SKT - 3 Of The Hottest Sunbelt-Focused REITs On The Planet

Summary

• I'm not used to frigid temperatures, and I miss the milder weather in my home state of South Carolina.
• As much as I have enjoyed visiting Minnesota, I look forward to returning to the Palmetto State.
• Covid-19 has transformed the habits and routines for many Americans, and over the last few years, we have witnessed an acceleration in migration to the sunbelt.

I'm in Minnesota right now on business meeting with fellow Seeking Alpha writer, Dividend Sensei. This is my first trip to Minnesota, the 12th largest U.S. state (in area) and the 22nd most populous.

I knew it was going to be cold here, but I completely underestimated the temperature when I was preparing for this trip. When I woke up this morning it was zero degrees.

The good news is that I can spend my morning inside, writing a few articles for Seeking Alpha, including this one: 3 Of The Hottest Sunbelt-Focused REITs On The Planet.

I'm not used to frigid temperatures, and I miss the milder weather in my home state of South Carolina. And besides the weather, I want to provide you with a few other good reasons to invest in REITs that are close to my home.

There's no place like home

In our 2023 REIT Roadmap , I explain that "office supply should continue to outpace demand through 2023 and we remain neutral on the sector given recession concerns and a sticky hybrid work environment".

However, there are a select few office REITs that we're recommending, especially landlords that "attracts candidates to their firms and employees to their offices with the highest quality (newer) buildings with amenities should perform best".

We concluded by saying:

We view Sunbelt markets best positioned to outperform as operating conditions likely carry forward with steady job and population growth."

As most of my readers know, I live in the heart of the Sunbelt - in Greenville-Spartanburg, SC - a market that's home to BMW's North American manufacturing facility and Michelin Tire's North American corporate headquarters.

I travel frequently across the Sunbelt, most recently I drove to Birmingham, AL to meet with the CEO at Medical Properties ( MPW ) and to Raleigh, NC to meet the CEO at Highwoods Properties ( HIW ).

These boots on the ground trips provide me with real-time insight into real estate dynamics and face-to-face contact with key decision makers in the REIT sector. In a few weeks I plan to travel to Nashville, TN to take a closer look at Tanger Outlet's newest 290,000 square foot project that's set to open in the Fall of 2023 ($140 Million):

As Editor at Wide Moat Research (based in Delray Beach, FL), I spend considerable time in South Florida, one of the hottest real estate markets in the world ("hot" meaning metaphorical rather than literal, or perhaps both).

One of the things that I learned the hard way, as a real estate developer, is that you must always consider supply and demand.

In my early days (as a developer), I never paid much attention to demographics, as many of my shopping centers were constructed in secondary or tertiary markets with County populations under 50,000 people.

Over the years, and during the Great Recession, I found out the hard way that population and income are highly correlated to valuation. Many of the properties that I once owned are worth 50% less than my development cost.

Back in 2008, my REIT skills weren't as strong as they are now, and as I pointed out, I had to learn about demographics by learning from my mistakes.

With that in mind, let me tell you why I'm buying up these three Sunbelt-focused REITs hand over fist…

Highwoods Properties ( HIW )

Highwoods is an internally managed REIT in the office sector that owns, develops, and leases properties mainly in BBDs (Best Business Districts). HIW has a primary focus on the sunbelt region with properties located in Charlotte, Orlando, Nashville, Atlanta, Pittsburgh, Raleigh, Tampa, Richmond, and more recently Dallas.

HIW has properties located in 6 out of the top 10 real estate markets according to ULI (Urban Land Institute) and earns 90% of its NOI from these top markets.

HIW's geographical focus should serve them well as more of the population migrates to the sunbelt region. The charts below represent annual growth from 2010 to 2021. The population and office employment growth rates for the sunbelt region (and HIW) far exceed the levels of growth seen in gateway locations and the US overall.

Along with the macro factors that have hurt almost all stocks, Office REITs have an additional headwind with the sticky stay at home movement.

As I've said before, in the long run, I believe the pendulum will swing back to the employers' favor, since most people ultimately need a paycheck, but the issue also cannot be dismissed out of hand. Ultimately it comes down to risk / reward.

There is extra risk in the office sector which the market has been pricing in, but that has also presented an opportunity for a high reward. Many office REITs are trading at levels we haven't seen in some time.

