2023-12-18 17:00:00 ET
Summary
- 2024 is expected to be a great year for income investors, especially those holding positions in REITs.
- Federal Realty Trust is a recommended REIT for boosting income, with strong pricing power and high-quality tenants.
- Both REITs pay well-covered dividends and are perfect investments for those looking to boost their income in retirement due to their low and conservative growth.
- Alexandria Real Estate Equities owns mission-critical Real Estate and I expect the REIT's share price to reflect positively because of growing life science demand.
- Both REITs have seen a drop in occupancy ratings in Q3 and tenant risk continue to be headwinds for FRT and ARE.
Introduction
With 2023 coming to a close and the FED hinting at three rate cuts in 2024, I think next year is shaping up to be a great one for income investors. Especially those who hold positions in REITs. Many know this year was a volatile one for the sector but the headwinds seem to be behind us. No one knows what the future may bring, but I think REIT investors are in a good position. Lots of investors who elect to hold REITs do so in a retirement/tax-deferred account such as a Roth IRA.
I had a conversation with my aunt & uncle a couple of weeks ago about helping them invest and supplement their income in retirement. My uncle recently retired but decided to start working for his youngest son again driving trucks. Both are 60+ years of age and I couldn't help but think REITs would make perfect investments for them to collect a steady stream of income. For others that hold them in retirement accounts, 2024 could be a very good year not only to boost their income with stable dividends, but have capital appreciation as well. In this article, I list two REITs I think are great for boosting your income next year.
#1 Federal Realty Investment Trust ( FRT )
Federal Realty Trust owns high-quality retail and mixed-use centers in wealthy, suburban locations. This gives the REIT strong pricing power and attracts higher-quality tenants. These locations have dense populations and strong household incomes. They also have high barriers to entry that prevent new competitors from easily entering into FRT's locations.
FRT's retail portfolio also boasts investment-grade tenants with the top 3 all sporting grades of BBB+ or above. They lease to some of the most well-known tenants like Home Depot ( HD ), TJX Companies ( TJX ), CVS Health Corporation ( CVS ), and Ahold Delhaize ( OTCQX:ADRNY ). Furthermore, 79% of their centers are anchored by a grocery component which makes them even higher-quality in my opinion. Grocery stores are often considered recession-resistant because consumers will always need to eat, no matter the state of the economy. Additionally, no tenant accounts for more than 2.8% of annualized base rent making them well-diversified. And although the current macro environment has continued to place downward pressures on consumer spending, I expect this to ease significantly in 2024 due to expected rate cuts.
FRT reported Q3 earnings in November and the company had a strong quarter. The REIT beat on both the top and bottom line with FFO of $1.65, beating estimates by $0.03. Revenue also beat analysts' estimates coming in at $286.6 million, surpassing the consensus $284 million. The strong quarter led management to raise guidance to $6.50-$6.58 vs the prior range of $6.46-$6.58. FRT has managed to grow both FFO and revenue in 2023 and now expects FFO of $1.59 to $1.67 in Q4. In the chart below, you can see FRT's growth in 2023 has been solid despite the macro environment and tenant risks I discuss later in the article.
Despite the minor decline quarter-over-quarter FFO growth was strong for the year driven by POI growth of 3.8% over the same period. The REIT also had some strong leasing activity in the quarter with 61 new deals totaling 423,000 square feet. This was obviously lower than prior years but that was due to the higher cost of capital from higher interest rates. Furthermore, they have $750 million worth of active redevelopments & expansions and this pipeline is expected to drive growth in 2024 & 2025.
A Dividend Fit For A King
Not only does Federal Realty have a strong portfolio they also have one of the best dividend track records in the sector with over a half of century of dividend increases. 56 years to be exact; making them a Dividend King! They are 1 of 49 companies who has this coveted status. The REIT recently raised the dividend this past summer by a penny to $1.09. And with FFO now expected to be in a range of $6.50 to $6.58, the dividend is well-covered by cash flows. Even if FFO comes in the lower-end at $6.50, this still gives FRT a very safe payout ratio of 67%.
So, investors get a safe dividend from a king that I'm sure helps them sleep better at night. As a dividend investor, these are the type of companies I choose to hold in my portfolio. Even though the increases are small, growth is still growth, albeit it may be low. Since coming out the pandemic, FRT has raised their dividend by a penny but I expect this to increase in the future as the economy stabilizes going forward.
#2 Alexandria Real Estate Equities ( ARE )
Number 2 on the list is a REIT that has been mentioned quite a bit here on SA, Alexandria Real Estate Equities. Like FRT, this REIT has been beaten down, even more so than the latter. They own office properties, but not just any office properties. These include laboratories that are mission-critical in the life science industry.
Despite headwinds in the office sector, I think ARE is poised to see a stronger recovery in 2024 because of the growing demand in the life sciences industry. These properties also have higher barriers to entry than your typical office REIT. Furthermore, ARE is the partner of choice to the most innovative companies in San Francisco, the birthplace of biotech. They are also the dominant landlord in UTC & Torrey Pines, the two most desirable life science submarkets in Southern California.
Most of their rental revenue comes from the Greater Boston Area at 36%, 23% from the San Francisco Bay Area, and 15% from San Diego. Other popular cities include New York, Maryland, and Seattle. Since 2018, total life science R&D funding has total $2.1 trillion dollars with $450 billion last year alone.
