Federal Realty is a retail-based REIT that owns and operates high-quality shopping centers and mixed-use assets in eight of the largest metropolitan areas. It has strategically acquired and developed assets in submarkets with strong demand drivers, creating a portfolio with average location population density and median household income that are higher than that of any other retail REIT. As a result, Federal Realty has been able to drive strong same-store net operating income growth and average double-digit re-leasing spreads over the past two decades. Its portfolio should continue to attract shoppers and tenants and produce solid internal growth even in a challenging retail environment.
Key Morningstar Metrics for Federal Realty Investment Trust
- Fair Value Estimate: $142
- Star Rating: 5 Stars
- Economic Moat Rating: None
- Uncertainty Rating: Medium
Economic Moat Rating
We don’t believe Federal Realty has an economic moat. Its portfolio contains very high-quality assets that are strategically located in some of the best submarkets. However, the continued growth of e-commerce places significant pressure on traditional brick-and-mortar retail. While Federal Realty’s assets focused on grocery, service, and entertainment will face significantly less pressure from e-commerce, the sales growth from this segment still won’t support significant rent growth. Therefore, the current rent levels and rent increases the company achieves on its properties compared with the initial capital investment produce returns that do not result in a significant spread over the weighted average cost of capital, leading us to conclude that there is no support for a moat.
Fair Value Estimate for Federal Realty Stock
Our $142 fair value estimate implies a 4.9% cap rate on our forward four-quarter net operating income forecast, 21 times multiple on our forward fourth-quarter funds from operations estimate, and a 3.0% dividend yield based on a $4.36 annualized payout. Our occupancy, minimum rent growth, re-leasing spreads, and margin assumptions drive total company annual same-store NOI growth averaging 2.5% across our 10-year forecast. We believe Federal Realty will focus on developing and redeveloping high-quality retail and selectively disposing of assets to partially fund its external growth. In addition to the current pipeline of $748 million of development and redevelopment projects, we project $400 million of investments each year in the company’s pipeline at a 7.5% average yield. We estimate Federal’s net asset value to be approximately $139 per share based on a 5.0% cap rate assumption.
Risk and Uncertainty
E-commerce has taken market share from physical retail sales. Additionally, many traditional retailers are moving more of their business online to compete with the prices and convenience offered by e-commerce. The United States is significantly overretailed on a square foot per capita basis, so shrinking market share for physical space will worsen the situation and make store closures more likely over time. Several of Federal Realty’s major in-line tenants have experienced declining sales and expect to close stores. The REIT will have to re-lease vacant space to new tenants, which may be at lower rents in a negative sales environment. Also, the company’s largest development projects are mixed-use projects that feature office, multifamily residential, and/or hotel components—lines of business that are outside its traditional retail focus.
Federal Realty Bulls Say
- Federal Realty reports peer-leading population density and annual household income in proximity to its centers, providing a strong demographic base for its tenants.
- The REIT could benefit as the nationwide physical retail presence declines, attracting quality tenants to its properties as inferior centers go under.
- Federal Realty continues to sign new leases at robust double-digit spreads, suggesting solid internal growth prospects upon lease expiration.
Federal Realty Bears Say
- Federal Realty’s development pipeline is focused on a few large mixed-use projects, which subjects the company to risk from any of these particular projects failing and also increases exposure to real estate segments beyond its traditional retail focus.
- Retailers are becoming more conservative in expanding their physical store presence.
- If consumers who were forced to purchase goods online during the coronavirus crisis permanently change their behavior to favor e-commerce and avoid public places, long-term sales growth could suffer.
Originally published on MorningStar.com