Last week I wrote a Seeking Alpha article that distinguished the risk attributes of the mortgage and equity REITs and specifically this article focused on risk avoidance and the essential element of risk control and consistency in avoiding losses. As I wrote, "risk assessment is an essential element in the investment process and the most skillful investors are distinguished by outstanding risk-control that is invisible in good times." Building a sound REIT portfolio with a remarkable record of consistency (not just high returns) is the mark of a champion investor and is what separates the best from the rest.
Because mortgage REITs engage in leverage (i.e., borrowing money to magnify returns) investors benefit from the steepening of the yield curve which increases profit margins by widening the spread between the interest cost of borrowings and the interest income from the mortgages. Interest rates are typically more volatile than real estate prices, so mortgage REIT investors experience a bumpier ride than equity REIT investors. Conversely, many mortgage REITs, including Annaly Capital Management (NLY), Chimera Investments (CIM), American Capital Agency Corp. (AGNC), and Armour Residential REIT (ARR) are connected to debt-laden deals - that increases the leverage, which in turn adds a high volatility component to a REIT's earnings and dividends. Moreover, since mortgage REITs do not own or control property, judging financial performance is more of a guessing game.
Conversely, the equity REITs have proven to be more consistent over time and the best brands have become recognized for maintaining skillful risk-management practices. Since rental income is the driving force behind equity REITs, the ability to manage sustainable revenue and consistent profits is perhaps the most important component for success (or failure).
Today there are 126 equity REITs (with a market cap of $454.58 billion) that make-up the FTSE™ NAREIT® index (as of February 29, 2012) and each of these are distinguished by risk control attributes that in turn provide for correlated returns (or dividend yield). There are 17 shopping center REITs (with a combined market cap of $35.74 billion) that are included in the retail sub-sector and the average dividend yield of the sector is 3.73%. This sub-sector is comprised of a broad range of operators - each having a differentiated approach to controlling and managing risk. I have previously written articles on Excel Trust (EXL), Retail Opportunity Investment Corporation (ROIC), Kimco (KIM), Federal Realty (FRT), and Equity One (EQY). Each of these REITs are distinguished by tenant composition, geographic focus, development fundamentals, growth characteristics, leverage, and other factors.
Rule #2: The Law of Category
In Al Reis and Jack Trout's bestselling book, The 22 Immutable Laws of Marketing, the co-authors detail 22 basic laws that govern success or failure in the marketplace. As Reis and Trout describe, "If you can't be first in a category, set up a new category you can be first in." As the co-authors explain,
"What's the name of the third person to fly the Atlantic Ocean solo? If you didn't know that Bert Hinkler was the second person to fly the Atlantic, you might figure you had no chance at all to know the name of the third person. But you do. It's Amelia Earhart."
So in Law #2 (The Law of Category) of The 22 Immutable Laws of Marketing it is easy to follow that Earhart is known for her historic record as the first woman to fly the Atlantic, and not as much by being the third person to complete the transatlantic flight. As Reis and Trout explain, "Think categories…When you're the first in a new category, promote the category. In essence, you have no competition."
Regency Centers - Stock Up On a 'Best in Class' Grocery Brand
Founded in 1963 by Martin and Joan Stein, Regency Square Properties developed the first regional mall in Jacksonville, Fla. As the family company evolved, the owners decided to differentiate from the major mall developers like Simon Property Group (SPG), Taubman (TCO), and CBL Properties (CBL) and instead focus on being the leader in the growing shopping center sub-sector. In 1993 (and 30 years after its founding) Regency Centers (REG) initiated a public offering by raising around $108 million and that initial capitalization grew into a grocery-anchored shopping center dynasty. This migration from a mall-based operator into a neighborhood center REIT was perhaps the most distinguishable initiative in which the Jacksonville-based REIT began to exploit its differentiated Law of Category.
