Co-produced with Beyond Saving

The pullback we saw during March as a result of the pandemic turned out to be one of the best opportunities that the markets has offered investors. When prices were falling at the time, we were encouraging buying the dip through a series of articles. Unfortunately, some were met with hundreds of comments to the effect that the impact of COVID-19 was going to be far worse and that investors should “sit on the sidelines” to wait and see how bad it would be. Some were even saying everything should be sold because it would certainly get much worse.

Unfortunately again, many investors were doing just that. Share prices go down precisely because more people are trying to sell than are trying to buy. We get the temptation, when you are down 20%-30% or even more, it’s very easy to “cut your losses” and sell “before I lose more.” That’s a very natural response. And if you sell, and then manage to buy back at a lower price, that works. This is why we encourage investors to keep a long-term view.

In many cases, that isn’t what happens. Investors sell out of fear and then when the price bounces back up they have one of two options, try to buy back in, or sit on the sidelines. As a result, they sit on the sidelines and miss the most profitable part of a bear market – the recovery.

Going back to history, following each bear market there was a strong recovery, and this year was no different. At HDO, instead of trying to catch the peaks and valleys, we buy in small bites. With dividend income streaming into our accounts several times a month, we always have access to at least a little bit of cash. Market drops are an opportunity. When a good investment is down in price, that’s a time to buy. You want to buy when the 10-year chart looks the worst. Buying at the bottom in March turned out to be a very profitable move.

Even today as we write, following the recovery, there remain many opportunities for some stocks that remained out of favor in the market. This includes several very high-quality, high-yield investments which remain on sale. We have been buying Dividend Aristocrats at large discounts. We have already discussed Realty Income (O) yield 4.4% and AT&T (T) yield 7.2%, and most recently we have highlighted Essex Property (ESS) yield 3.8%.

Today we are looking at one of the first REITs to achieve Dividend Aristocrat status, Federal Realty Investment Trust (FRT), yield 5.3%.

FRT is hands down best in class in a sector that has been significantly impacted by COVID-19. FRT primarily owns shopping centers, though they have very good diversity with exposure to offices and residential in addition to retail.

Over the decades, FRT has provided very good returns, routinely beating the indexes. Today, FRT is in the midst of their largest drop from peak that it has seen since 2009.

ChartData by YCharts

FRT’s business model is very simple – they buy real estate and lease it out. They focus on high-quality real estate assets. It’s a time-honored way to become very wealthy. Of course, those who have ever been a landlord know that things can become quite a bit more complex. Bad locations, bad tenants, too much leverage and various other issues can limit profitability.

Let’s take a look at how FRT has become one of the best landlords for investors to invest in.

Location, Location, Location

Well we didn’t come up with it, but it’s true. The most important part of real estate starts with location and in many ways it ends with location. All real estate is not equal. Real estate is only valuable to the extent that it can be used for something useful. So it’s important to buy real estate that’s in high demand, or better yet, real estate that isn’t super high demand right now, but will be in high demand in the future.

FRT focuses on what are often called “Super Primary” markets. These are markets of the big, readily recognizable cities in the US. These cities feature dense populations, household incomes well above the national average, along with legal and physical barriers limiting new construction.

Source: FRT Presentation

FRT does not focus on downtown locations. Instead, they prefer to own properties in first-ring suburbs of these cities. Many have talked about the flight from urban areas, that isn’t entirely new as for decades those who can afford to move to the suburbs frequently do. FRT has benefited from this trend as these areas have become more dense over the decades, driving property values up.

Flexible

The other aspect that has made FRT a winner over the years is that they focus on buying real estate that has, or can be converted, to multiple uses. The harsh reality of real estate is that what’s popular in an area today might not be popular in a decade.

We have seen this discussion with enclosed malls, with many landlords looking to convert large anchor retail space into other uses. FRT’s desire for flexibility has led them to focus on open-air style properties which are more easily converted to other uses.

In fact, FRT has been one of the pioneers of the increasingly popular “mixed-use” property which incorporates retail, office space and residential uses all within convenient walking distance with shared open space.

Source: FRT Presentation

This has led FRT to have a very diverse selection of tenants, which has helped insulate them from the turmoil among apparel tenants as well as the unexpected benefit of having exposure to “essential” tenants that were less impacted by COVID-19 shutdowns.

