The Federal Realty Investment Trust (NYSE:FRT) is one of the truly successful long-term stories in the REIT space. It has been raising the dividend it returns to shareholders for 46 years now, an impressive feat for any company to accomplish (and especially for a real estate company through the early 1990s as well as 2008 and 2009). It has also given its owners wealth accumulation that rivals the best of the blue-chip investments, turning a $10,000 investment exactly 25 years ago into $197,053 today (for a compounded annual return rate of 12.66%).
The company has increased its funds from operations from $4.31 to $4.55, and has recently increased its dividend from $0.73 quarterly in 2012 to $0.78 now. This growth can be explained by intelligent managerial moves-Federal Realty now has more people in its real estate than last year, and is able to charge them a much higher average rate. The occupancy rate has inched forward from 94.2% to 95.3%, but most significantly, the REIT has increased the amount of money it is able to charge its lessees.
The company owns the real estate where you tend to see at L.A. Fitness, The Gap, Bed Bath and Beyond, or TJX Companies. The average rent is now up to $31.10 per square foot, and this represents a sizable 15% increase over 2012. Management is doing their job to move FFO up 7% or so per year.
The problem with Federal Realty is entirely valuation driven. Profits have not even doubled over the past decade, yet the stock price has quadrupled. I don't know if it is right to use the word bubble, but Federal Realty's funds from operations are capitalized at a rate far in excess of its valuations during periods of higher interest rates. Heck, during most of the early 2000s, Federal Realty's valuation was capitalized at a rate between 12.0 and 15.3x funds from operations. If Federal Realty were to endure a similar valuation today, that would place the stock price somewhere between $54.60 per share and $69.61 per share. In a rational world, this stock has no business trading at over $100, for a valuation of 21-22x FFO. If interest rate increases came sooner rather than later, Federal Realty's valuation would be looking at a 30-50% justified decline in stock price.
Of course, interest rates are not the sole determinant of a REIT's valuation. There is also growth; a rising FFO per share rate can mute some of the effects that rising interests can toll upon the stalwarts of the REIT sector. The management team seems quite excited about the Pike & Rose and Santana Row development projects, dedicating almost half a billion in investment to bring them to fruition. Even if we stipulate 7-8% FFO growth from here (the high end of what Federal Realty has historically achieved), we'd still only be looking at $6.45 to $6.78 in FFO per share come 2018. If this REIT experiences a reversion to the mean and traded at 15x FFO, we'd be looking at a share price of $96.75 to $101.70 five years from now. And the current price is $100 per share.
In other words, you'd be buying the dividend (and that's it) for the next five years. And even that is not such a great deal right now, as the yield is only 3.11%. The last time Federal Realty's yield got this low was in 2007, right when the company's stock price peaked before the financial crisis hit. At that point, the shares of the stock took a grueling dive from $98.90 per share in 2007 to a low of $36.90 in 2009.
Unless you know the future, investing is a probabilistic exercise. You try to stack as many of the cards in your favor as you can before placing your bet. None of that is the case with Federal Realty right now. The dividend yield, even accounting for the 7% raise, is at one of the lowest points it has even been in the past generation. The valuation of the stock is clearly influenced by low interest rates, as it could be regularly purchased at 12-15x FFO in a world where interest rates were three percentage points higher. If the company's valuation were to hit the 15x FFO figure seen before the decline in interest rates, it would take five years of 7-8% growth for the company to be worth $100 per share. Your only return would be the dividend. If you are considering a purchase of Federal Realty today, it would only make sense if you believe that interest rates will stay low for a long time, or Federal Realty will be growing at a higher rate than the top end of its historical average. If you don't want a 30-50% price decline when interest rates rise, the wise course of action would be to sell now and find greener pastures elsewhere.