These factors combine to give Simon Property Group strong cash flow predictability ,which allows for some of the strongest and most consistent dividend growth in the REIT industry in recent years. From 2010 through 2015, Simon Property Group’s free cash flow and dividends per share compounded by 10.1% and 18.4%, respectively.
Key Risks
There are two main risk factors to consider with Simon Property Group. The first is the continuing growth of e-commerce and online retailing. Up until now, management has used its decades long expertise in premium retail to prevent this growing threat from harming its growth capabilities.
However, there is no guarantee that the company will be able to continue to do so. After all, at the end of the day if rivals like Amazon can deliver what shoppers want more conveniently, and at a better value than mall-based retailers, even luxury mall stores may end up falling into secular decline.
Then there is the risk of rising interest rates, which have risen by about 0.7% since the surprise results of the November 8th election.
This has been due to markets pricing in growing inflation from a combination of rising oil prices and a Trump stimulus package of tax cuts and infrastructure spending. While such a package is thought to be likely to spur economic growth (based on the market’s knee-jerk reaction at least), it’s also likely to cause inflation to rise, and long-term interest rates are primarily determined by inflation expectations.
Add in the improving economy, and the fact that this will likely keep the Federal Reserve gradually raising short-term interest rates, and Simon Property Group is likely to face rising rollover costs on its large debt load.
That will mean higher costs of capital and lower overall profitability, which could make future growth harder to come by.
In addition, remember that the REIT business model requires, due to the way REITs are structured for tax purposes, that the company pay out at least 90% of earnings as dividends. While this provides investors with high yields, it also means that REITs must periodically raise external debt and equity capital to grow.
If long-term interest rates, such as those on 10- and 30-year Treasuries, rise to 4%, 5%, or even 6%, it’s likely that much of the yield-starved capital that has gravitated into the industry in recent years could depart for less risky alternatives that provide safer income and better capital preservation.
Or to put it another way, high interest rates may make REITs less attractive to income investors and (temporarily) result in lower share prices and higher dividend yields (to serve as a risk premium over risk free treasuries).
That might mean that REITs, like Simon Property Group, will have a harder time raising equity growth capital, further limiting their ability to keep generating such strong returns.
Like almost all things in life, moderation is important. REITs can certainly help a portfolio’s current income generation, but they should be just one part of a well-diversified dividend portfolio. No one knows what could happen with interest rates, the value of real estate, and numerous other factors impacting this sector.
My preference is to keep my bets spread out across many different types of businesses (so long as they remain within my admittedly limited circle of competence).
Dividend Safety Analysis: Simon Property Group
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.
Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors (3) such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.
Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.
We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their track record has been, and how to use them for your portfolio here.
