Federal Realty Investment Trust (FRT) Earnings Call Transcript & Summary

Welcome to Citi's 2026 Global Property CEO Conference. I'm Craig Mailman with Citi Research. We're pleased to have with us Federal Realty and CEO, Don Wood. This session is for Citi clients only and disclosures have been made available at the corporate access desk. [Operator Instructions] Don, I'm going to turn it over to you to introduce your company and team provide any opening remarks, tell the audience for the top reasons and investors should buy your stock today, and then we'll get into some Q&A.

Well, thank you very much. [Audio Gap]

Don, hit the button on your microphone. There you go.

Is that on?

Now we're good. We're good.

So none of that was recorded, right? I'm going to start all over again. Time to invest in hard assets. And when you think about why Federal Realty in terms of investing in hard assets, you know we've been around a real long time. There's this notion of paying a dividend that is less important to investors today. But what is critically important is that dividend has been paid in an increasing amount for 58 years. That's kind of ridiculous. If you think about a business that is cyclical, the notion that a dividend has increased every year since 1967, and through 2026 is kind of unheard of, and it is unheard of. It's the only REIT that can say that. And so when you think about that level of quality in the asset, when you think about that level of safety in the asset, frankly, the only thing that knocked us off our perch was COVID. And that's because our markets were closed that way. So when you think about how that happens, the quality of this portfolio and particularly the -- what we've been doing lately over the last year to recycle capital at an extremely low cap rate, it's selling some residential in the 4s, selling some more stable retail product in the 5s, and redeploying that accretively into 7% yielding assets. I'm not sure who else has that built-in level of that cost of capital to be able to redeploy that way. I think that's really important. What that's creating is sector-leading growth at the bottom line for '26. Everything that we see suggests that, that will continue into 2027. So you're getting sector-leading growth. You're getting all of that with the highest quality portfolio out there in a hard asset category that is based on the notion of continuing to increase that cash flow in a self-sustaining way. I think that's pretty unique. We've also opened up our markets to be able to take what it is that we've done historically really well on the coast and brought that to the center of the country in the form of Kansas City on the Kansas side, Leawood and Omaha, which we are finding undermanaged assets dominant that we can create incremental IRRs in excess of 9%. And that is the same thing we've been doing for a long time. But being able to fund that with such a low cost of capital is really unique to what we're doing. Look hard at us these days. It's a little different than it was a year ago or 2 years ago. And I think we're communicating that better also. Take a look at what's happening with us today. It's a good time to think about us.

Great. That was short versus history.

Greg, you're going to ask another question, and I'm going to go on for 35 minutes. So take that opportunity to bring it on.

Now all jokes aside. You highlighted the capital recycling, which has been a bit of a differentiator for you guys versus others, given your -- some lower cap rate retail, the apartments. At the same time, you're talking about starting new apartments, right, Hoboken, Bala Cynwyd, right? How should we think about the incremental unit growth? Is that going to be the merchant building model where you guys are building it, realizing it, selling it? Or is there a part of it that you need to keep for the mixed-use component where you want to control it?

So one of the core competencies of this company that has not changed in the 30 years that I've been there, is the notion of how to intensify real estate. And that doesn't mean that public companies that are primarily developing companies are very easy to run. So we're not primarily development companies. But we do incrementally add to the intensity of our projects. And if you look today, with a development team that is very well experienced and has frankly not failed one time with respect to the products that we built, to the extent you can see what works in development, it's hard to build retail today. It's hard to make retail pencil. It's hard to make anything pencil with respect to building new products except for an exception. And that is Federal Realty's properties are generally larger than the average shopping center. Therefore, they have excess parking lots, et cetera, on them. What we've been able to do is to incrementally without land cost, huge advantage, incrementally add units with our team, our capital, 100%, to be able to add units that, on average, the consumer or the person living in that apartment will pay roughly $200 a month more. To be in an environment that is fully amenitized than they would in that same box in the sky, 4 blocks away without those amenities. That's been proven by us time and time again. It certainly started to your point, Craig, with the mixed-use properties, but can also and does also apply to Darien, Connecticut to Bala Cynwyd, Pennsylvania, to what new projects starting in Willow Grove, Pennsylvania. Hoboken, New Jersey, et cetera. If you look at our new investor package, there's some new stuff in there, and it gives you more clarity with respect to that. Now to your point, what is different is I am willing to monetize those assets, not in a merchant building model, please make that go away. We're a REIT. We don't do that. But the notion of building and taking that income in for a period of time. And then at that time, considering overall cost of capital and the opportunities as to how to redeploy that capital, there's a willingness to monetize and sell those assets. And we've done that a few times this year at Santana Row, at Pike & Rose, Mid-4 caps, Santana Row, Low 5 caps at Pike & Rose, pretty important stuff. The tax gains associated with those are large, as you would imagine, to be able to tax efficiently, 1031 into assets that we find White Kansas City, like Annapolis, Maryland, like Omaha that have higher growth projections. Why? Because they've been under managed for a long time. Because the tenants that we can bring to those properties with retailers who want to be there, but have not found the landlord and the property that they're comfortable with is where we're making great pride, great strides. So that bit of recycling will continue, Craig, and today, if you look at the income stream of Federal, 80% of it is retail and the reason 80% of it is retail is because that's where we are. That's what we do and bringing those communities together and creating higher sales for higher rents. But while we have those pieces of land and a capacity and core competency, if you will, to be able to add residential product to that makes all the sense of the world. It's very hard for us to not do that. So 10% of our income stream is from residential, 10% is from office. Only on the large mixed-use properties that we have and some of our better shopping centers. So that should continue. That's how you should think about it with a couple of hundred million dollars put to work each year in a repeatable income stream where in '26, for example, our Bala Cynwyd residential project next to the Bala Cynwyd shopping center has just been completed. We're just starting to lease now that will start contributing in the second half of '26, certainly into '27. There'll be another -- you'll see Hoboken in '27. You'll see Santana, where we sold those 2 assets. We're building another 260-some-odd units on the third periphery, the third block of Santana Row that will be contributing '27 and '28. So and there's been -- we just announced Willow Grove, Pennsylvania, which will be '28 and '29. So you'll see each year, the repeatable notion of incremental resi added to really great shopping centers. You can't do that everywhere because you need $3 a foot rents. You need marketplaces. You can't build if the rental rates are $1,400 a month. Just can't do it. But at $2,700 a month, $2,800 a month, you can. That's the incremental value that we're exploiting by owning great shopping centers in marketplaces that will support incremental intensification.