By becoming a grocery anchored REIT, Regency capitalized on the law of category and the grocery branded REIT gained broad recognition for exploiting its strategic grocery relationships. One of the earliest relationships was with Publix Supermarkets. Given Regency's close proximity to Publix's headquarters in Lakeland, Fla. (just 200 miles away), Regency has built a strategically beneficial role with Publix as one of the "best in class" grocery partners. Today (latest quarter reported) Regency has around 56 Publix stores and the other major grocery tenants include Safeway (57 stores), Kroger (51 stores), Supervalu (28 stores), Ahold (13 stores), Harris Teeter (8 stores), Whole Foods (8 stores), Trader Joe's, and H.E.B. (5 stores). Here is a list of Regency Center's top 10 tenants:
Because of Regency's differentiated grocery anchored strategy, the REIT has built a well-balanced model on consistency and value. With a grocery-anchored portfolio of around 80%, Regency has targeted its "law of category" strategy around major markets and university towns. Regency owns 364 shopping centers (including a few single tenant properties) and by focusing on infill grocery-anchored centers in areas with household incomes above the national average, the "best in class" REIT has gained a strategic advantage over the less resilient competition. Regency's high-quality 49.5 million square foot portfolio is built on sound demographic trends where almost 90 percent of the REIT's NOI is generated from the top 50 markets, while 70 percent comes from the top 25 markets.
Regency's strategy of investing and developing highly productive grocery-anchored shopping centers in trade areas with above-average income has been a leading differentiator that has resulted in reliable income and growth. This proven strategy has resulted in a recession proof model that generates consistent customer traffic and repeatable revenues. In addition, the grocery-based model is not as threatening to grocers as the other retailers that are impacted by e-commerce sales.
Regency - Ingredients for Success
One of the best ingredients of the Regency model is access to capital. With more than 80% of NOI unencumbered, Regency enjoys a strong and healthy balance sheet that provides significant financial flexibility. The BBB rated (S&P) and Baa2 rated (Moody's) debt enables the investment grade REIT to access multiple sources of capital. Many of the Regency's assets are unencumbered and the REIT has a significant $600 million line of credit and a $250 million term loan (balance on line is $95 million and balance on term loan is $150 million as of January 31, 2012). With around $21.6 million of cash on hand, Regency has around $512.3 million of capital available (includes costs to complete development and redevelopment and other financing requirements. Also, assumes no new investment activity and no additional free cash flow).
In addition to its strong debt relationships, Regency also maintains excellent co-investment relationships. This risk-aligned partnership strategy allows Regency to diversify its balance sheet while also providing for enhanced third-party revenues. Currently Regency has around $3.6 billion invested in co-investment partnerships with around 42% of total GLA (gross leasable area) that has resulted in third-party revenue in excess of $25 million.
Another important ingredient to the Regency success model is management. Upon graduating from Washington & Lee University in 1976 (where he was also a former Trustee), Martin "Hap" Stein, Jr., (now chairman and CEO) went to work for Regency Centers. During Stein's tenure, the grocery-focused REIT has grown in size from around 2 million square feet (at the time of the IPO) to around 50 million square feet today. When asked about his greatest accomplishment (in an interview in the January/February 2012 edition of REIT Magazine), Stein explained,
"The most important accomplishment is that we've built an extremely talented, engaged team, with a very strong culture that puts an emphasis on the customer."
Stein explained that Regency's customers are both tenants and investors and clearly this investor-aligned strategy is providing strong shareholder value. Notably, Regency's experienced development team has around nine new projects underway with estimated development costs of $161.3 million (2 Target, 1 Publix, 1 King Soopers, 1 Whole Foods, 1 Harris Teeter, 1 Giant, 1 Trader Joe's, and 1 TJ Maxx). With a proven track record (180 developments since 2000 with average returns of 8.7% and value created of $660 million since that time), Regency's skilled development efforts provide investors with considerable growth and income. In addition, Regency's in-house expertise should enhance overall portfolio quality while also providing accretive value to FFO.