That presents an opportunity to get real estate at great valuation and receive a large yield in the process. Considering the uncertainty in the sector, we need to examine each company closely to see if it's well positioned to maintain and grow its lease and occupancy rates.

One of the main competitive advantages I look for in an office REIT is where its properties are geographically located. HIW checks that box as most of its office buildings are in the southeast and Texas.

Another thing to consider is the financial shape of the company's balance sheet:

Highwoods was founded in 1978 and went public in 1994. It is investment grade rated at BBB and has a strong balance sheet with a Net Debt to EBITDAre of 5.6x, a weighted average interest rate of 3.7% with a weighted average maturity of 6.1 years, and no debt maturities coming due until 2025. Almost 85% of their debt is fixed rate and approximately 84% of their debt is unsecured.

HIW is on sound footing financially and is well positioned geographically, both which should help HIW weather whatever storm the next few years may bring.

When looking at HIW's occupancy levels, as of 3Q22 they had a total occupancy of 90.7. Their outlook range for year-end occupancy in 2022 puts them at levels close to that of 2019, before the pandemic.

Additionally, new leasing both as a percentage of available SF and of total volume both show growth since the pandemic. New leasing as a percentage of available SF is higher than any time since 2013 and new leasing volume is approaching 2019 levels. Large companies with very capable management teams would not be signing new leases if they thought no one would show up to the office.

According to the numbers and information we have, HIW has properties in the right locations, is in a strong financial position, and has encouraging occupancy and new leasing levels. Additionally, HIW is not slowing down on the development front, especially as they expand into the Dallas market.

In July of 2022, HIW announced it was entering the Dallas market with a joint venture with Granite Properties to develop two office properties located in two Dallas BBDs and plans to fund the development with its Pittsburgh asset sales.

In December, Highwoods and Granite Properties formed another JV to acquire McKinney & Olive which is a trophy mixed-use asset in middle of Uptown Dallas BBD. McKinney & Olive (M&O) was built in 201i6 and is a 557,000 square foot, comprised of 507,000 SF of class AA office space and 50,000 SF of retail. M&O is 99% leased and has a weighted average lease term of 6.2 years and has current rents that are 35% below the current market rate.

Currently, HIW is trading at a blended P/FFO of 6.82x, less than half its average multiple of 13.28x. The dividend yield is 7.28% and is well covered with an AFFO payout ratio of 73.5%. At iREIT we rate HIW a STRONG BUY.

Tanger Factory Outlet ( SKT )

Tanger Factory Outlet operates and owns open-air outlet properties. It owns and / or manages 36 centers with one center in development. SKT has properties in 20 states and Canada totaling approximately 13.9 million square feet and lease to over 2,700 stores managed by more than 600 different brand name companies.

SKT is headquartered in Greensboro, North Carolina with locations across the US but with a large focus on the sunbelt. 3 out of the top 5 states they operate in are in the sunbelt as measured by GLA (Gross Leasable Area). Combined, South Carolina, Georgia, and Texas make up 31% of their GLA.

SKT tenant base is reasonably diversified with the top ten tenants making up 35.1% of their annual base rent ((ABR)), and with all other tenants making up the remaining 64.9% of ABR.

Their largest tenant is The Gap with 5.8% ABR followed by SPARC with 4.8% ABR. Although their tenant concentration is somewhat high, most of their top 10 tenants are well established, recognizable names like Tapestry, Under Armour, American Eagle, and Nike to name a few.

SKT has had very consistent occupancy with occupancy levels above 90% going back to 2012. Even during the height of the pandemic, they maintained an occupancy rate of 92.2%.

Since 2020 SKT has been improving on this front, and as of the third quarter of 2022, they have a 96.5% occupancy rate which is several points higher than it was in the third quarter of the prior year.

Like most REITs, the pandemic took a toll on SKT's earnings, with FFO declining by 30% in 2020, resulting in the dividend being cut in half, going from $1.41 down to $0.71. FFO declined another 18% in 2021 before rebounding in 2022 with an expected FFO growth of 40%.

Analysts expect FFO growth to level off over the next two years with projected FFO growth of 1% and 3% in the years 2023 & 2024, respectively.