And just to clarify, so think about like at least a 2-year hold period to get through a safe harbor post development and then you guys decide what to do with the resi?

I'm sorry, say it again.

Simplistically, you're not going to be a merchant builder. You said you hold on to it a while. I'm assuming to get through the safe harbor, so you can 1031 and do all that. So like a 2-year plus hold period of that new...

Yes, I think that's a fair way to look at it. And then even at that point, there's always capital allocation decisions. Is that the best cost of capital? What's the marketplace happening at that time? Is that a good time to monetize? Should it be held because there's new supply in the area? All the typical considerations, I guess I really want to make sure that this audience understands that our #1 priority is smart capital allocation. That's on the buy, that's on the sale. That's on the tenant coordination money, that's on salaries, that's on everything. How we use your money is the most important thing and the most set of decisions that we make. And so it's why I sound sometimes like, no, I'm not going to give you this is not exactly what we're doing because it does depend. It depends on the market at that time and you want it to depend on the market at that time where we can be very opportunistic.

And on the other side of it, you guys have entered Omaha, Leawood, as you said. You clearly -- I assume you have an acquisition pipeline behind it. From a strategic perspective, how quickly should we see you enter new markets versus try to scale at least in the markets that you've more recently entered, right? Like what's the strategic to not spread yourselves too thin and get scale to make it worthwhile to go to some of these locations?

Yes, obviously, it depends on the art of the possible, what's available, what makes sense at the time. But there are a few things I want to talk about with respect to this initiative. So some of the people in this room, a couple at least, have came to our Property Tour Plus late last year at Leawood, in Kansas. And the reason we had that and the reason we wanted -- I guess we had 35 investors or so sell side there. The reason we wanted to do that is to have you leave with 2 things clearly in your minds. Number one, that federal was not going down quality and chasing FFO for the sake of chasing FFO. And I think it became really clear to everybody that was there, and we took them downtown Kansas City through the neighborhoods, to the property, met with the mayor, showed a lot of numbers in terms of what it is that we were effectively doing there. And I think everybody left with the notion, yes, these guys aren't going down quality. This is an under-managed asset that is in a marketplace that feels a whole lot like what they do in other parts of their business. And the second thing we wanted everybody to come away with is the understanding that this is not a new business plan. This is what we do and same plan, different dirt. So entering -- and we also said, and it's important to understand you shouldn't think of Federal as having dots all over the United States of America now with all kinds of new markets, 3 to 5, 3 to 5, Kansas City is one, Omaha is a second. I'd love to add a third this year. I'm not close enough on anything to be able to talk about that today. I can tell you that we've got nearly $100 million close to being able to get something done in our existing markets, more strategic stuff that you should see in the first half of this year. And hopefully, as we go through the year, the continuation of that. Now when we enter a new market, Craig, to your point, it's with a large dominant asset. There could be a great 125,000 square foot grocery-anchored shopping center, but I'm not going to enter a new market with 125,000 square foot grocery-anchored shopping center. We're not -- doesn't -- first of all, it's not big enough to spread costs over to be efficient in terms of that. But more important than that doesn't make you a player. When you own the best shopping center on the Kansas side of Kansas City, you're a big deal, and we're already seeing that. So the notion of [Audio Gap] map of where we want to go. If you guys are there, we'll give it a shot. And we see that over and over again because if you think about it, same at Pembroke, it's the same kind of notion. If you think about it, if you're a retailer, and it cost you millions of dollars to open a store of any size, hundreds of thousands if you're small. Before you, why would you invest money in a place where you don't know if your landlord is going to make it a safe place that's built out well, that's got the right neighboring tenants. Why would you hang yourself out? Why would they hang you out dry? Why would you do that deal? With a track record that we have, what you're seeing at these places, Pembroke, Kansas City, Virginia Gateway, Del Monte in California, et cetera. What you're seeing is that willingness. It's not a fluke that there is increased demand for the properties at much higher rents because the track record says the sales are going to be higher. It all comes down to sales.

