Stock Strategist Industry Reports

Shopping Center REITs Currently on Sale

Kevin Brown

We have increased our fair value estimate for  Federal Realty (FRT) to $141 from $138 and we have increased our fair value estimate for  Kimco Realty (KIM) to $17.70 from $15.80 after updating our modeling framework for the shopping center REITs and reconsidering both companies' redevelopment opportunities. Federal Realty has one of the best retail portfolios in the industry with high-quality assets in markets with high income, high population density, and significant demand drivers. Kimco is finishing up a strategic disposition program that has sold over 400 assets for $6 billion since 2010, dramatically improving the portfolio's overall quality so that it is better-positioned in a changing retail landscape. Both companies continue to see double-digit releasing spreads and solid net operating income growth. 

While e-commerce continues to pressure brick-and-mortar retail, we believe that sales at high-quality properties will remain positive despite industry headwinds, which should help keep releasing spreads and NOI growth positive over the next decade for both companies. Both companies should be able to incrementally add value through key development and redevelopment opportunities, particularly in mixed-use developments that blend retail, office, multifamily, and hotel assets. While these assets do introduce additional operational risk from segments outside of the traditional retail focus, they provide captured demand for the retail segment in a symbiotic relationship. We think that both companies are well-positioned to drive value in the ever-changing retail landscape.

We think that the shopping center REITs should be able to handle the increased online competition. As consumers change their habits from shopping in physical stores to shopping online, the demand for retail space will shrink and many existing stores and shopping centers will not survive. However, less than half of the tenants for either company are focused on segments like apparel, home decor, electronics, and other segments that either directly compete with the Internet or require omnichannel strategies. 

While this sector will face slowing sales from consumers moving online, retailers will still want to keep their stores located in the top retail locations as the strong demographic trends produce high foot traffic and strong sales growth. Most store closures will occur at lower-quality assets that have a worse tenant mix and lack the sales productivity to keep those stores profitable, which should reduce competition for the high-quality properties owned by the REITs. 

Meanwhile, the other portion of these companies' portfolios includes grocery stores, restaurants, fitness centers, dollar stores, autos, and entertainment tenants--tenants whose businesses are insulated from the threat of online shopping and as a result should see higher, steadier growth. Even as online shopping starts to penetrate the grocery and restaurant businesses, the online option will only drive more business to the physical tenant rather than take it away as the grocery store or restaurant remains the essential point of distribution. We believe that low but steady growth over the next decade should be achievable for the retail REITs.

Both companies are also of interest to dividend-focused investors. Kimco Realty's dividend yield is currently 6.7%, one of the highest dividend yields among U.S. REITs. The company's dividend is well-covered and the company is operating at reasonable leverage ratios, so we think that this payout ratio is sustainable in the current retail environment. 

While Federal Realty's current dividend rate of 3.2% is quite low, the company has the best track record of paying out dividends among all U.S. REITs as the company has increased its dividend every year in its 51-year history. We believe that the company operates at solid leverage ratios and, given that the company has made the dividend a priority over its entire history, we feel safe that the company should be able to continue to pay its dividend going forward. Both companies should be considered by any dividend-oriented investor looking to add an REIT to his portfolio.

Kevin Brown does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.