UDR - 10 REITs For The Long Haul

2023-05-04 22:06:07 ET

Summary

• No junk. No terrible REITs with excess leverage hoping to support a fat yield.
• These REITs compound wealth for investors over the long haul.
• Unlike highly-leveraged real estate investments, these REITs can withstand even a prolonged recession.

These are REITs that are long-term dividend-growth machines. Investors who only care about how much cash the REIT puts in their hand will hate these picks. Any REIT can take out debt and use it to pay a special dividend. Putting cash in your hand one time isn't something special. We're looking for long-term growth fueled by great real estate. The REITs here will be in no particular order, other than clustering them by property type.

Alexandria Real Estate

The first REIT on the list is Alexandria Real Estate ( ARE ). This great office REIT... Wait. Why does this keep getting labeled as an office REIT? ARE got pounded in correlation with office REITs, but lab space is not the same as office space. Most office buildings cannot be converted to lab buildings either. It isn't a superficial difference.

ARE continues to deliver with solid leasing spreads and high occupancy. While some companies are struggling with debt, ARE locked in the vast majority of their debt before rates soared. That put them in a more favorable position on financing.

Cell Tower REITs

All three of the big ones go here. American Tower ( AMT ) is the only one not sporting a fresh 52-week low. They aren't all that far off it though.

Why are cell tower REITs going higher? Because they can generate growth in revenues. Strong margins and excellent scale on operating expenses result in a large portion of that revenue reaching AFFO. As it stands, AMT and Crown Castle ( CCI ) are facing the headwind of higher rates on their floating rate debt. SBA Communications ( SBAC ) is facing that headwind, but they expect to have all of their floating rate debt paid off by the end of the year. That's why SBAC's dividend yield is so low. They are retaining cash, and they use it to repay debts (or repurchase shares).

AT&T ( T ) and Verizon ( VZ ) want to reduce capital expenditures. Good luck. KeyBanc points out that cutting capital expenditures doesn't work well when T-Mobile ( TMUS ) keeps investing in their network.

I could've made the point using a few big charts, but many of you are reading from your phones and a few people would've been sad about blowing their data on those charts. Yeah, low data limits are sad.

At least a handful of you were probably stuck waiting more than 10 seconds for this article to load. It shouldn't be that slow.

Industrial REITs

How about Terreno ( TRNO ) and Rexford ( REXR )? These industrial REITs have extremely high occupancy, huge leasing spreads, and operate in areas where there are dramatic barriers to entry. One of the biggest barriers is the price of land. Industrial real estate simply takes more land because it isn't practical to build to the same heights as other property types.

That makes development within those higher-cost areas extremely difficult. Consequently, rent increases dramatically because there is an ongoing imbalance between supply and demand. People want to order their junk online (not calling you out, I do it too). Sellers want their junk to reach people quickly. That makes industrial real estate very important.

Could you convert vacant retail space to industrial space? Sure (if the lot is large enough and zoning laws permit it), but the rent per square foot is dramatically lower. Which landlord wants to accept massive capital expenditures only to achieve a lower rent per square foot?

If industrial rents are growing vastly faster than other property types, but for them to actually catch up it would require monumental increases. No, not just 50% or 90%. The REITs are already achieving leasing spreads in that range. Wonder why these REITs are worth such high multiples of AFFO? Because if their real estate was leased at market rent the AFFO would be much higher. Further, the AFFO would still grow faster than other sectors because market rent on the real estate continues to climb faster due to the imbalance between supply and demand.

Manufactured Housing REITs

Sun Communities ( SUI ) owns MH parks as well as marinas and RV parks.

SUI is a great REIT. Strong management team. Great properties. Nothing to dislike.

The AFFO per share estimates bounced around a bit, which makes the following chart a bit harder to read:

The chart for FFO per share is smoother. We prefer AFFO for analysis, but in this case, the smoothing can help to demonstrate trends.

That's a good REIT. Like most REITs, they are facing some challenges with higher interest rates in 2023. However, in 2024 that headwind should be dramatically reduced or gone. There is a significant chance for entering a recession later this year, but SUI is a strong REIT to withstand difficult times.

Apartment REITs

I see all the big apartment REITs as reasonable choices here. Some are better than others, but none (of the big ones) are bad. Despite significant reductions in consensus estimates for NAV, the REITs still trade at a material discount to the estimated value of their assets.

What's the difference between owning apartments and owning apartment REITs? The apartment REIT shares are far more liquid, they have great scale on their operations, and you can buy them at a substantial discount to the market value of the underlying real estate.

The three we own shares in are AvalonBay ( AVB ), Essex Property Trust ( ESS ), and Camden Property Trust ( CPT ). I don't see anything wrong with Equity Residential ( EQR ), Mid-America ( MAA ), or UDR ( UDR ) either (though we don't own these 3 currently). Leasing spreads are clearly coming down year-over-year and relatively flat quarter-over-quarter. That's fine. Some investors hate the idea that rents aren't growing dramatically every quarter, but that was an unrealistic expectation anyway. Someone needs to live in those apartments. A world where rents go up 10% per year is pretty dystopian.

Conclusion

These are not the picks for most high-yield investors. I'm not speaking to investors who think the only purpose of a REIT is to get a big dividend today and an excuse to complain tomorrow when it gets cut. We do trading in the mortgage REIT preferred shares, but most of our equity REIT positions are long-term positions. That makes it imperative to be buying REITs with great properties and great balance sheets.

We absolutely do not want to deal with high leverage on real estate. Leverage is what really wrecks investors in a recession. Most of us will live through multiple recessions. Recessions create opportunities to get good companies at bargain prices. They also wipe out investors who put their money into companies with too much leverage.

None of these REITs is likely to suffer that fate. This isn't a scheme to get rich quick. It is the steady path to growth.

Of course, at least one investor thinks growth is speculative. They think high dividend yields today are the certain return of capital. That simply isn't the case. Dividend cuts happen, and they happen much more to the more dangerous stocks. There is no merit to the idea that future dividends are certain while growth is not. Neither is certain, but the REITs that can afford growth often have dramatically stronger positions.

Think authors should put their money where their mouth is? I'm right there with you. I own shares in all 10 of the REITs I suggested. Not just a few shares so I can disclose a position. The smallest of these positions is worth $10,769. The largest is $96,811.

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