Published October 4th, 2017 by Bob Ciura
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.
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. 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 50 years in a row.
Not only is Federal Realty a Dividend Aristocrat, but it is a Dividend King as well. The Dividend Kings have increased their dividends for an amazing 50+ years in a row. You can see all 22 Dividend Kings here.
This article will discuss the only REIT on the list of Dividend Aristocrats and Dividend Kings.
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. 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%.
Source: Second Quarter Earnings Presentation, page 5
It has a high-quality property portfolio, which is made up of 99 properties. Approximately 95% of Federal Realty’s properties were leased, as of the second quarter.
Its properties are geographically focused on the East & West coasts, as well as south Florida, although recently the company has expanded to the Midwest as well. Its major markets are Washington, D.C., New York, Philadelphia, Boston, San Francisco, and Los Angeles.
The company’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.
Federal Realty’s growth comes from new properties, and rental increases.
In 2016, Federal Realty grew funds from operation (otherwise known as FFO) by 12%, to $5.65 per share, which was a record for the company. FFO is a non-GAAP financial metric that analyzes cash flow available for distributions.
In the preceding five-year period, Federal Realty increased FFO by 7% per year, on average.
Growth in 2016 was due to a 7.7% increase in rental revenue, which rose to a record of $802 million.
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.
Source: Second Quarter Earnings Presentation, page 11
2017 is shaping up to be another year of slow-and-steady growth. FFO is up 5% through the first six months, and will likely continue growing.
Last quarter, Federal Realty signed 111 leases, encompassing over 430,000 square feet of retail space. It also announced it will form a new joint venture with Primestor Development Inc., in which Federal Realty will own an approximately 90% interest in the venture.
The joint venture will have an interest in six community shopping centers, as well as one center under redevelopment.
New properties should keep the “snowball effect” intact.
The company expects FFO-per-share in a range of $5.86 to $5.94 for 2017. This would represent growth of 3.7%-5.1%, compared with 2016.
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.
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 company’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.
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 2016 FFO-per-share of $5.65, Federal Realty stock trades for a price-to-FFO ratio of 22. Investors can think of this as similar to a price-to-earnings ratio.
On a valuation basis, Federal Realty appears slightly overvalued. REITs do not typically grow FFO at high enough rates to justify a price-to-FFO ratio above 20. And, rising interest rates could compress FFO growth—and consequently valuations—moving forward.
Therefore, future returns will be comprised mostly of FFO growth and dividends. A forecast of future returns is as follows:
- 5%-7% FFO growth
- 2% dividend yield
In this scenario, total returns would reach approximately 8%-11% per year, plus or minus any changes in the price-to-FFO multiple.
The current dividend yield of 3.2% may be disappointing, since it is a fairly low yield for a REIT. However, Federal Realty helps make up for this with strong dividend growth.
Source: Second Quarter Earnings Presentation, page 50
It has increased its dividend for 50 years in a row, including a 2% raise on July 31st.
And, the company 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 50-year streak.
The dividend appears secure. Federal Realty has a payout ratio less than 70% of FFO, and a manageable debt-to-EBITDA ratio of 5.8.
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 171 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.