This should help to fund most of the remaining ~$600 million of investment capital for redevelopments and mixed-use property expansions coming in the next few years.
In 2019, FRT’s FFO payout ratio sat at a very low 65.4%. For 2020, it is expected to jump up to 90%. In the first half of this year, FRT has paid out 92.5% of FFO. Needless to say, the REIT has taken a big hit so far this year, although the second half of the year should be better than the first.
Here’s the good news: With a high dividend yield of 5.77% (as of this writing), it won’t take a high dividend growth rate for this REIT to make a strong DGI stock. Even if the dividend only grows at an average rate of 2.5% per year going forward, the same as its average over the past three years, buying at today’s price would render a yield-on-cost of 7.39% in ten years. That is comfortably above the 7% YoC threshold I like to target for conservative DGI stocks.
Headwinds & Risks
FRT has had only three CEOs since its founding in 1962. That indicates an average CEO tenure of 19.3 years. Top executives average 18+ years at the company. They have absorbed and helped to sustain the financially conservative and forward-looking culture that has contributed to FRT’s 53-year dividend growth record. It is certainly a majestic legacy to guard and protect, and they seem to take it seriously.
Management’s experience and tenure will help them face the challenges ahead, and those challenges cannot be underestimated. As more business is done online, even if items are picked up in the store or the parking lot, retailers’ margins will be squeezed. This could cause many of them to renegotiate lower rents. Moreover, the strongest tenants are likely in the process of trying to lock in lower rents right now since they feel they have the upper hand over landlords. How much that will affect a landlord like FRT with prime locations remains to be seen, but it must be acknowledged as a risk.
Another big risk is the threat of second shutdowns. Most of FRT’s properties are located in cities and states that had stricter Covid safety regulations and were slower to reopen. If a second wave of the coronavirus hits the US this Fall/Winter, the governors and mayors in the areas where FRT’s properties are located could decide more restrictions are necessary, which would pressure rent collection rates again. If rent collection falls below 60% again, FRT will be burning cash unsustainably. Only, next time (if there is a next time), FRT will not have nearly as much financial flexibility to handle it.
In my opinion, FRT will not likely have to endure the same shutdowns and restrictions, even if there is a second wave. My reasoning is that healthcare providers have more effective ways of treating Covid today than they did back in the early Spring, and people are more accustomed to social distancing and other voluntary safety measures.
Management is seasoned, liquidity is substantial, interest rates are low, rent collection is improving, and FRT’s diversified retail portfolio is second to none. Right now, some challenges and risks remain, but I believe FRT has the tools to handle this suboptimal situation. And when we have gotten through this crisis, the REIT will look extremely attractive on the other side. That’s when investor fear will turn into investor greed.
If one is going to bet on any multi-tenant retail real estate in the United States at all, it should be FRT.
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Disclosure: I am/we are long FRT, SPG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.