Is Federal Realty Investment Trust a Buy?
Shopping center owner Federal Realty is expecting occupancy rates to keep falling, but that doesn't mean it thinks the future is bleak.
Reuben Gregg Brewer
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Reuben Gregg Brewer believes dividends are a window into a company's soul. He tries to invest in good souls.
Real estate investment trust (REIT) Federal Realty Investment Trust (NYSE:FRT) has been muddling through the economic shutdowns used to slow the spread of the coronavirus pandemic. It's been tough at times, but long-term investors might want to take a closer look today. That's true even though the REIT thinks things are likely to get worse before they start getting better.
A retail reboot is in progress
For several years the retail sector has been working through what's been called the "retail apocalypse." Looking back, that term seems more and more like hyperbole, given that it was basically meant to describe the slow-moving decline of retailers that weren't keeping up with shifts in consumer tastes. That includes the increasing demand for online shopping options, but it isn't limited to that factor. Complicating things was the excessive debt taken on by some retailers, which became increasingly hard to maintain as business declined. Real estate investment trusts like Federal Realty that specialize in retail assets were forced to fill the empty storefronts left behind as retailers closed stores and went out of business.
And then 2020 came along, with the coronavirus pandemic basically upending the normal functioning of the global economy. The slow-moving changes taking shape in the retail sector turned into a tidal wave, finally turning the retail apocalypse into a very real thing. In essence, the shutdown of non-essential real estate simply pushed a lot of the retailers that were teetering over the edge. Many won't come back, and others will muddle through with reduced store footprints. In the end, Federal Realty and its peers will be fighting over a smaller number of customers.
In fact, the fallout probably isn't over just yet -- there are still a number of businesses that are holding on in hopes of better days ahead, like movie chain AMC Entertainment. It has already warned that it could run out of cash before the end of the year or in early 2021, but it is still a viable tenant for now.
That gets to the core of a comment by the CFO of Federal Realty during the REIT's third-quarter 2020 earnings conference call. He said he expects occupancy to fall from 90.6% to the mid-to-upper-80% range. That's not the right direction, and it suggests that times will continue to be tough in the months ahead.
Location, location, location is still the driving force
Times are already tough for Federal Realty, with funds from operations (FFO), which is like earnings for an industrial company, falling nearly 22% year over year in the third quarter. Investors have reacted by pushing the stock lower by 27% from its early-2020 highs. The dividend yield, at roughly 4.5%, is the highest it has been since the 2008-09 recession. That suggests the stock is relatively cheap today. But if the CFO is right about occupancy levels, performance could remain weak for several more quarters, so buying comes with some risks here.
FRT Dividend Yield data by YCharts
For long-term dividend investors, the risk/reward balance is probably tilted in favor of buying. For starters, Federal Realty has increased its dividend annually for more than five decades, which puts it in the Dividend Aristocrat sphere. It clearly places a high priority on returning value to investors through distributions, which helps explain why it upped the payout in August despite the current headwinds. That makes sense, given that it has already seen a lot of ups and downs over the last half-century. While this downturn may be unusual because of COVID-19, Federal Realty knows that it will eventually pass, just like every other downturn before it.
That brings up the value of Federal Realty's properties. It owns a highly curated list of around 100 shopping centers and mixed-use properties. They are located in densely populated markets with high median incomes near large cities. These are the types of locations that customers want to shop at and retailers want to be in. In fact, Federal Realty has been fielding inquiries from retailers with nearby existing locations, owned by other landlords, that want to move to better locations. That's a huge statement about how desirable the REIT's properties are, and speaks volumes about what the longer-term future holds.
Yes, there's probably going to be more bad news over the next few months. A spike of retail bankruptcies after the holiday season wouldn't be a shock. And Federal Realty will have to work through that and wait for its weakest tenants to fall. But once they do, it can get to work upgrading its tenant roster at the same time as retailers upgrade their locations -- a win/win transaction that will eventually mean improved results for investors.
It's time for some risk-taking
It's entirely possible that Federal Realty's stock could fall from its current levels given the company's expectation for increasing vacancy rates. But using yield as a rough valuation tool, this well-run REIT with an impressive retail portfolio looks pretty attractive today -- doubly so given its incredibly long history of rewarding investors with a steadily growing stream of dividends. If you can stomach a little uncertainty, Federal Realty looks like it is worth the risk today.