EPRT - 17 Fast-Growing REITs With 17 Strong Balance Sheets

2023-04-03 08:00:00 ET

Summary

• A FROG is a REIT that shows a Fast Rate of Growth and a strong balance sheet.
• This article discusses how to identify a FROG, and lists all the FROGs as we head deeper into 2023.
• We also give attention to several near-FROGs, as well as some Tadpoles that would be FROGs, if only they were a little larger.
• Finally, we discuss how the FROG-hunting mindset differs from the more common REIT investment approach.

There are two kinds of real estate investment trusts, or REITs, that investors are constantly seeking. One is COWs (Cash Only Wanted), where the object of the game is to milk the company for its safe, above-average dividend Yield. The other is FROGs (Fast Rate of Growth), where the object of the game is to maximize total return by maximizing share price Gain.

Historically, since the invention of REITs about 60 years ago, the average Yield on a REIT is about 4%, (give or take a fraction of a point), and the average total return is about 12%, so the average share price Gain is about 8%.

Total Return = Gain + Yield.

The Yield you sign up for tends to be the Yield you get, at least in the first year. Gain is much less predictable, but there is no limit on how high the Gain can go. In a good year, a well-chosen FROG can gain 30% or more. That is many years' worth of dividends!

Yield and Gain tend to move in opposite directions. As Hoya Capital says in a seminal article ,

The highest-yielding REITs have persistently underperformed while the lowest-yielding REITs have delivered outperformance by roughly 3.6% per year over the REIT average.

So higher Yield usually means lower Gain, and vice-versa. Otherwise, REIT investing would be easy. We would just pick the REITs with the highest Yield.

As a REIT investor, you can focus on Yield, to maximize your dividend cash stream, and that's what many professional REIT investors do . But they usually sacrifice a significant measure of Gain in the process, and end up with inferior total returns.

2022 Was an Anomaly

Hunting FROGs gave me nice results for the first few years. Last year was an exception. Thanks to the spike in inflation at the start of 2022, yield-dependent investors stampeded to high yield securities, dumping their shares of healthy, lower-yielding companies. Thus, 2022 was one of the rare years in which lower Yield also meant lower Gain. 2022 was brutal to REITs in general, and even a little worse for FROGs.

Through December 26 of last year, the Equity REIT Index was down (-28.68)%. Nearly all the major indices lost ground last year, but not as badly. By comparison, the S&P 500 shed (-19.38)%, and the Dow only (-8.64)%. Only crude oil, commodities, and the U.S. dollar gained ground.

The list of FROGs I published going into last year is shown below, along with their 2022 returns.

Source: MarketWatch.com, Seeking Alpha Premium, and author calculations.

The FROGs as a group slightly underperformed the dismal (-28.68)% posted by the Equity REIT Index, returning an average of (-30.61)%. This underperformance came in spite of stellar operating results for most of these companies, which continued their rapid growth in revenues, cash flow, and dividends.

Only VICI, CUBE, and EPRT outperformed, and that is no accident. They were 3 of the 4 highest-yielding FROGs when 2022 began.

How do you identify a FROG?

That question is answered in detail in my December 2021 article . For now, suffice it to say, you can do it with just 14 commonly available data points and a few simple calculations in a homemade spreadsheet. You are looking for 6 key numbers:

1. Funds From Operations per share ((FFO)) growth rate (at least 10%, preferably 20%)
2. Total Cash From Operations ((TCFO)) growth rate (same levels as FFO growth)
3. Liquidity ratio (Assets/Liabilities) (at least 1.66, preferably 2.0)
4. Dividend growth rate (the faster, the better. Average is currently 9.4%)
5. Market cap (at least $1.4 billion, with sweet spot $4-$10 billion)
6. Price Gain (the bigger, the better).

Once you have identified the REITs that pass the criteria above, add their 3-year Price Gain CAGR to their dividend score (which combines current Yield with dividend growth rate, projecting the Yield on cost 3 years from now) to arrive at a Modeled Return. If that Modeled Return exceeds the 3-year total return for the Vanguard Real Estate ETF ( VNQ ) (currently 8.87), then the company is a FROG. The more the Modeled Return exceeds the VNQ's return, the better the chance the REIT in question will outperform in the coming year.

Welcome To The FROG Pond, 2023

Here are the 17 REITs that currently meet or beat all the above-listed criteria, in order by Modeled Return:

Source: Hoya Capital Income Builder and TD Ameritrade.

You might notice that the average rate of dividend growth for these 16 FROGs is 13.8%, which is considerably faster than the REIT average of 9.4%. Because of this, FROGs are often better dividend payers than they appear at first blush. Meanwhile, Yield at purchase is 3.5% for the FROGs, compared to 3.9% for the average REIT.

Note that just because a company is a FROG, that does not mean I will necessarily invest in it. This article does not constitute a Buy recommendation on every REIT listed here, and Modeled Return is not an attempt to predict total return. Not every REIT listed here will outperform the market in 2023 (probably), and I'm sure there are other REITs not listed here that will!

Investor's bottom line

How well FROGs do going forward depends on the conditions for growth stocks and commercial real estate in general. If inflation continues to outpace Yield, this inhibits Gain for the FROGs, and Fed interest rates higher than the Yield tend to attract investors into debt instruments. For the time being, growth is out of favor. But when it comes back into style, FROGs will leap to the front. In the meantime, the dividend income stream will likely fatten. RIBBIT!

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