Over the past year, the business media raised attention about cracks in the commercial real estate sector. Office commercial real estate is a well-known problem, and issues are emerging in retail as well. Rising interest rates raised the cost of financing for many developers, and according to some reports, the value of distressed retail real estate assets rose from $18 billion at the end of March 2023 to $23 billion at the end of June.
Of course, not all commercial real estate is the same. Some properties perform better than others. One real estate investment trust (REIT) that seems to be bucking the trend with strong fundamentals is Simon Property Group (SPG -1.03%). Here's why the company (and the stock) are still doing fine.
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The economy is holding up well despite interest rate increases
Simon Property Group owns, develops, and manages shopping malls, outlet centers, and mixed-use facilities. It owns 196 properties consisting of 93 malls, 87 Premium Outlets, 14 Mills, and 20 other properties in the United States. It also owns an 80% non-controlling interest in Taubman Centers and a stake in French retailer Klepierre. The company also owns or has an interest in 35 properties overseas.
Simon Property's focus on discretionary retail makes it subject to the strength of the economy. The company did struggle during the worst of the COVID-19 pandemic; however, it has recovered since then. Despite aggressively tight monetary policy actions from the Federal Reserve, the labor market remains exceptionally strong, and the consumer is still spending. Credit metrics, like delinquencies for credit cards, remain below pre-pandemic levels.
Simon Property Group raised guidance and hiked the dividend
In the second quarter of 2023, Simon Property reported funds from operations (FFO) per share of $2.88, a year-over-year decline from $2.91 in the same quarter last year. REITs tend to use FFO to describe earnings because depreciation and amortization (D&A) is a large expense under generally accepted accounting principles (GAAP).
D&A is a non-cash charge, meaning net income, as reported under GAAP, materially understates the actual cash flows of the business. This is why REITs might look expensive on a price-to-earnings (P/E) basis. If you look at price-to-FFO, the multiples are lower and make more sense.
Occupancy increased from 93.9% a year ago to 94.7% at the end of June 2023, while Q2 revenue rose 7% year over year to $1.37 billion. Base minimum rent rose 3.1% year over year to $56.27 per square foot.
While the FFO numbers were a touch below Street expectations, the quarter was strong overall, and Simon raised the midpoint of its FFO guidance for the year and increased the quarterly dividend from $1.85 to $1.90. The company is currently guiding for 2023 FFO per share to come in between $11.85 and $11.95 per share.
Simon Property is a great stock for an income investor
At current levels, Simon Property Group stock is trading at a price-to-FFO ratio of just under 10 times. This is a reasonable multiple for a high-quality REIT. Given the company's increased dividend, the stock has a yield of 6.4%. The annual dividend of $7.60 per share is well-covered by the company's FFO guidance of $11.90 per share. Despite the massive increase in interest rates, the economy remains resilient, and Simon Property remains an attractive stock for the income investor.