Source: FRT Presentation

In addition to significant diversity in categories, no tenant makes up more than 3.5% of FRT’s base rent.

Strong Balance Sheet

To top off FRT’s strengths of premium locations and excellent diversity, FRT has a very disciplined balance sheet. One of only a handful of REITs the have earned an “A” credit rating, they are rated “A3” by Moody’s and “A-” by S&P.

Even with the impact of COVID-19 on Q2, FRT has very strong statistics.

Source: FRT Presentation

Additionally, they have just under $1 billion in cash and a $0 balance on their $1 billion revolver providing nearly $2 billion in liquidity. That’s more than twice their annual gross revenues.

This strong liquidity position is the primary reason why FRT was able to continue paying their dividend while most other peers have suspended theirs. In fact, FRT just increased their dividend for the 53rd consecutive year. Just like numerous turbulent times that FRT has gone through before, their strong balance sheet helps them get through disruptions and keep raising their dividend. Here is a look at their dividend over the past 52 years.

Source: FRT Presentation

FRT has proven to be a very resilient pick through numerous economic cycles.

COVID-19

COVID-19 has been a very different impact from what we have seen in the past. For REITs, the largest impact has been that many tenants were closed by government mandate and their revenues went to zero, making it difficult if not impossible to pay rent.

Thanks to their strong balance sheet, FRT had a lot of options for negotiating with tenants and have worked with them to make deferral plans for rent. For FRT, their “breakeven” collection rate after interest, G&A, leasing and maintenance capital expenditures, is 60%. That’s a number they got close to, but they were always above breakeven even in April.

The collection rate has steadily improved, and we can expect it to continue improving. On one hand, FRT had the advantage of having exposure to “essential” businesses that never shutdown, on the other hand, they are exposed to suburbs of large metro areas which have been more cautious with allowing businesses to reopen.

It’s a testament to the strength of FRT’s business model that their breakeven is so low, and that even with many tenants deferring rent, FRT is not only capable of paying their dividend, they can raise it.

Growth

FRT has a whole host of growth projects underway. Historically, they have provided very steady growth, with interruptions at identifiable times like the dot-com bust and the great financial crisis.

ChartData by YCharts

COVID-19 will certainly be another event to join the long list that FRT got to the other side and then kicked right back into growth mode.

FRT has 10 projects underway, with many scheduled to stabilize in 2021.

Source: FRT Supplement

They also have dozens of opportunities within their current portfolio that they have identified for future investment.

Source: FRT Supplement

Not to mention that with nearly a billion in cash on hand FRT is well positioned to be an acquirer if any of their peers start selling properties at low prices to improve their cash position.

Investors today can be very confident that FRT will recover from COVID-19, just like they recovered from the various other bear markets they went through in their history. These price drops are the ideal time to buy FRT and hold for the next decade.

Conclusion

FRT has proven to be best in class, not just for a decade, but for many decades.

ChartData by YCharts

This kind of endurance makes FRT a great choice as a conservative, long-term buy and hold. If you buy today, you will get a growing dividend that currently yields 5.3%.

Also there’s substantial capital upside as FRT has historically traded with a dividend yield within 1% of US Treasury yields, sometimes even lower than the 10-year Treasury rate. Here is a look at the spread between FRT’s dividend yield and the 10-year treasury rate:

ChartData by YCharts

COVID-19 has pushed FRT to its highest spread ever! If FRT was to get back to just a 1.5% spread over the 10-year Treasury rate, that implies upside to $150. Historically, it has actually done much better, after spiking up it has returned to a zero spread.

In other words, FRT is a Dividend Aristocrat with a 5.3% yield, a dividend growing at 2-5%/year and capital gains potential to double.

All from a REIT with an “A” rated balance sheet and a proven history of over 50 years. These are the kinds of opportunities that do not come around very often. We are definitely taking advantage of this one, and you should too. FRT is set to be one of your biggest winners in your high yield portfolio!

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Disclosure: I am/we are long FRT, O, AND T. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Treading Softly, Beyond Saving, PendragonY, and Preferred Stock Trader all are supporting contributors for High Dividend Opportunities.

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