Federal Real Estate Investment Stock: There Are Better Options


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Over the past two years, I’ve started buying several Real Estate Investment Trusts (“REITs”) for my Roth IRA. I like the income orientation of the sector, and the long-term returns for investors have proven attractive. If you can lower your concentration at the best REIT opportunities, returns can be even better.

I bought positions in several different REIT sectors, cell towers, net lease and even cannabis REITs. As an investor with limited capital and an aversion to exchange-traded funds (“ETFs”), I had to narrow things down to what I considered the best options at the time. One of the REITs I forwarded is Federal Realty Investment Trust (NYSE: FRT). Although the REIT is a dividend king, I found some of the alternatives more attractive.

Investment thesis

Federal Realty Trust is one of the oldest REITs in the market, and it has earned the coveted title of dividend king, with 54 years of consecutive dividend increases. Like most public markets, FRT shares have struggled in 2022 and are down nearly 30% year-to-date. This might lead some investors to think now is the right time to start a position or add one, but there are a few factors that kept me away.

The first is valuation, which is cheaper today, but at 16.7x price/FFO it still doesn’t leave a huge margin of safety. The other factor is slower dividend growth, which is one of the main things I look for with REITs. Stocks are now yielding 4.4%, but I don’t think investors will see double-digit returns from here without a meaningful multiple expansion.

Insight

FRT is a mixed-use REIT that focuses on suburban areas of major cities in the United States. They target affluent areas and have an attractive rental mix, including housing, offices, restaurants and other types of commercial properties. FRT has a market cap of $7.7 billion and an impressive streak of dividend increases, with 54 annual dividend increases.

Overview of Federal Real Estate Investment

Presentation of FRT (federalrealty.com)

FRT also maintains a solid balance sheet with ample liquidity and well-laddered debt maturities. The debt is a mix of mortgage notes and senior unsecured debt, most of which bears interest at rates below the current rate of inflation. They have notes that are due in over two decades, showing that the smart money in the bond market is ready to lend to FRT for a long time at low interest rates.

Federal Real Estate Investment Debt Maturities

FRT debt scale (federalrealty.com)

As you can see, FRT doesn’t have a bunch of debt maturing at once, and they should be able to issue debt in the future at attractive rates. While most of the article so far is reason enough to be optimistic, one of the reasons I haven’t bought FRT stock is the valuation.

Evaluation

FRT had a rough start to 2022, like most markets outside of the energy sector. Stocks are down almost 30% since the start of the year, which certainly offers a better entry point than the start of the year. Shares are now trading at 16.7 price/FFO, which is lower than the average multiple of 20.6x over the past two decades.

FRT/FFO price

Price/FFO (fastgraphs.com)

Bullish investors could expect a return to a multiple of 20x (or more), which would certainly lead to attractive returns. However, I’m not ready to bet on that, which is why I currently have no positions. Although the valuation is not so attractive for new investors in my opinion, the slowdown in dividend growth is the other reason why I stayed away from FRT.

Slower dividend growth

FRT is currently yielding 4.4%, which is a solid dividend in the current market environment. They also have a 54-year history of dividend increases, so it’s safe to assume that dividend increases are likely to continue for years to come. However, slowing dividend growth is the other main reason I stayed away. Over the past 5 years, they have only increased the quarterly dividend by 7 cents from $1.00 to $1.07. Dividend increases will likely continue, but I don’t see dividend growth accelerating from here.

Conclusion

If your priority is a secure current income with a high likelihood of continued increases, FRT might be an intriguing option for you. The company certainly has an impressive portfolio of assets in attractive markets with high barriers to entry.

However, I don’t think the valuation is that attractive right now at 16.7x price/FFO. Multiple expansion is possible, but I think unlikely with FRT’s growth profile. The other issue is slowing dividend growth. While 54 consecutive dividend increases are impressive, recent growth hasn’t generated much excitement, even with a 4.4% yield.

If stocks continue to fall, valuation could reach a point where the margin of safety is greater and future returns better, but I think there are better risk/reward profiles for REIT investors today. The stocks are currently locked in my book, but that could change in the coming months depending on what happens with the stock price.

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