Saul Centers: Access To Affluent Shoppers Will Fuel Growth (NYSE:BFS)

Saul Centers (NYSE:BFS) is an old-line shopping center REIT with its properties concentrated in the Washington DC MSA. Despite its tenure, the company never really came across our radar because it consistently traded at a premium FFO multiple. Back in 2015 it traded at 20X while other shopping center REITs were far cheaper.

Saul’s multiple dropped to about 11X during the pandemic but even that wasn’t cheap because REITs were so absurdly discounted in 2020 that we were buying other shopping centers at 8X or lower.

Today, however, Saul trades at just over 12X FFO and 17X AFFO making it cheaper than the grocery-anchored shopping center averages of 14.6X and 17.8X FFO and AFFO respectively.

It is now interesting as a potential way to buy prosperous Washington DC properties at a significant discount to replacement cost. We bought a tiny starter position in BFS and began our due diligence.

We shall begin with a company overview of BFS and then follow with our analysis on fundamental outlook, valuation and the multitude of idiosyncratic factors to consider with this somewhat atypical company.

Saul Centers Overview

Saul Centers is a mid-cap REIT with properties consisting primarily of shopping centers with about a quarter of its portfolio in mixed-use apartment/office.

It has a few properties located along most of the East Coast, but the bulk of its assets are in DC.

We see this as a great market for shopping centers because DC has higher median household income than any other state, coming in at $106,049.

In combination with fairly high population density, Sauls’ shopping centers have access to a high number of affluent customers within their catchment radii.

Since the company has been around for a long time, long-term charts of key metrics serve as a means of understanding its track record.

FFO/share has grown moderately over time.

For most real estate sectors the above growth would be quite slow, but recall that the period from 2007 through 2018 was the dark ages for retail real estate. Shopping centers were overbuilt heading into the Financial Crisis and then the already oversupplied sector had to battle the advent of E-commerce.

Thus, while the growth rate was not impressive from a broader standpoint, it is more than adequate given the environment in which it was operating. As we have discussed more thoroughly here, fundamentals of the shopping center sector have improved dramatically. Shopping centers are now undersupplied and strong net absorption is allowing landlords to raise rents materially.

Thus, the forward growth rate for shopping centers should be much higher than it was historically. This is showing up in the numbers with Saul achieving greater than 6% same-store NOI growth in the most recent quarter.

Its earnings were fairly typical of retail REITs in 2024 with rental rates getting rolled up upon renewal/re-leasing.

Saul is among the more dividend focused shopping center REITs with a current yield of about 6%. Aside from a small cut from the Financial Crisis, Saul’s dividend has been stable to growing.

Given the fundamental outlook, we see its forward dividend as quite reliable, making it a reasonable income investment.

Growth Potential

Occupancy is roughly full with the typical frictional level of vacancy, so most of Saul’s growth potential comes from rental rate growth.

Saul’s rent per square foot is about $24 for its retail portfolio, which strikes me as well below market rates, particularly for the DC area. Saul’s leasing strategy is less aggressive than most with a clear preference to renew existing tenants rather than finding new tenants. Doing so allows them to forgo most of the tenant improvement costs and other capex but it likely leaves money on the table with regard to rental rates. 84.7% renewal rate is very high and I would argue a bit too high.

That said, the currently well below market rents can be unlocked in the future as rents roll.

I would anticipate forward organic growth around 5% annually with some fluctuation based on the percentage of existing leases expiring each year. More expiration would translate to more growth given the magnitude of mark-to-market.

Valuation

Saul is quite discounted relative to its own history, but a purchase decision today is not based on it being a better buy than it was. The hurdle it must overcome is being better than shopping center peers. For this, we can turn to a relative valuation.

As discussed above, Saul trades at a lower multiple than peers, but it also higher leverage than most of the sector.

Below we plotted the AFFO multiple of each shopping center REIT on the Y axis against the debt to capital on the X axis.

Those with higher leverage should trade at lower multiples and indeed they do as seen with the trendline.

On a leverage neutral basis, Saul trades right in-line with peers.

Absolute valuation is also worth considering here and it is perhaps the area where Saul looks more opportunistic. Consensus NAV is $52.50, so its $39.70 price tag represents a substantial discount.

Analysts forming the consensus are using a 6.61% cap rate in valuing Saul’s properties and that feels about right given age, location and type.

DC shopping centers would typically go for higher prices (maybe a 5.5% cap rate), but Saul’s properties are a bit higher average age which would pull the cap rate back up.

Idiosyncratic oddities

BFS is a quiet company. It doesn’t raise capital very often, so it operates more like a private company than a public. It doesn’t do quarterly conference calls and rarely puts out investor presentations. We have seen similar levels of quietness among One Liberty Properties (OLP) and Urstadt Biddle (UBA) prior to UBA being bought out.

Another strange detail is that BFS has extremely high insider ownership. 35.5% of common shares are held by B.F. Saul Real Estate Investment Trust. An additional 3.14% of common shares are held by B. F. Saul Co.

Additionally, there are 10 million OP units, many of which are owned by the Saul Family.

Per the 10-Q:

“As of September 30, 2024, the B. F. Saul Company and certain other affiliated entities, each of which is controlled by B. Francis Saul II and his family members, (collectively, the “Saul Organization”) held an aggregate 29.0% limited partnership interest in the Operating Partnership represented by approximately 10.0 million convertible limited partnership units. These units are convertible into shares of Saul Centers’ common stock, at the option of the unit holder, on a one-for-one basis provided that, in accordance with the Company’s Articles of Incorporation, the rights may not be exercised at any time that the Saul Organization beneficially owns or will own after the exercise, directly or indirectly, in the aggregate more than 39.9% of the value of the outstanding common stock and preferred stock of Saul Centers, excluding shares credited to directors’ deferred fee accounts (See Note 8). As of September 30, 2024, approximately 628,000 units could be converted into shares of Saul Centers common stock.”

Insider ownership of this magnitude is a double-edged sword. On the positive side, management is financially aligned with shareholders and on the negative side, the Saul family has nearly impenetrable control of the company.

It is difficult to say if this is overall positive or negative. Thus far, I have not been able to detect any signs of management abusing their entrenched position. It is merely something to make note of.

Buyout potential

Among the shopping center REITs a few stand out as the most ripe for getting bought out.

• Whitestone (WSR) has repeatedly been the subject of hostile takeover attempts
• Slate Grocery (OTC:SRRTF) and Saul each trade at steep discounts to NAV

Due to its small size, Slate is a highly accretive acquisition target because there would be substantial opex savings.

Saul stands out as a potential target due to its property concentration in DC. It is a highly desirable submarket and it would be difficult to otherwise assemble such a portfolio so the prospect of getting that exposure at a discount to NAV could be enticing to peer REITs or private equity.

Overall take

Saul’s valuation looks about right relative to its peers although I think the entire shopping center sector is opportunistic given the fundamental outlook being stronger than multiples imply. It has a strong property portfolio but some internal oddities which along with high leverage make it slightly riskier than peers.

Overall, it is not a slam dunk but potentially a good investment. We will watch it and perhaps buy more if it gets cheaper or there are signs of more imminent M&A.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.