Federal Realty’s prudent strategies serve it well in a tough period.
May 4, 2010 10:55 AM, Mike Janssen
...certainly a very large part” of Federal’s success, says Bill Acheson, REIT analyst with New York-based Benchmark Co. The area has weathered the economic downturn comparatively well, thanks in particular to a boom in government hiring and consistent military employment, Acheson says.
“There’s really no one else that comes close to reporting the demographics that Federal Realty has,” Acheson says. “They’re really head and shoulders above everyone else for the income levels around their centers.” Federal’s markets are densely populated as well and are mostly infill areas.
With the rest of its properties primarily in California and elsewhere in the mid-Atlantic region, Federal controls 18.2 million square feet of retail space occupied by 2,500 tenants. The average Federal property is about 200,000 square feet, twice the size of the average retail property. According to Federal, no one tenant or affiliated group accounted for more than 2.6 percent of its base rent last year.
The quality of its locations is reflected in the rents Federal is able to maintain. As of mid-2009, its average rent was $21.93, per square foot compared to $11.24 per square foot for all shopping center REITs, according to a report from Memphis, Tenn.-based Morgan Keegan.
Becker and Blocher say Federal’s primary strategy for increasing revenue from year to year depends more on rent growth at its existing properties than on looking to new acquisitions for higher returns. “We are an operating company, first and foremost,” Blocher says.
Federal Realty’s concentration of properties around Washington D.C., including the Village at Shirlington in Northern Virginia, have helped insulate it from the effects of the downturn.
Despite the economic downturn, Federal was able to take in 10 percent more in rent from 2008 to 2009. That was down from the 21 percent increase the year prior, but Federal was one of the few REITs to achieve an increase last year, Blocher says.
The focus on generating revenue from rent increases allows Federal to take a more cautious approach to acquiring new properties. By doing so, it can find greater assurance that the properties it does acquire will prove to be sound long-term investments. The reasoned approach also allows Federal to develop cozier relationships with potential sellers, Becker says. An example of this arose when an owner who had sold Federal a property in Charlottesville, Va., was looking to unload a site in Northern Virginia. He went to Federal first.
Federal’s management also attributes the REIT’s success to a team of leaders who work together and have long tenures—a decade or more for most. Managers tell a “clear and consistent story” to analysts, investors and ratings agencies, Blocher says. And “we tell people what we think even if at times it’s not what they want to hear,” he adds.
For example, a few years ago Blocher and Jeff Berkes, Federal’s chief investment officer, met with an institutional investor who urged them to increase their leverage to 60 percent. Blocher and Berkes rejected the suggestion—“and that was the right decision” given the ensuing performance of capital markets during the recession, Blocher says.
Indeed, Federal carries a conservative balance sheet. Debt and preferred equity represented 33.7 percent of Federal’s market capitalization according to the October Morgan Keegan analysis. At that time, the shopping center sector’s average was 50 percent.
Small changes to face downturn
Because Federal’s course had proven reliable over time, the REIT did not find it necessary to radically change its strategy when the economy turned sour. “What we did was tweak and refine how we execute it,” Becker says.
Federal continued striving to maximize returns from its operating portfolio but took care to lock in tenants quickly rather than be forced to seek new tenants. It also bulked up its team of short-term leasing agents to fill vacant spots. That kept centers full but gave Federal the flexibility to free up spaces when it could raise rates again.
About 20 percent of its tenants asked for rent relief from the end of 2008 to the third quarter of last year. Federal worked to understand the problems tenants faced and considered whether marketing efforts at properties would help to boost sales or if farther-reaching restructuring was needed.
After acquiring no new properties last year, Federal is planning to invest $1 billion over the next four years and acquire three to five properties a year—but Blocher acknowledges the REIT is “off to a slow start” on that front. Regardless, in Federal’s 2009 annual report CEO Donald Wood wrote that acquisitions “will probably take on a greater role at Federal as prices have moderated and opportunities are expected to surface for some top-quality real estate locations that have not been available for some time.”
Federal also expects to increase its redevelopment activity. The REIT expects to stabilize seven redevelopment projects in the next few years, Becker says, and another 10 to 15 projects are underway, with $35 million remaining to fund these projects.
In the mid-’90s Federal entered the mixed-use arena, an area where it continues to develop today. It is now securing funding for its Assembly Square project in the Boston area by looking to local, state and federal funding sources, but the project may take longer than initially anticipated to come to fruition. “This is not a time you want to start a retail project,” says Becker.
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