Federal Realty is developing Assembly Row in Somerville, Massachusetts, 3 miles from Boston. The mixed use will contain retail, office, entertainment and outlet retail space.Beyond their consumer goods, Federal Realty Investment Trust's centers have been selling something nice for decades: dividends.
It's nothing new to Wall Street or the real estate investment trust community, but Federal Realty has increased its dividend consistently for the last 44 years. That includes 2008 to 2010, arguably the worst real estate recession in a lifetime.
Today, the company maintains little debt and its stock is trading near an all-time high. While other REITs are subtly selling properties and refinancing debt, Federal Realty is actively acquiring, developing and increasing its record earnings.
To see how Federal Realty thrived during the recession — and how it will be one of the first to develop a major retail project after — Shopping Center Business visited with the company at its headquarters in Rockville, Maryland, in February. While there, SCB spent time touring Federal Realty's shopping centers and urban districts with President and CEO Don Wood and Senior Vice President of Leasing Chris Weilminster. SCB also met with senior executives Dawn Becker, executive vice president and chief operating officer; Andy Blocher, senior vice president and chief financial officer; and Don Briggs, senior vice president of development.
A Solid Core Portfolio
Federal Realty owns just under 90 shopping centers, town centers and large retail properties in urban districts. About 30 percent of the company's portfolio is located in the Washington, D.C., suburbs. On the East Coast, the company also owns centers in the Philadelphia, Boston and New York suburbs as well as Charlottesville and Richmond, Virginia, and has acquired a few centers in South Florida over the past several years. On the West Coast, the company owns properties in Southern California and the San Francisco Bay area. The company also owns a few properties in Chicago.
Congressional Plaza has been in Federal's portfolio for 45 years. Fresh Market recently joined as an anchor.Many of the company's centers have been held by the REIT since the 1960s and '70s. Many have no debt on them. Federal Realty constantly reinvests capital into its centers to maintain their competitive advantage in their markets and to attract consumers and retailers. As a result, the REIT can garner top rents in these markets.
Two properties are shining examples of this in its Maryland portfolio. Federal Realty's Congressional Plaza in Rockville, Maryland, has been held by the REIT since 1965. In its more than 45-year history with Congressional, Federal Realty has redeveloped the property four times. Wildwood Plaza, a few miles away in Bethesda, Maryland, was purchased in the late 1960s for $1 million. Today, the center brings in over $6 million per year in rent.
Despite its reputation as a developer of strong mixed-use and urban-oriented centers, the REIT is, at its heart, a community shopping center owner. Federal's track record of continual reinvestment in its centers, its long tenure of ownership and the number of properties that are debt free has helped it to grow top line revenue even through the tough times, enabling the company to take a deliberate approach to both development and acquisition pursuits.
With a strong platform of existing assets that produce a consistently increasing stream of earnings, Federal Realty isn't under financial pressure to acquire centers that will be immediately accretive, or to maintain an excessive development pipeline in order to grow. The principal source of growth comes from the REIT's existing assets, resulting in outsized growth with a lower level of risk.
Location is everything in retail real estate, and Federal has capitalized on that fact with centers, positioned in trade areas that have the highest surrounding average household incomes of any community center REIT. The median household income around any given Federal Realty center is $76,000.
A recent study also showed that Federal's centers had 113 percent greater population density surrounding them than the average grocery-anchored center in the U.S. What is interesting about Federal's core portfolio is that if you look at the population of an infill market like Bethesda, Maryland, the population has barely changed in the last 30 years.
What has changed is the average household incomes, which have risen dramatically. Infill areas where Federal has properties — like Bethesda, Maryland, and Santa Monica, California — have seen incomes skyrocket over the last four decades as affluent families moved closer to city centers.
Federal Realty was criticized during the boom years for not going on an acquisition spree. The company's ability to leverage its strong financial position to acquire was off the charts and yet, it purchased only a few properties between 2005 and 2007.
"We would have bought, had we found properties that furthered our goal of an increasing stream of Bethesda Row is one of the most popular shopping and dining destinations in the Washington, D.C. area.cash flow over time," says Wood. "While we could have created earnings in the short term by utilizing our strong balance sheet to acquire lesser quality assets, we would have sacrificed our solid and consistent core platform for the longer term — not a good trade in my opinion."
That strategy paid off as the REIT had property level income that has been consistently higher year after year — including from 2008 to 2011 — and it is on track to continue that pace in 2012. When he took over the CEO role at Federal 10 years ago, Wood — along with his team and board of trustees — decided to mold Federal Realty into a real estate investment choice for investors that was "as foolproof as possible in a cyclical business," says Wood.
The team went about that by revitalizing and strengthening its core portfolio, through redevelopment, leasing and solid core operations, to consistently grow top line revenue and earnings. This enabled it to use its strong balance sheet capabilities to pursue development and acquisitions in dense infill markets.
