Federal Realty Investment Trust: Blue Chip for sale (NYSE: FRT)

buzzer

Federal Real Estate (NYSE: FRT) is an old-school mall REIT that I’ve long admired but never wanted to buy because it consistently traded high. After decades of high valuation, this REIT has finally been put up for sale, now trading at a reasonable FFO multiple of 14.5X and just over 80% of net asset value (NAV).

FRT prides itself on having strong properties in strong locations and for the most part the data backs up their claim. If you like investing in MSA gateways, FRT is a good way to get that exposure with its mix of quality and value.

Real estate portfolio

FRT’s portfolio is very different from that of its shopping center REIT counterparts. They focus on particularly large properties. With just 104 properties, they have 25 million leasable square feet, indicating an average property size of around 240,000 square feet. It would be a large industrial warehouse, but that’s especially important for shopping malls.

At the Bank of America conference 9/13/22, FRT describes their affinity for large properties rooted in the redevelopment opportunities they present. With so much acreage, they can always find ways to improve properties after purchase to improve the NOI. Its current enhancement pipeline is $1.3 billion.

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As these come to an end, this will likely lead to a nice increase in FFO/share, as $1 billion of expenses have already been paid.

Beyond property size, FRT is quite particular about where it acquires. Their portfolio is located in high-income, high-density areas, as their presentation slide highlights.

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TRF

It should be noted that Urstadt Biddle (UBA) has been conveniently left out compared to his peers. UBA’s 3-mile household income is actually slightly higher than FRT’s. Here is the peer comparison table as UBA presents it.

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UBA

If we follow this chain of obfuscation even further, one might note that Whitestone REIT (WSR) is conveniently left out of UBA’s peer comparison. When considering the cost of living, Whitestone has the highest household income within its catchment areas.

While I would have preferred FRT to include the full set of peers in its presentation, its household income and population metrics are very good.

Overall, FRT’s portfolio of assets is of superior quality and should trade at the high end of the shopping center FFO multiple range.

Growth

Historically, FRT has achieved a moderate growth rate via a few mechanisms:

  1. Comparable store NOI growth
  2. Deviations acquisition
  3. Developments spread

These 3 levers remain available today, but the same store NOI growth is likely to be significantly above trend for a few more years as it rebounds from a recent low.

The same store’s NOI had been fairly consistently around 3% per year until a massive drop in the pandemic.

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This decline in comparable store performance was far more severe than that of comparable shopping centers, as shown in the slide below.

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TRF

It should be noted that the FRT did not suffer during the financial crisis, so its problems in 2020 were probably not related to the recessionary aspects of the pandemic. I attribute the underperformance to the location as its assets are mostly located in areas that have seen the longest and strictest COVID lockdowns.

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It is also partly related to tenant diversity with substantial exposure to gyms and restaurants which are normally good tenants, but not during the pandemic.

While the hit to NOI was substantial, I think it’s pretty clear that the challenges were temporary in nature and not related to the desirability of their properties.

As these sites reopened, NOI quickly rebounded. Tenants have started paying rent again and new tenants have arrived with recent quarters with record rental volume. This activity facilitated an ascent of orientation.

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TRF

POI is the operating income of the property. It’s not a metric I’ve seen many REITs use, but it’s basically equivalent to the NOI of the same store which would be more standard. 5.5% to 7% is a good pace that should drive substantial FFO growth, as each percentage point of NOI growth typically translates into more than one point of FFO growth.

In combination with the upcoming redevelopments, FRT envisions moderate to rapid growth which is reflected in the consensus estimates.

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Evaluation

FRT is still trading at a somewhat premium multiple to its mall peers.

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It is, however, quite cheap compared to its own history as it has often traded at over 20X.

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It is also cheap compared to its asset value.

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NAVs are of course based on a capitalization rate assigned by analysts and the capitalization rate used above is 5.12%.

While I believe this is the correct cap rate for current market conditions (actual property sales data), there is an argument that with rising interest rates, capitalization will increase slightly.

Thus, the FRT may be closer to 90% of NAV rather than 80% using cap rate data.

Dividend Aristocrat

A recent series of dividend increases is just the tip of the iceberg.

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This company has been raising funds for 54 years, which places it in the rare club of dividend aristocrats.

At a current yield of 4.32%, this is also a better yield than most of this elite group.

I bring this up because I know that dividend history is a big issue for a large portion of investors who rely on dividend income, but I don’t think it has a particularly big impact on fundamental value. It’s a good indicator of a company that has been run in a conservative and generally shareholder-friendly way, but I wouldn’t pay too much to chase companies on the Aristocrats list.

That said, given the substantial pullback in the market price of FRT and the reduced FFO multiple, I think it would be reasonable to buy FRT at these levels.

how i play it

In malls, I have significant exposure to Whitestone (WSR) Kite Realty (KRG) and the retail portion of Armada Hoffler (AHH).

I prefer them due to their extremely cheap valuations and their exposure mainly to the Sunbelt. Consensus market pricing still shows a slight preference for coastal gateway markets with associated REITs trading at premiums, but I believe the Sunbelt will continue to fundamentally outperform.

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