Federal Realty's Rent Collection Improves to 83% in Q3 Despite Ongoing Retail Headwinds

Federal Realty on Wednesday presented a business update. The retail REIT said it collected 83% of third-quarter rent, up from 68% in the second quarter.

This trend gave management the confidence to raise Federal Realty's dividend by 1% in August, marking the company's 53rd consecutive annual increase.

While higher collections are welcome news, we previously estimated that Federal Realty's pre-pandemic rent revenue could only decline around 15% to 20% before cash flow would fall short of covering the dividend.

The company appears to be hovering around that level now, but incremental improvement could prove difficult.

As of October 1, approximately 94% of Federal Realty's tenants were open and operating compared to just 47% as of May 1.

With most of its tenants now back in business, additional reopenings won't be as big of a driver of higher rent collection rates going forward.

Meanwhile, Federal Realty's business will likely face more downward pressure on rental rates and occupancy.

Federal Realty has exposure to tenants facing greater risk of failure during this downturn, including casual dining restaurants (about 8% of rent); gyms, movie theaters, and other entertainment centers (6%); and small, local businesses (11%).

As more bankruptcies, store closures, and lease expirations (13% expire through 2021) roll through in the months ahead, management believes occupancy will bottom in the first half of 2021 in the 80% range ("89%, 87%, 86%, something like that") compared to 93.7% in the second quarter of 2020.

Additional revenue pressure could arise if Federal Realty is unable to justify its relatively high rental rates in this environment where supply appears poised to outstrip demand.

Compared to other shopping center REITs, Federal Realty's 2019 rent per square foot tops the chart.

The company's 104 properties sit primarily in "strategically selected 1st ring suburbs" of 8 major metropolitan markets, including Los Angeles, Chicago, Miami, and New York.

These areas have a high cost of living, but some of Federal Realty's peers have similar strategies. 

For example, Urstadt Biddle's shopping centers are mostly located within 75 miles of downtown Manhattan, yet its rent per square foot is about 20% lower.

Retail Opportunity's rent is similar to Federal Realty's, but it focuses only on West Coast markets and has reported higher rent collection rates (85% in July vs. 76% for FRT). 

Depending on how the retail landscape shifts, Federal Realty may need to give up some pricing to keep its properties filled.

Given these pressures, it would not be surprising to see Federal Realty's payout ratio hover close to or above 100% for the next few quarters, even if its rent collection rate ticks higher.

How long it takes for retail real estate to stabilize is anyone's guess, but Federal Realty's high rental rates suggest it has a strong portfolio that will remain relevant on the other end of this crisis. 

The REIT's financial health remains solid as well. Federal Realty maintains an A- credit rating with a stable outlook and has excellent liquidity with nearly $1 billion of cash on hand.

For context, the REIT's dividend costs about $315 million annually and its maintenance capital expenditures total less than $15 million per year. 

Thanks to continued improvement in rent collection trends plus the firm's financial health, management remains committed to the payout despite Federal Realty's poor dividend coverage in the near term. 

However, it's important that results strengthen after the next couple of quarters.

Given this backdrop, we expect to maintain the REIT's Borderline Safe Dividend Safety Score until its dividend coverage improves. 

Federal Realty next reports earnings on November 6, and we will continue monitoring the health of its business as the retail world evolves.