Anything to add on that, Buddy?

No, I think we have done enough of these now that we're able to do such good due diligence that we're finding we can hit the ground running really fast too. So I think the 2 dozen deals, I think, even exceeded our expectations and we would and certainly getting some of the tenants like Alo and Vuori to step up when they stepped up is ahead of schedule. And a lot of that is just the groundwork we're able to do when we're under diligence because we have such good relationships across now such a big geography.

Give a preview of what they'll see at Pembroke tomorrow.

I mean I -- since we've owned Pembroke, we bought that in '22. We've signed -- you'll see under construction, Pottery Barn, West Elm, Williams-Sonoma, you'll see an open Anthropologie, Lululemon, Kendra Scott, Lovesac, I don't want to steal all of our thunder, Coach just opened, Ares under construction. And so again, it's just this momentum that starts to feed off of itself as the tenants come in and start doing sales and you start to kind of get your aperture opens further and further, who will consider it. And so I think you'll see that's now ahead, obviously of Leawood, but it's a pretty good example. The same direction we're going there as well.

And maybe just one thing to say on that, too, when we underwrote Pembroke last year. We underwrote it based on everything Stu just said. What we found when we got there, in addition to the positive surprises on the retail side, was a parking lot in the back of the shopping center that is completely unencumbered by tenant leases. That's unusual. Usually, there's negotiations that have to happen with tenants if you're going to try to build something or expand or intensify, no such encumbrances. And so what we've done over the last 15, 18 months is get 300-plus residential units fully entitled and approved for Pembroke. That was not in the original underwriting. That type of stuff happens on larger pieces of land that are regionally driven, where you can create a great retail place and have people participate in that retail by living there. And I don't know whether the numbers at work on that residential project or not. We're darn close and we're working it, turning it up, et cetera. But that's the kind of thing that creates growth that is not in the underwriting, it's not paid for upfront. What tends to happen as long as you've got the core competency to make it happen.

Yes. And the returns when we underwrote Pembroke back in 2022 was a targeted unlevered IRR just north of 8%. Re-underwriting it because it was so under managed and because we've exceeded kind of our expectations in that underwriting, we're now reforecasted that to be north of 10%. And that does not even include the incremental returns we potentially could get from the residential, that would be taken even further. So just -- we're really excited to have everybody come visit tomorrow and look forward to it and looking forward to having you host us.

Yes. No, we're excited. And I'm kind of curious, you brought up 28 leases you did that in Kansas City already. I mean how many of those are new relationships that had reached out to you and said, "Oh, you're going there. take me with you versus how many more are on that list of potential, they didn't want to be the first mover, but they still want to be in the submarket. And so the upside to that center over time could continue.

Other than a handful of the best-in-class local tenants we found and done, all the other tenants we were talking to all the way through diligence, which is how we were able to get them done so fast. What would have 7, 8 months ago we closed. So that, I think, is why we had such conviction going into it because we had talked to 50, 60 tenants that we knew. I think we've gotten them to commit to signing a lease a little bit faster than we thought. And then it just -- they build on each other. So that momentum has built. So LEGO and Coach and Solid Core and Alo.Now you start to stack those names together. You're building a bigger, bigger list of others that will consider it. But most of them, if not all, we had talked to in the lead up to closing.

I don't want to mix apples and oranges just because the IRR was on Pembroke, so maybe we'll focus on that. But I'm curious, when you underwrite that 10% unlevered IRR, like what's your exit cap? Are you assuming -- so the point I'm getting at is like if you improve the center this much, is that even being captured in potential cap rate compression in that 10%?

Yes. No, we don't kind of compress the cap rates on the terminal side. It's either at or higher in terms of what the terminal cap rate will be going in. So it will be a wider cap rate than what we did going in or flat depending upon where we are in the capital market cycle.

