Caveat Emptor: Shopping Mall REIT in crisis

Federal Realty Investment Fund (NYSE: FRT) invests in shopping centers in the Northeastern United States, the Mid-Atlantic states, California, and South Florida.

FRT’s Investors homepage boldy proclaims that “With an increased annual dividend rate for 52 consecutive years, we hold the longest consecutive record in the REIT industry“. FRT is part of the S&P 500 since 2016 and has investment grade credit ratings.

Source: FTR 2019 Annual Report

FRT is a historically solid REIT with a distinguished track record. However, the coronavirus crisis and the incoming recession may threaten its long term survival.

Should you invest or sit this one out?

1 – Portfolio

FRT’s portfolio consists of 104 properties with a total of 24 million square feet. They have roughly 3,000 tenants and 2,700+ residential units. Its top 10 tenants include TJX, GAP, Bed bath & Beyond, and Dick’s Sporting Goods, among others.

Source: FTR 2019 Annual Report

FRT’s tenants are diversified across multiple industries. Theoretically, this is a good thing as it ensures that a crisis in a single sector won’t cause all revenue to dry up. However, since all the tenants are located in malls, a crisis in the shopping mall sector will have profound effects on the company’s earnings.

The majority of FRT’s square footage is concentrated in major coastal metropolitan areas. Its shopping centers are located in areas with an average population of 162,000 and average household income of $127,000.

FRT’s commercial property leases range from 3-10 years and 60% of FRT’s tenants have leases expiring by 2024.

2 – Coronavirus Business Update

Obviously, the coronavirus will have a profound impact on the retail sector and it remains to be seen how many of FRT’s tenants will survive the challenging context.

As of May 1st, 2020, FRT states that all 104 of its shopping centers are open but only 47% of its tenants are operating.

Q2 revenues are likely to take a big hit as only 53% of total April 2020 billed recurring rents have been collected to date. The good news is the 100% collection rate from Grocery & Drug tenants, 95% rate from residential tenants, and 87% from office tenants but the bad news is the 45% collection rate from Retail, 16% rate from Full Price Apparel and 27% rate from Restaurant tenants.

Consequently, FRT has taken several measures to raise cash: It accessed close to $1bn of its revolving credit facility, completed a $400M loan and withdrew 2020 guidance. This provides liquidity to cover operational expenses during these troubled times.

3 – Q1 2020 Financial Performance

FRT recently published its Q1 2020 financial results.

As expected, earnings were disappointing. Compared to Q1 2019, all metrics have decreased:

  • Revenues decreased 28.8%, to $231.5M from $232.2M
  • Operating Income decreased 5.87%, to $85.7M from $91M
  • Net Income decreased 9.25%, to $52.7M from $58.1M
  • FFO decreased 2.25%, to $115.7M from $118.3M
  • EPS decreased 10.25%, to $0.70/share from $.78/share

The good news is that FRT tapped into its credit lines and now has cash and cash equivalents of $1.019 billion. This provides liquidity to finance operating expenses while rent collection remains low. Total liabilities ot $5bn are quite high, this represents a reasonable Debt/Equity ratio of 1.9.

Further, the vast majority (77%) of FRT’s debt is due in 2023 of thereafter. Therefore, there are no immediate liability concerns that will weigh on the company during the covid crisis.

4 – Dividend

FRT’s dividend is $4.20 per share, which represents a dividend yield of 5.79%. The payout ratio of 72.57% is very low but this may prove a blessing as it frees up liquidity to deal with operating costs during the covid crisis.

The 51 years of consecutive dividend growth suggests that FRT is a very reliable company that knows how to navigate troubled waters. On May 6th, FRT declared a $1.05/share cash dividend, in line with the previous dividend payment. For now, a dividend cut is not on the cards but investors should remain cautious as the US is currently entering a recession.

Conclusion

FRT is a historically strong REIT with a very solid portfolio of tenants across diversified industries. However rosy past performance was, the current issue is the very challenging economic context.

The Covid19 crisis will have longlasting societal effects and may redefine the way business is conducted. The drastic drop in rent collection will result in disappointing Q2 2020 earnings. The stock may pursue its downward trend and maybe even breach the $65 support zone. This has happened before: In 2009, the stock reached a low of $39. If a recession maintains the record high unemployment, and consumers shun shopping malls over fears of the cirus, then FRT will enter a very severe crisis.

VERDICT: Shopping malls are in serious crisis and it is unclear when or if shoppers will return en masse like before. Prudence is key. I’m very tempted to buy at current levels but I’m holding off due to uncertainty. If you do initiate a position, spread out your purchases over several weeks, possibly over several quarters, to hedge against the risk of another market drop. I like this REIT but I will wait until the economy is on a clear path to recovery before buying shares. Given the current context, I’d be much more comfortable investing in Realty Income Corp (O) than FRT.


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DISCLAIMER: This is not financial advice. Always do your own research before investing.

2 thoughts on “Caveat Emptor: Shopping Mall REIT in crisis

  1. I am worried about all REITs right now. Most people have been working at home for months now- makes me wonder about office buildings. Add the decline in traffic for shopping malls….

    FRT does have a strong dividend history- maybe watch for a drop in price!

    Like

    1. I’m also worried about REITs, but the market seems to disagree.

      Since writing the article, FRT’s fundamentals have not improved but the stock price increased 20%.

      This is surprising given that May rent collection is only 54%, three percentage points lower than April’s.

      Given the economic climate, I’d be hesitant to buy shares even if the stock dips back to sub-$80 levels. If the recession continues, then FRT’s rent collection is doomed to remain low, profits will be razor thin and ultimately the dividend could get cut. There comes a point where taking on extra debt just to honor dividend payments becomes unjustifiable. The main issue is FRT’s decision of specializing in shopping malls. This is great when the economy’s roaring but it’s awful when you have a virus-induced recession.

      In contrast, O’s May rent collection is 82%, two percentage points lower than April’s. The slight decline is slightly worrying but O is very resilient due to being specialized in single-tenant properties and having massive tenant industry diversification. This crisis may be trying to prove that diversification of revenue streams is of utmost importance (for just about everybody actually).

      Despite FRT’s share price performing well and invalidating my initial conclusion, I still stand by my statement that investing in FRT is very risky, and investors wanting to invest in REITs should look to companies with great diversification like O.

      Hhappy investing.

      Rgds
      Tim

      Like

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