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Blocking and Tackling: Federal Realty Focuses on Fundamentals to Deliver Dividends

Blocking and Tackling: Federal Realty Focuses on Fundamentals to Deliver Dividends

Federal Realty Trust is a prime illustration that sticking to what you do best often delivers the best results.

For the bulk of its 50-year history, the Rockville, Md.-based REIT has invested in high-quality retail properties. It delved into mixed-use in the early 2000s and learned some valuable lessons in the process. Straying too far afield from its core business created some challenges that it had to overcome. Recently, however, it has taken a foray into the multifamily sector. The difference today is that the multifamily development it is undertaking today is a direct extension of its successful retail projects—not part of an attempt to build mixed-use complexes wholesale.

As of year-end 2011, Federal Realty’s portfolio consisted of about 19.3 million sq. ft. located primarily in metro markets in the Northeast and Mid-Atlantic, as well as in California. In addition, Federal Realty has an ownership interest in approximately 1 million sq. ft. of retail space through a joint venture.

Federal Realty’s operating portfolio (excluding joint venture properties) was 93.4 percent leased as year-end 2011. It generates operating earnings north of $380 million annually and generally grows at 2 percent plus each year.

In 2011, the REIT posted its highest ever funds from operations (FFO), which grew 3.1 percent from the previous year. During that period, it generated revenues of $553 million and EBITDA of $354 million, also besting its previous heydays of 2006 and 2007.

This year, it has allocated $500 million of development capital to mixed-used construction for its Assembly Row, Pike & Rose and Santana Row projects. These projects are all mixed-use, featuring a combination of retail and residential space. Pike & Rose also includes 80,000 sq. ft. of office space in its $250 million first phase.

In addition to development, the REIT has been active on the acquisition front. Last year, the REIT acquired more than $300 million of real estate interests in Plaza El Segundo in Greater Los Angeles and Montrose Crossing in Rockville, Md.

Federal Realty’s investment decisions have allowed it to pay quarterly dividends to its shareholders continuously since its founding in 1962. Moreover, the REIT increased its dividend rate for 44 consecutive years, the longest record in the REIT industry.

REIT Insider caught up with Dawn Becker, Federal Realty’s COO, executive vice president and general counsel. Becker, who has been with the REIT for 15 years, offers some insight into the company, its operations and its future plans.

An edited transcript follows.

REIT Insider: How has the Great Recession impacted Federal Realty?

Becker: Every decision this company has made since it was founded has created a portfolio that is well-located and strong. That portfolio provides a base of ongoing and growing cash flow that makes it possible for us to continue to refine our business during difficult times without being forced to focus on other things.

For example, in 2008 and 2009, a lot of REITs were dealing with joint venture partners that wanted to monetize their interests. We only had one partner, so we were able to focus on our business and how to do things smarter so we could put ourselves in a better position to execute and deliver results.

Without those distractions, we saw our income increase every year from 2007 to 2011. During that period, we moved to three distinct operating regions and decided to really focus on how to lease space when demand was not particularly strong and how to handle bad debt collection—basic blocking and tackling.

REIT Insider: The recession was really tough on retailers, especially mom-and-pop retailers, and many of them looked to their landlords for help. How did you deal with their requests?

Becker: We did get a lot of rent relief requests from tenants. And I think we did really well handling them because we didn’t lose focus on what was really going—we tried to make sure that we were making decisions that would maximize cash flow in the short-term without impacting the long-term value of the assets.

We did try to work with tenants to keep occupancy at an appropriate level. What we’ve seen since then is that a number of tenants that we gave rent relief to are still in our centers, and they’re seeing their sales go back up.

REIT Insider: So you feel that retailers are in better shape today—that their sales have rebounded and things are good?

Becker: Our day-to-day info comes from our experience with 87 assets in highly urban areas with relatively affluent customers—a small microcosm. Our opinion is formed by what we see in that pool of assets, and it’s not always indicative of the overall sector.

But, there is one thing that I think transcends our assets and applies to the broader industry—retailers really have gotten used to operating and running a business profitably with a lower level of sales. By and large, our tenants have gotten smarter about their businesses.

REIT Insider: Most REITs were severely impacted by the credit crisis. How did Federal Realty handle such a difficult situation?

Becker: Before the credit crisis, debt was so cheap, and it tempted a lot of companies, REITs included, into playing the leverage game.