While that's been the plan, Federal had several projects on its boards at the time that needed stabilization. Santana Row, Federal's most ambitious project to date, required a lot of work to rightly tenant the property. As well, a town center in downtown Rockville, Maryland — Rockville Town Square — completed as the recession set in. Federal spent time getting those projects to perform, and now reports them as some of the strongest assets in its portfolio.
The largest development project in Federal's history was Santana Row in San Jose, California. The mixed-use property which incorporates retail with entertainment, office, a hotel and residential uses, has been a gamble that paid off for the company. Initially criticized as too expensive and too high-end for the market, Santana Row has adjusted its retail tenant mix over the years to meet the needs of the surrounding community, while its high-end apartments have made money and remained fully leased from opening day.
Santana Row has transformed to be a town center for the San Jose market and is one of Federal Realty's top performing properties.Federal recently opened its latest phase of residential at Santana Row — a 108-unit building named Levare — and broke ground on another phase of 212 residential units at the property to complement the mixed-use development.
Federal Realty is pursuing development as a growth strategy, but insists its main growth comes from its existing portfolio.
"Development and acquisitions are the sexy part of our business," says Wood, "but they will never be more than a minority portion of our business. You can't have too much of the volatile side of the business and continue with our goal of having a steady stream of cash flows, but if you don't have any of it, there is not enough growth to keep investor interest."
To create its top line revenue growth, Federal Realty relies on leasing. The company has done extensive research regarding tenant location.
A greater focus on merchandising than most other landlords results in retailers that complement each other, which results in higher tenant sales and a greater ability to pay higher rents. It knows which tenants need to be in its portfolio. The company has also been steadfast in not relying on any group, category, or specific tenant to represent a disproportionate amount of its rental stream.
Its largest category may be grocery stores, but the portfolio contains a diverse assortment of brands in the category. While the company has strong relationships with tenants, it has no preferred programs, doesn't generally cut multiple deals and focuses on each property's leasing needs individually.
Federal's leasing strength comes from its desire to create gathering places which feed off the strong surrounding neighborhoods. The company spends a lot of time and effort making its centers attractive to its shoppers. It was a pioneer in putting outdoor seating areas and landscaping at its open-air centers. It learned this philosophy from its urban town centers, many of which were developed in the 1990s.
"When we started to develop Bethesda Row in 1994, we looked at it as our laboratory," says Weilminster. "We learned a lot about what customers wanted. Most developers think about their centers as being functional space. We realized that our centers needed to be more appealing. We wanted to create spaces where you didn't want to just shop; you wanted to hang out and meet your friends there."
Federal has taken that philosophy, learned at its urban properties, and applied it to community centers like Congressional Plaza. There, outdoor eating and seating areas mix with nice landscaping and pedestrian friendly walkways.
"We are constantly looking at how we can improve the tenant mix of our centers so it can be more Federal Realty acquired El Segundo Plaza in Manhattan Beah, California, at the end of 2011 after 12 months of negotiation.relevant to the constituents who surround the properties," says Weilminster. "When you are in a market where there is so much retail space, you have to figure out ways to be competitive and create the best mousetrap to get more consumers in your center versus others."
Wood has said several times at industry gatherings — and again during this meeting with SCB — that he believes retail in the U.S. is oversupplied. But, he says, not all locations are created equally.
"Own real estate in the right places and serve the needs of your communities, and you'll be fine," he says. "Does that mean more restaurants? More services? It depends on the center. Less hard goods and apparel? It depends on the center."
Wood, and his leasing team, are big believers in restaurants. Federal has a bigger portion of its rent roll coming from restaurants than any other REIT in its peer group. Because Federal knows its markets well, it knew going into the recession that many of its restaurant tenants would be fine. In fact, they were one of the company's best performing tenant categories over the last 4 years.
"In Bethesda, American Tap Room, Mussel Bar and Jaleo are necessity-based — for Bethesda," says Wood. "It comes down to location. Because we only have 87 centers, we can think locally with all of them."
In the 5 miles between Bethesda and Rockville in suburban Maryland, Federal Realty owns seven shopping centers. In the 1 square mile on Rockville Pike around Congressional Plaza, Federal controls 1.2 million square feet of space. In that kind of environment, caution is the key to survival.
"We could cannibalize our own centers if we weren't sensitive to the retail mix we create," says Weilminster. "Internally, we act with great conscience to make sure that we are not making deals that will impact our other retailers."
"We merchandise all our 1.2 million square feet as one property," adds Wood.
Like Rockville Pike, Federal Realty has a similar ownership structure along Route 7 in Virginia, which runs through some of Washington, D.C.'s most affluent suburbs.
Federal has two major projects planned, both of which will break ground in 2012. Along Rockville Pike, Federal is developing Pike & Rose over the next few years. The center is the ground-up redevelopment of Federal's Mid-Pike Plaza, a property the company has controlled since the 1980s.
