Updated January 10th, 2019 by Josh Arnold
When it comes to dividend growth stocks, the Dividend Aristocrats are the “cream of the crop”. These are stocks in the S&P 500 Index, with 25+ consecutive years of dividend increases.
At the same time, Real Estate Investment Trusts (REITs) seem like natural fits for the Dividend Aristocrats. REITs are required to distribute at least 90% of their earnings to shareholders, which leads to steady dividend growth for the asset class, provided earnings grow over time.
And yet, there is only one REIT on the list of Dividend Aristocrats: Federal Realty Investment Trust (FRT). The reason for the relative lack of REITs in the Dividend Aristocrats Index is primarily due to the high payout requirement of REITs. It’s difficult to grow dividends year-in-and-year-out when the bulk of income is being distributed, as this leaves little margin for error.
Federal Realty is a relatively new member of the Dividend Aristocrats, as the stock was only added to the S&P 500 Index in 2016. But it has a very impressive dividend history: Federal Realty has increased its dividend for over 50 years in a row, which makes it a Dividend King as well.
This article will discuss the only REIT on the list of Dividend Aristocrats and Dividend Kings.
Business Overview
Federal Realty was founded in 1962. As a REIT, Federal Realty’s business model is to own and rent out real estate properties. It uses a significant portion of its rental income, as well as external financing, to acquire new properties. This helps create a “snow-ball” effect of rising income over time.
Federal Realty primarily owns shopping centers. However, it also operates in redevelopment of multi-purpose properties including retail, apartments, and condominiums. The portfolio is highly diversified in terms of tenant base. No individual industry represents more than 9% of the portfolio, and no single tenant accounts for more than 3%. Federal Realty has a high-quality tenant portfolio.
Source: Investor Presentation, page 6
Federal Realty’s retail portfolio is second to none in the industry in terms of average base rent, and consists of 105 properties. Approximately 95% of Federal Realty’s properties were leased, as of the third quarter, which is consistent with recent results.
Its properties are geographically focused on the East and West coasts, and the trust now has properties in Miami and Chicago. Its major markets are Washington, D.C., New York, Philadelphia, Boston, San Francisco, and Los Angeles.
The trust’s investment strategy is to pursue densely-populated, affluent communities, with high demand for commercial and residential real estate.
This strategy has fueled strong growth over the past several years.
Growth Prospects
Federal Realty’s growth comes from new properties, and rental increases.
In 2017, Federal Realty grew funds from operation (otherwise known as FFO) by just 2%, to $5.74 per share, which was a record for the trust at the time. FFO is a non-GAAP financial metric that analyzes cash flow available for distributions.
However, since 2010, Federal Realty increased FFO by 6% per year, on average, which is more in line with our expected growth rate for the trust.
Source: Investor Presentation, page 12
Importantly, growth is back on track for 2018 with FFO expected to come in at $6.21 per share, or 8% higher than 2017.
Recent leasing activity is being completed at higher average rents than properties in the existing portfolio, which is a good sign that future rental income will grow.
2018’s growth is being fueled by the familiar tailwinds of high occupancy and the trust rolling over leases at higher rates than before. This is leading to significant comparable property income growth, which is fueling higher FFO.
Last quarter, Federal Realty signed 101 leases, encompassing over 469,000 square feet of retail space. Not only is the trust keeping its occupancy rates high by reassigning its vacant properties, but it is doing so at ever-higher rates. Q3’s leases were made at an average rate of $38.31 per square foot, compared with $36.22 last year. That represents cash basis rollover growth on comparable properties of 6%, but in the past 12 months, that number is even better at 12%.
New properties, therefore, should keep the “snowball effect” intact.
The trust expects FFO-per-share in a range of $6.18 to $6.24 for 2018. This would represent growth of 7.7%-8.7%, compared with 2017.
Competitive Advantages & Recession Performance
One way in which REITs establish a competitive advantage is through investing in the highest-quality portfolios. Federal Realty has done this by focusing on affluent areas of the country, where demand exceeds supply. This is also how it can continue to boost its cash basis rollover growth over time; it owns properties in the most desirable areas and tenants are willing to pay more.
Federal Realty benefits from a favorable economic backdrop, with high occupancy rates, and the ability to raise rents over time.
Another competitive advantage for Federal Realty is a strong balance sheet. The trust’s senior unsecured debt holds a credit rating of A- from Standard & Poor’s, which is solidly investment-grade, and is a high rating for a REIT. Indeed, there are only five REITs with a “A” rating, with Federal Realty being one of them.
A strong balance sheet helps keep borrowing costs low, which is critical for the REIT business model.
These competitive strengths allowed Federal Realty to perform well during the last recession. Federal Realty’s FFO during the Great Recession is shown below:
- 2007 FFO-per-share of $3.63
- 2008 FFO-per-share of $3.87 (6.6% increase)
- 2009 FFO-per-share of $3.87 (flat)
- 2010 FFO-per-share of $3.88 (0.3% increase)
- 2011 FFO-per-share of $4.00 (3% increase)
FFO either held steady, or increased, during each year of the recession. This was a remarkable achievement, and speaks to the strength of the business.
Valuation & Expected Returns
Based on 2018 FFO-per-share of $6.21, Federal Realty stock trades for a price-to-FFO ratio of 19.6. Investors can think of this as similar to a price-to-earnings ratio.
On a valuation basis, Federal Realty appears slightly undervalued. The trust has generally traded with a price-to-FFO ratio in the low 20s, and we expect it will again. Should the stock return to our forecast fair value of 22.6 times FFO, it would provide a ~3% tailwind to total annual returns.
Therefore, future returns will be comprised of a roughly congruent mix of FFO growth, valuation expansion, and dividends. In this scenario, total returns would reach approximately 11%-12% annually as the trust would see growth in its business while also enjoying a steady tailwind from a higher valuation.
The current dividend yield of 3.4% is a fairly low yield for a REIT. However, Federal Realty helps make up for this with strong dividend growth and its impeccable track record.
Source: Investor Presentation , page 27
It has increased its dividend for 51 years in a row, including a 3% raise for 2018.
And, the trust has increased its dividend at a consistently high rate. According to Federal Realty, it has maintained a 7% compound annual dividend growth rate, over the course of its 51-year streak.
The dividend appears quite secure. Federal Realty has a payout ratio of about 65% of FFO, and a manageable debt-to-EBITDA ratio of 5.4, which is a slight improvement upon 2017.
Final Thoughts
Investors flock to REITs for dividends, and with high yields across the asset class, it is easy to see why they are so popular for income investors.
We have compiled a list of 171 REITs, that are worthy of further consideration, based on their dividend yields and dividend growth potential. You can see all 167 REITs here.
Federal Realty does not have a high dividend yield, particularly for a REIT. This is because the stock consistently trades for a relatively high valuation. However, high-quality businesses tend to sport above-average valuations. Investors interested solely in receiving high income right now may not be impressed by Federal Realty. That said, it is a strong choice for dividend growth investors.