We actually had some investors who pressured us to leverage up because they viewed it as a way to increase results, But from our perspective, when you’re sitting on a portfolio that is generating good, steady growth without doing anything to enhance it, why add more leverage? A lot of REITs had to leverage up to show growth, but we didn’t have those pressures because our core portfolio is able to generate growth on its own.

REIT Insider: Federal Realty has managed to not only pay quarterly dividends to its shareholders continuously since its founding in 1962, but to also increase its dividend rate for 44 consecutive years. How is that possible, especially during the downturn when a lot of REITs suspended their dividends?

Becker: Wall Street tends to lump real estate into overall financials, and the people who didn’t understand REITs thought our sector had the same risks as the financial stocks. The REIT sector saw its stock prices plummet. We saw all types of panic, and there were a number of REITs that decided to decrease their dividends or pay their dividends in stock because they either had cash flow issues or they felt the need to preserve cash.

We understand that every REIT makes its own decisions, but we fundamentally don’t think that’s what a REIT is about. We believe that we have a contract with our shareholders to deliver dividends, and we didn’t do either of those things—we didn’t want to do them. I personally believe that our decision not to cut our dividends—to increase them, in fact—is something that differentiated us.

Prior to this downturn, investors considered Federal Realty a defensive stock because our portfolio is strong, and everyone expected the company to perform well during difficult economic periods. Even so, I am not sure everyone quite appreciated the returns we achieved. But now we’ve seen the best of times and the worst of times in the past six years, and Federal Realty still managed to perform well. I think investors have taken note of that.

REIT Insider: Strong performance notwithstanding, Federal Realty has experienced its share of difficulties—namely, the problems with Santana Row, which was severely damaged by a fire during construction in 2002. What kind of lessons did Federal Realty learn from Santana Row?

Becker: At the time we began development on Santana Row, we were a $2 billion market cap company that undertook a $500 million project that was 3,000 miles from our headquarters… probably not the best risk-adjusted way to deliver value. We absolutely learned from Santana Row, and it’s evident in our new developments.

We’re a much bigger company, and every decision we make we make sure that what we’re doing from a development perspective makes sense from a scale standpoint and that it is a smart risk-adjusted decision. We always want to supplement our growth, so development is a key part of what we do, but we want to do it in a way that makes sense.

Santana Row also taught us something else—that residential at Santana Row does extraordinarily well. So, we made a decision to develop another residential building there, 8B at Santana Row. It’s a $70 million residential building housing 220 apartments right behind the main retail street.

REIT Insider: Federal Realty describes itself as a REIT that focuses on retail real estate, and the market considers the company to be a retail REIT, yet much of its recent investment activity has been focused on multifamily. Can you explain that decision and strategy?

Becker: If you look at our portfolio and the investments that are not retail, they’re all in connection with retail projects that we own. As we step back and look at what we learned from mixed-use, it’s that the environment we create on the ground level with the retail creates a great environment for the uses above.

Based on our experience, we believe the retail below creates more value for the uses above than the above uses create for the uses below. … We’re so confident that we’re going to create such a great environment, we don’t see why we should give away that value—that’s how we end up doing those additional uses. And, we think they offer good risk-adjusted returns.

REIT Insider: Beyond development, what kind of emphasis does Federal Realty put on its existing properties?

Becker: We continue to deploy money into our existing properties—that’s always a piece of our business—the strategy of fully maximizing our existing portfolio. We have the ability to continue to generate investment opportunities within our own portfolio.

REIT Insider: This year, Federal Realty marks its 50th year in business. What’s on tap for the next 50 years?

Becker: With the anniversary, we’ve gone back and looked at all the annual reports since 1962. In doing so, we’ve found that the old saying “The more things change, the more things stay the same” is so true.

The company was saying the same things then that we’re saying now—the business principles are timeless. They’ve allowed us to get to this point, and they’ll allow us to grow in the future. Although we’re always tweaking and refining, there’s nothing wholesale that needs to change.

REIT Insider: Fifty years is a big deal. You’ve got to have something big planned to celebrate?

Becker: Yes, we do. We’re going to New York in June to ring the closing bell at the New York Stock Exchange. We’re taking a good chunk of our employee base and having a big party and doing some fun things while were there.

What’s really cool is that—knowing you can’t bring the entire company—we’ve decided that anyone who has been with Federal Realty for 10 years or more automatically gets to go. We want this to be for the people who have been around the company for a long time to celebrate how much of their lives they’ve committed to the company.

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