For many years, Federal did not own the land underneath the center, but gained ownership in 2007, opening the door for development. Federal Realty will develop an 80,000-square-foot office building, 400 residential units and more than 115,000 square feet of retail space in the first phase, which will break ground in July.
The retail will deliver first, beginning in 2014. At that time, the company hopes to break ground on the second phase of the project. Federal Realty has so far signed iPic to anchor the project with its innovative, upscale theater and dining experience.
"One of our strategies with phasing Pike & Rose in this economy is making sure that we anchor the retail correctly," says Don Briggs, senior vice president of development. "The creation of 80,000 square feet of office and more than 400 residential units will create a full sense of place prior to executing additional phases."
Rockville Town Center incorporates civic areas like a library, ice rink and city uses with retail and residential space. The center serves as the downtown for Rockville, Maryland.Part of Federal's strategy with Pike & Rose falls in line with future plans for Montrose Crossing, a 357,000-square-foot power center that sits on 38 acres across Rockville Pike, that Federal acquired a controlling interest in at the end of 2011 for $127 million.
"Between Pike & Rose and Montrose Crossing we control 63 acres at one of the busiest intersections in the D.C. market," says Wood. "In addition, there will be a new Metro stop. When you sit at the intersection and think of the future possibilities of this property over the next 40 years, it is almost limitless."
In Somerville, Massachusetts, 3 miles north of Boston, Federal Realty is under development with Assembly Row, a project that will combine entertainment and restaurants with outlet retail, office and residential space. A new stop for Boston's T subway is under construction at the property. It is the first new station for the system in 27 years. The first phase of development at Assembly Row contains four buildings.
Avalon Bay will build and operate the multifamily properties in the first phase. A three story retail and entertainment building will be built by Federal Realty and will include a new AMC theater that will serve as the entertainment anchor for the property. IKEA controls a parcel of land adjacent to Assembly Row.
Phase I will be completed by 2014 and at full build out — not expected until around 2020 — the project will be similar to Santana Row, with open spaces anchoring both ends of the project. Waterfront restaurants will be a significant attraction, and retail, restaurants and entertainment will feature prominently in the tenant mix.
Enabling Federal Realty to create these two major projects is its strong balance sheet. The REIT raised a lot of cash in 2008, preparing for a buying spree that never materialized during the banking crisis. That proven access to capital at advantageous rates remains a competitive strength, as Federal Realty plans to deploy significant capital to fund development at Pike & Rose and Assembly Row, and potential acquisitions in the next several years.
"Our access to all types of capital has been demonstrated in both the tough and stable times," says Blocher. "With low overall leverage, limited use of secured debt and strong access to the capital markets, we're in a great position to meet our funding needs. We plan to fund our development pipeline corporately, rather than through a construction loan, which provides significant flexibility as we work through development construction."
While not a true development, Federal Realty has another upside opportunity in a property it acquired in Southern California in late 2011. The REIT purchased the 380,000-square-foot Plaza El Segundo at Rosecrans and Sepulveda Boulevards in Manhattan Beach. While the center was purchased in late 2011, the company has already spent some time on remerchandising the center to fit the market.
Before closing, a former Borders location was replaced with The Container Store. Other tenants at the property include Whole Foods, Cost Plus and Dick's Sporting Goods. Smaller tenants are grouped together in The Edge, which has small food and service retailers, and The Collection, which has apparel retailers like H&M, J.Crew, Bebe and BCBG. The center also has expansion potential of up to 70,000 square feet.
"We had a strong presence in Southern California before, but this is a truly great asset that makes us an even greater player in the market," says Becker. "It gives us the ability to leverage our local expertise."
Federal Realty was one of the few prospective buyers for the center, since the previous owner had leveraged the property to 90 percent of value. The company acquired a controlling interest in the center for $8.5 million cash plus the assumption of a share of a $175 million loan on the property. The cap rate for the acquisition was in the low 6s, but had it not been for the debt, the property would have traded in the 4 to 5 percent range, says Becker. The acquisition took 12 months of negotiations.
"We don't have to do a significant volume of deals," says Becker. "Every acquisition and development is impactful to our financial position, so we are forced to spend the time to do it right."
"We wish we could buy everything free and clear of issues," Becker adds. "The best real estate rarely comes in that form. Having the right team to work with sellers on their tax structure and take the time to do a deal correctly is what we do best."
While Federal Realty would love to be known as the developer with the flashy projects, it would rather be known as the one who keeps increasing its dividends to investors. That, says Wood, is the toughest of jobs for his team.
"We deliver a steady stream of increasing cash flows to our investors, no matter what the cycle," says Wood. "That is not an easy thing to do."
The outlet industry has seen increased sales as Americans turned to value in the recession, and they've also seen continued development, as the sector proved to be recession proof over the past few years. Mainstream developers have steadily moved in to the sector, forging a new drive that is creating stronger outlet centers that outlet retailers appreciate.
— Randall Shearin