Capital Recycling is also a valuable strategy being initiated by Stein and his skilled leadership team. Since 2010 Regency has sold nearly $100 million of properties and acquired more than $200 million. By selling off "non-strategic" assets, Regency reinvests capital back into centers that meet high-quality standards.
One of Regency's biggest tests for its management team was during the historic great recession. During this period, Regency demonstrated a sound strategy of risk-control where the grocery-anchored landlord got back nearly 100 Blockbuster video stores. Although the video rental concentration was high, Regency was successful in releasing many of the closed Blockbuster stores that were either located on end-cap or free-standing sites. In addition, most of the video sites are anchored by high volume grocery chains that enable the "necessity" based consumer to make frequent (weekly) visits that generate steady and consistent traffic. Although Regency's occupancy dropped (primarily due to Blockbuster), the "best in class" chain has begun to grow its overall occupancy performance back towards its goal of being 95% leased:
As the number one grocery-anchored REIT in the U.S., Regency continues to grow and maintain its position as a focused grocery landlord. This defensive investment strategy enables shareholders (and tenants) to benefit from a repeatable model aimed to generate consistent retail traffic and revenue. This sustainable track record is the "crown jewel" of the Regency brand and this necessity-based strategy is the foundation of the risk-aligned REIT model. Regency has maintained extraordinary consistency in its anchor (spaces in excess of 20,000 square feet) revenues as evidenced by the snapshot below:
Regency - An Enduring Grocery-Anchored REIT
Investing in a core grocery-anchored REIT can provide for a valuable inflation hedge and reliable and repeatable revenue. For the year-ending December 31, 2011, Regency renewed or newly leased 6.9 million square feet through 1,828 transactions. Total year-ending (2011) assets were $3.987 million and total liabilities were $2.117 billion. Total equity increased from $1.744 billion in 2010 to $1.870 billion in 2011. Total year-ending revenue (2011) was $500.42 million up 5.1% from $476.16 million in 2010 (using GAAP basis). Recurring Funds from Operations (FFO) for the latest quarter (Q4-11) was $56.8 million, or $0.63 per diluted share and Net Income attributable to common stockholders for the quarter was $8.1 million, or $0.09 per diluted share. The annual dividend pay-out was $1.85 per share (In 2010 and 2011) resulting in a current dividend yield of 4.3% (using price of $44.25).
Regency's dividend yield is closely aligned with its peer group (Kimco, Excel Trust, Retail Opportunity Investment Corp., Equity One, Diversified Developers, and Federal Realty):
With a 49 year track record of retail investments, Regency Centers has grown into a formidable leader in grocery-anchored shopping centers. This successful income-oriented strategy has resulted in decades of consistency and reliability. Regency's differentiated approach to risk-control can be best explained by the chairman and CEO, Hap Stein:
"Grocery anchored shopping centers are highly resistant to recessions and the Internet and Regency Centers has the most dominant portfolios of grocery anchored shopping centers. Our market leading grocers are generating average annual sales of $25 million, which represents approximately 20,000 necessity driven shopper visits to our centers each and every week."
The Regency Center brand is built on the power of its repeatable income model that turns the sources of grocery-anchored revenue into durably attractive dividends. The essence of Regency's "crown jewel" strategy is the REIT's sharp differentiation (on grocery-anchored centers) that provides a strategic competitive advantage. This prime competitive advantage is what makes Regency a "best in class" REIT and an attractive investment choice (Regency closed last at $44.25 per share). I expect Regency to continue to build on its accretive development pipeline and its strategic recycling initiatives -both providing for enhanced FFO growth resulting in increased dividends and capital appreciation. (My price target is a year-end price of $48.50 resulting in a total target return of approximately 15%).
Regency is listed on the New York Stock Exchange, traded under the symbol REG, and is included in the S&P MidCap 400 Index. There are also three series of preferred shares that trade under REG PRC, REG PRD, and REG PRE.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.