It's a great question, Craig. Because, look, you talk IRRs, anybody can say whatever they want. What you can't do is fool yourself. And so the deal that our standards for doing it is we do not ever assume in the underwriting of an asset cap rate compression to make the numbers work. If it doesn't work at the same cap rate that we went in or higher depending on what the situation is then we don't do the deal. And to your point, that is the biggest piece of cushion that our underwriting effectively has. Because if you do it right, you are absolutely compressing the cap rate. Even in an interest rate stable environment. That cap rate should come in. I mean, we bought Kansas City at would we buy that?

6, 7...

So we bought it at 6, 7 with what we're doing in 5 years from now, let's assume everything stays the same with interest rates just for fun to take that variable out of it. In 5 years, that income stream will be significantly higher. And what I believe is that cap rate will be 50 basis points or more inside of it. So the combination is really where you create your value. It's why honestly, it's why on all of our dispositions, we have huge gains that have to be tax shelter to make the most sense. It's why this whole capital recycling program is so unique.

And just -- I don't want just to come off antagonistic. No, no. The story you guys are laying out shows the value of the platform over time, right? You find in a piece of land behind Pembroke, you didn't even know you can have, right? These are all long-term value plays, and it takes a couple of years to remerchandise and effectuate the plans on some of these assets as to get to your levered IRR. In the world of public REITs, investors have gotten a little bit -- time frames of seeing that value materialize have compressed, right? And so you do see the numbers from an earnings perspective when developments come on and you do see that uplift. But a lot of the value is still in the dirt over time that isn't realized in FFO. So I'm just kind of curious, as you guys continue to evolve the platform, how you bridge those 2 realities?

The word is bridge or balance or however you want to look at it. I know that I can't run this company 12 months at a time. It's real estate. And the beauty of the investor base is to have that liquidity to get in and out, whenever you want to get in now. And that's our deal. But on our side, the ability to keep this going ties back to this notion, how did the dividend go up every year for 58 years. You have to be able to balance it. So for us to be able to provide you with 6% plus growth and create that value that suggests that, that will continue long after 2026 or 2027, et cetera, is the name of the game. And that is both the benefit to being public and the hit to being public is all summarized with that balance between owners and operators. And I think we've got that balance really, really good right here now.

Any questions, by the way? Can you just hit the button?

This is an Australian question. In Australia, our kind of mall owners are reluctant to do resi because of permitting problems. And the concern is that subsequent developments might be impinged by the rights of the resi people who have bought in the neighborhood or bought your development. Can you just expand on that?

Well, with regards to kind of getting it permitted to talk about it. Yes.

So what would happen would be say you do, I think you said something like 212 at Santana or something like that. And then apartments, so you do a bunch of apartments need more and then those owners have sort of rights or

We negotiate.

They become a potential source of aggravation as it were if you were trying to expand your mall.

Look, that's one of the things that we do and sometimes permitting problems in the markets that we're in, we welcome them in certain cases because we're establishing those markets with good relationships with the surrounding neighborhoods and so forth. We're able to get those permits done and the entitlements over the finish line, and it's difficult. It's not easy. And so we're able to accomplish that. And so that is, I think, a competitive advantage we have in the markets that we're in to be able to understand that entitlement process, to be able to deal with the aggravation of neighbors, to be able to negotiate with the neighboring -- to be able to figure out how high we can build the residential buildings that we're in and so forth. Some of those negotiations go into -- there's a whole host of things. But that's a competitive advantage and the extent that we can get those entitlements done and approved by the neighborhood as well as the is something that is a skill set we have that allows us to create value at these opportunities.

It's also one thing to think about here. And there are times when it makes all the sense in the world to put a shovel on the ground and go -- there are other times when it makes no sense in the world to do that. But what always makes sense is to work with those communities, with those neighbors, with those city council people and county council people to create the ability to do that when the time is right. So for those of you who are in Boston, for example. To me, one of the best assets that this company has is Assembly Row. And what is great about Assembly Row is it is such a dominant destination that what we're working on now is the ability to entitle nearly 3 million square feet more on the power center section of the property, which would continue the community, if you will, all the way through. Those numbers don't work today. And there isn't a public investor that will value that. However, a private investor would look at that and say, you've been working for 3 years on the entitlements. The entitlements will cost us over $1 million to effectively get. They don't have value in terms of putting a shovel in the ground today. Yet the value of that asset, I would never be able to take the NOI divided by 0.05 or whatever and sell that asset today because I would be leaving tons of private value on the table. So this is part of the balance part that Craig is talking about. You're right. You don't get paid for that in the public markets. But there is a time that all of that aggravation and all of that work, that's why Assembly Rows there in the first place, tons of aggravation, and it's turned out to be one of the best things we have. They're generally worth it to Dan's point to go through it.

Well, that's same-store NOI for next year?

Mid-3s.

Same, more or fewer companies?

Fewer.

Thank you guys so much. Appreciate it.