Before the pandemic, SKT had a great track record of dividend increases and has since been working to restore the dividend back to pre-pandemic levels. In October of 2022, SKT announced a 10% increase in the annual dividend from $0.80 to $0.88.

Analysts project a payout of $0.92 in 2023 and for the dividend to reach $1.00 by 2024. While this is still well below the pre-pandemic payout of $1.41, we are encouraged to see SKT back on track with annual raises.

SKT has a strong balance sheet, 95% of their debt is fixed rate and most of their debt is unsecured. Their effective interest rate stands at 3.3% and their weighted average years to maturity is 5.9 years. SKT is well positioned to service debt obligations with an EBITDA to fixed charges of 4.5x. Additionally, they have an investment-grade credit rating of BBB-.

SKT has a dividend yield of 4.95% which is well covered with an FFO payout ratio of 49.7%. Currently, though, SKT is trading at a premium on a P/FFO basis, with a current FFO multiple of 9.71x. Likewise they are trading over NAV with a P/NAV of 1.17. Due to the valuation we currently rate SKT a HOLD.

Mid-America Apartment ( MAA )

MAA is an REIT that owns, manages, and develops apartment communities. Their properties are diversified mainly across the sunbelt region with MAA's top 10 markets all located in the sunbelt. Atlanta, GA is their top market with 12.8% of same store NOI, followed by Dallas, TX with 9.2% same store NOI.

As previously mentioned, the migration to the sunbelt region has been underway for some time now. Many factors may play into this population shift, from weather, to state taxes and regulations, and overall cost of living.

This trend was only accelerated during the pandemic as different states responded to the pandemic and the associated shutdowns in drastically different ways. MAA is very well positioned to benefit from this trend as most of their properties are in the Southeast and Texas.

MAA has a strong balance sheet with an investment grade A- credit rating and a Net Debt to Adj EBITDAre of only 3.97x. They can service their annual debt obligations 6.9x over with the consolidated income available to them. MAA's core FFO payout ratio is 59.2% which not only makes the dividend well-covered, but also allows them to retain cash for future investments.

MAA has a very conservative capital structure with debt and preferred shares only representing 19.9% of their total capitalization. Most of their financing is in the form of equity which stands at 80.1% of their total capitalization. MAA has a weighted average interest rate of 3.4%, a weighted average maturity of 8 years, and 97.2% of their debt is fixed rate.

Currently, MAA pays a well-covered dividend yield of 3.66% and has paid consecutive quarterly dividends since 1994. Their 5-year dividend growth rate is 3.40% and their FFO is projected to grow by 9.20% in 2023 and 5% in 2024.

MAA trades at a discounted valuation when compared to its normal FFO multiple. Currently MAA has a P/FFO of 16.69x vs its historical P/FFO of 19.83x. They are also trading slightly below their NAV with a P/NAV of 0.98.

The current macro backdrop bodes well for apartment REITs in general. Although both mortgage rates and home prices have recently pulled back some, both are still well above their recent levels and makes buying a home prohibitively expensive for many.

This should continue to spur demand for apartment units which in turn will provide pricing power for apartment owners. More specific to MAA is that they are in the fastest growing areas of the country. Between the migration to the sunbelt, along with the overall macro factors, MAA has several catalysts for growth in the coming years.

MAA has a strong balance sheet with low debt levels and a conservative capital structure. Additionally, they have a strong dividend track record with a low FFO payout ratio and have multiple tailwinds for continued growth. We at iREIT rate MAA a BUY.

Nothing Could Be Finer Than To Be In Carolina

I'll be flying back to South Carolina tomorrow, and as much as I have enjoyed visiting Minnesota, I look forward to returning to the Palmetto State.

I can't over emphasize the importance of geography, especially when you're designing a REIT portfolio.

Covid-19 has transformed the habits and routines for many Americans, and over the last few years, we have witnessed an acceleration in migration to the sunbelt.

I'm happy to say that I'm situated directly in the path of progress and in addition to increasing exposure in REITs, I am also beginning to acquire more private real estate in the southern states.

At iREIT on Alpha, we will be using more demographics to enhance the value of our research platform, recognizing that we can gain an edge by analyzing data in real-time.

As always, thank you for reading and I look forward to your comments below.

Author's note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.

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3 Of The Hottest Sunbelt-Focused REITs On The Planet