And this industry is expected to grow at a 6.7% CAGR for the next 7 years. And although the office REIT sector has faced headwinds with the hybrid work schedules, I expect more of them to require workers back into the office in the coming years, which would likely benefit ARE in the future. Although the pandemic seems like forever ago, several companies are still recovering from this. Speaking recently with a family member, his company only recently required their workers back into the office 3 months ago. But as I previously mentioned I suspect them to require more workers back into offices in the coming years.
Strong Dividend
Although the REIT is not a king like FRT, they do sport a pretty impressive dividend growth record with 12 years of increases making them a dividend contender. They recently raised the dividend by 2.4% to $1.27 earlier this month. Quant gives ARE a dividend safety grade of A- and I agree. The current dividend is well-covered by FFO and the company has managed to grow their (FFO) by 32.2% from Q1 2019 to present. During Q3 earnings in October, the REIT posted some solid numbers as well growing FFO from $2.24 to $2.26 quarter-over-quarter. This was also up over 3% from $2.19 in Q1. Like FRT, their strong Q3 allowed management to raise guidance to $8.97-$8.99 from their prior guidance of $8.93-$8.99.
Revenue fell short of analysts' estimates by quite a bit at $713.8 million vs the $728.5 million consensus. This grew from $700.8 million in Q1. They also posted more than 867,000 square feet of new leasing activity, but this was down from Q2. This was also probably due to the higher cost of capital but as rates decline in 2024, I expect this to increase for the foreseeable future. With a total dividend payout of $4.96 this gives ARE a very safe payout ratio of 55% using the lower-end of guidance, making it even safer than FRT's 67%. So, investors get two well-covered dividends and the potential for some capital gains holding these two stocks going into the new year. With their high-quality, I view these two REITs as long-term investments.
Healthy Balance Sheets
Both REITs sport investment-grade ratings and have strong balance sheets with ample liquidity. At the end of Q3, FRT had a total of $1.3 billion liquidity including $100 million in cash available. ARE had quadruple the amount at $5.9 billion. Additionally, FRT had a net-debt-to adjusted EBITDA of 6x which has held steady over the course of 2023 and they expect this to be 5x in 2024.
ARE stated they are on track to achieve a net-debt-to adjusted EBITDA target of 5.1x by Q4. Both have total debt fixed rates of 85% & 99%, respectively. ARE has no debt maturities until 2025 and with rates expected to decline significantly next year, investors shouldn't worry about the current state of each REITs debt as both are targeting debt ratios of roughly 5x, below the acceptable range of 6x for REITs.
Risk Factors
With Federal Realty having mixed-use office exposure and Alexandria technically considered an office REIT, both have been plagued by the downturn in the sector. But both REITs have class A properties in their portfolios which will help aid them in a faster recovery than some of their office peers. FRT's office portfolio was 97% leased and overall occupancy was 92.3% while ARE's portfolio occupancy stood at 93.7% at the end of Q3. But the life science REIT expects growth in occupancy by Q4 and management is targeting a rate of 95.1%.
Both saw dips in Q3 with occupancy declining 30 & 50 basis points on a leased and occupied basis for FRT. ARE executed a lease termination in Torrey Pines but leased approximately 89% of the space to a stronger credit tenant. Direct and sublease activity also increased in the Greater Boston, San Francisco, and San Diego largely due to move outs. FRT's occupancy decline was due to two Buy Buy Baby locations and a Christmas tree shop. Even with rates expected to decline lower occupancy ratings will continue to be a headwind for the foreseeable future. Especially if we enter into a recession which data supports in 2024 or 2025. Although, I foresee occupancy ratings ticking up slowly in the coming quarters but investors should keep a close eye. A drop in ratings will likely lead to lower rental revenues.
Valuation
Since October, both REITs have bounced back significantly in price. Currently, both offer little upside to their price targets but are still buys in my opinion. ARE offers the better bargain as they trade at a price-to-book value less than their 5-year average and the sector median. FRT on the other hand trades at more than 3x book value and above the sector median of 1.53x. But those who know quality usually comes at a premium. And with rates all but sure to decline, I suspect these two REITs' prices to move higher in the coming months. Using the Dividend Discount Model for FRT and a WACC of 6%, I come to a price target of $125 for the REIT. As rates subside and the economy stabilizes I foresee FRT getting back to larger increases and growth similar to pre-pandemic.
I decided to use a higher WACC and expected growth rate for ARE for obvious reasons. The REIT has a higher average growth rate of 5.4% compared to roughly 1% for FRT so therefore it warrants a higher WACC & growth rate. This brings me to a price target of $146.57 for the REIT. I decided to be pretty conservative so it's likely both REITs could surpass these price targets by the end of 2024.
Bottom Line
Both of these REITs have experienced some headwinds due to their association with lower quality office properties. But as rates subside in 2024, I expect both to post positive growth in occupancy ratings which will likely boost investor confidence. This should positively affect each stock's price. In my opinion, these are perfect stocks to hold for retirees in a tax-advantaged account due to their low, but sustainable growth. Both are high-quality REITs with strong balance sheets and dividends well-covered by growing FFO. Additionally, I expect the REIT sector to outperform next year due to declining rates and ARE and FRT should benefit as well, albeit at a slower rate due to the office sector recovery. But for investors, especially those who are retired, they collect a near 8% yield combined to help them sleep well at night from a dividend king and contender.
For further details see:
Boost Your Retirement With These Two Stocks In 2024