By: Dividend Sensei
Dividend aristocrats, companies with 25+ consecutive years of annual dividend growth, are beloved by income investors. It’s not hard to see why. Not just have these blue chips proven they can generate safe and steadily rising dividends in all economic, industry, and interest rate environments, but they also tend to crush the market over time. For example in this century the dividend aristocrats have nearly doubled the returns of the S&P 500 while enjoying 26% less price volatility. However, the one downside to their renown is that dividend aristocrats and kings (50+ consecutive years of dividend increases) are rarely on sale.
However, Federal Realty Trust (FRT) is one such undervalued aristocrat. In fact having just raised its dividend for the 51st consecutive year, it’s a dividend king. One with a great track record of delivering not just safe and steadily growing dividends but market crushing returns as well.
So let’s take a look at the three reasons why I expect FRT to continue delivering strong and steady dividend growth over the coming years, as well as market beating double digit total returns.
Federal Realty Trust: The Only Dividend King REIT Is The Bluest Of Blue Chips
Founded in 1962, Federal Realty Trust is one of the oldest REITs in the world. It’s managed to reward income investors with 51 consecutive years of dividend growth, averaging 7% over that time. That’s thanks to its focus on owning 105 premium shopping centers in eight major markets leased to about 1900 tenants. Now don’t let the fears of the “retail apocalypse” scare you. Because FRT’s properties are literally without peer, which has allowed it to continue thriving in the age of Amazon. Federal Realty’s properties are all located in highly affluent and dense urban areas. In fact, on average its centers are located within 3 miles of 160,000 people, with an average household income of $120,000.
In addition management has spent the last several years increasing the value of its properties via mix used facilities. This means adding office, hotels, and apartments near or attached to its properties. This boosts traffic and helps its tenants thrive. Today 16% of its assets are mixed use and management eventually expects that to get to 20%, adding valuable diversification to its portfolio. FRT’s tenant base in extremely well diversified with its largest tenant, TJX Companies, making up just 2.6% of its rent. In total its top 25 tenants represent just 27.5% of rent and its lease expiration schedule in extremely well staggered. This creates incredibly stable cash flow with which to pay its steadily rising dividend.
FRT’s focus on top quality properties and healthy tenants is why it enjoys 95% occupancy, which is up 0.5% in the past year. More importantly it’s able to convert its stable long-term leases (stable recurring cash flow) into industry leading growth rates. For example, its lease spread, the amount it raises rents on expiring leases, over the past 12 months was 15%. For context over the past 20 years the REIT’s lease spread has averaged 16%, double that of its peers (9%). Note that FRT’s lease spread has remained positive even during the Great Recession when it was still able to command 8% rental increases while its peers were cutting their rents by an average of 1%. This highlights how Federal Realty’s premium property portfolio holds up well even during the worst economic downturn since the Great Depression. In fact, during the financial crisis the REIT’s revenue and cash flow per share actually increased. This kind of recession resistant business explains why FRT’s cash flow per share has grown at 6% annually both since 2010, but also since 2003 (including the Financial Crisis).
The REIT’s biggest competitive advantages are the quality of its management team, and its ability to invest profitably thanks to strong access to low cost capital. FRT is led by Donald Woods, whose been with the REIT for 20 years and CEO for 16. Meanwhile the CFO, Dan Guglielmone, has 25 years of industry experience financing profitable real estate deals. Before coming to Federal Realty he put together over 175 property deals worth over $30 billion. And on average FRT executives have been with the REIT for over 15 years, meaning they bring centuries of experience in creating long-term shareholder value.
Cheap capital is the lifeblood of the REIT sector, and ultimately long-term dividend growth and total returns come from being able to invest at cash yields above a REIT’s cost of capital. Fortunately FRT enjoys very low costs of capital thanks to its conservative use of debt (second highest credit rating of any REIT) and well earned share price premium (from being a dividend king).
- Cost Of Capital: 3.8%
- Average Yield On Invested Capital: 7.0%
- Gross Investment Spread: 2.2% (industry average 1% to 2%)
The REIT’s cost of capital of 3.6% means that it can achieve industry leading profitability even while focusing only on the most premium investments. Because of the lower risk nature of such properties cash yields are lower yet FRT is still able to achieve very fast growth rates in adjusted funds from operations or AFFO/share. AFFO is the REIT equivalent of free cash flow and what funds the dividend. Currently FRT is the one of the fastest shopping center REIT in America, despite its laser like focus on quality over quantity.
Over the long-term management expects to grow AFFO/share by 6%, in line with its historical rate. That in turn will likely drive similar dividend growth, which when combined with the stock’s attractive valuation, will likely result in double digit and market beating returns over the next five years.