SBAC - Brad Thomas Laser Focused On Earnings And REITs

2023-10-31 11:00:00 ET

Summary

• REITs were formed to give individual investors access to quality properties and have evolved over the years.
• REITs have outperformed stocks and bonds since 1991.
• Sound fundamentals, cash flow growth, and attractive valuations make REITs a good investment option.

Listen below or on the go via Apple Podcasts or Spotify .

Industry expert Brad Thomas dives deep into real estate and the individual investor (1:00). Sound fundamentals and why it's time to own REITs (3:50). Cost of capital, interest rates and keen earnings focus; Brad's favorite picks (6:00). This is an excerpt from our recent webinar, Brad Thomas' REIT Playbook For 2024 - to watch the full conversation with a trove of informative charts and slides, click here.

Transcript

Daniel Snyder: Hey, everyone, thanks for joining me today. Daniel Snyder here from Seeking Alpha. We have a legend of the industry joining us today. Brad Thomas, the Investing Group leader of iREIT on Alpha here on Seeking Alpha and you have 10 analysts with you. It's a true powerhouse of a service, which we'll talk about later.

Also, Brad has been a part of writing for Seeking Alpha for over a decade. I'm pretty sure he is our most followed author on the site. I think it's up to around 113,000 followers. Brad, how are you doing today?

Brad Thomas: Excited to be with you today.

DS: Pulling these recent numbers from Savills World Research, which I know you like to quote as well. So $228 trillion worth of real estate, that's worldwide, right? And then you broke it down $169 trillion in residential, $35 trillion in commercial. Real estate has such ability to help bring people into this new category of wealth.

BT: REITs were formed for the individual investor to obtain access to institutionally held property – quality properties. And so that's why REITs were formed in 1960. They've come a long way. There's been a tremendous evolution of the REIT structure over the years, but these key elements are still in place. And I want to touch on just four of those real quickly, because this is relevant to our call.

First of all, REITs have to distribute 90% of taxable income. Again, that is just a key, key point to remember. That's why REITs are higher yielding than most of the other alternatives we see out there. Certainly, C corporations and even the other alternatives you see in the – in your asset mix.

Secondly, REITs must have at least 75% of assets in real estate, loans, or other REITs. And so that's a really important part. They've got to have and they've got to hold at least 75% in real estate. And next point is REITs must derive at least 75% of their income, their rents, in real estate.

Last but not least, REITs must have at least 100 shareholders with less than 50% of the outstanding shares concentrated. So those are the key points. So if you look at REITs over longer periods of time, back to 1991, REITs have actually outperformed stocks and bonds.

So office, down 17% year-to-date. Again, that's just through the end of September. Sector's yielding about 6.3% offices today. Net lease sector, down 17%, almost as bad as office.

And then let's move over to infrastructure, which primarily we're talking about cell towers and fiber. American Tower ( AMT ), Crown Castle ( CCI ), SBAC Communications ( SBAC ), sector's down 25% year-to-date, again. And that does not include, by the way, the sell-off of Crown Castle we have with the third quarter earnings . We’ll touch on that in just a minute.

The highlight there is data centers. Of course, we've been following data centers for a while. Full disclosure, I do own Digital Realty ( DLR ). I do own Iron Mountain ( IRM ). I think I've got a few shares in Equinix ( EQIX ). I'll go ahead and point that out. But data centers have done really well. That's obviously powered by artificial intelligence.

AI has been a tremendous catalyst within the data center sector, which we knew it would be. And we'll get more to the data center space in just a minute.

All right. Now, let's move on to perhaps the most popular quote we're seeing today on Seeking Alpha, 'be fearful when others are greedy and greedy when others are fearful.'

I've got another quote I want to mention. I point it out here, Seth Klarman, who probably everybody knows, runs a pretty big hedge fund. He talks about the margin of safety. 'A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable, and rapidly changing world.'

That's the world we're living in right now. Wake up and read the paper, Wall Street Journal. You might see Lauren Thomas, by the way, or go to CNBC or go to any other media source, including Seeking Alpha, and you're going to see all of this fear baked in the market. And obviously, REITs have been impacted by that today.

Now, I'm going to tell you today why you should own REITs. And again, I want to be clear. I've pointed out why not to own REITs and I've pointed out what REITs not to buy. And I'm not batting – I don't have the best batting record out there, but I think we've been able to avoid many, many of these so-called sucker yields, which we'll talk about in just a minute.

Now, there's really three reasons why we think the REITs should be purchased today or considered today. Number one, its attractive fundamentals. Look, first quarter same-store NOI growth, 7.2%. This is all equity REITs. Second quarter same-store NOI, 5%.

Now we just went through, just started launch, I guess the third quarter earnings. And by the way, the average same-store growth is 2% since the year 2000. So that shows me fundamentals are on really sound footing.

Let's talk about Prologis ( PLD ). Prologis just announced their third quarter earnings and 97.5% occupancy, 77% retention, development pipeline from 3 billion to 3.5 billion. Fundamentals are strong, at least in the industrial sector.

Let's move on to the cash flow growth for REITs. Cohen & Steers also has some great research which you can obtain on their website. Cash flow growth for REITs historically, and it's still relatively strong. 2023, 2024, REITs are projected to grow by 3.2%, 3.5%. That's actually fairly strong.

And again, even though it's not – we're moving down to a more modest growth level, I think we're going to see – continue to see the strength of these higher quality companies that we're recommending right now.

If we go on to look at REITs and how they perform in a recessionary environment , based on historical terms, REITs have delivered returns of more than 10% in the U.S. and 14% for Europe, which means the best entry point for REITs have come in the early cycle. Now, at the end of a rate cycle is typically a very good time for REITs because they have historically produced returns of 15%. Historical evidence.

Again, we're looking at current fundamentals as they exist today, as well as historical and how REITs have performed coming out of these cycles. Again, I think a big part of this, and I know a lot of you have commented and asked me questions about cost of capital and interest rates, and all of that is certainly relevant and tied in, and that's why the growth that we're seeing today is not 5%, 6%, 7%. We're seeing more like I said, 3.2% to 3.5%.

Now what we're really focused on, keenly focused on, is earnings . Earnings is really the best predictor. And I've got this other quote. Many of you know Chuck Carnevale . Chuck is a very good friend. He also has a service called FAST Graphs.

Chuck taught me this about 10 years ago when I just started writing on Seeking Alpha. Number one quote, “ emotions determine market price in the short run .” The next quote Chuck tells me is “ earnings determine market price in the long run .” One more time, “earnings determine market price in the long run.” We are laser focused on earnings.

Right now REITs have sold off massively. What we're really looking for are those companies that have historically been able to generate growing earnings and dividends that are doing it right now, and they will be in the future. And that's important when we look at their cost of capital and their ability to transact and what are those cap rates and what is their cost of capital.

So now, in terms of the margin of safety concept and the cheapness that we see in the REIT sector today, U.S. REITs trade in an approximate 6.1% implied cap rate versus historical average of about 5.7%. As a result, REITs look to be on the cheap side of fair value.

So Mid-America, I'm going to touch on our favorite apartment REIT today, my favorite apartment REIT, may not be yours, Mid-America ( MAA ). Mid-America, headquartered in Nashville, Tennessee. They own 10 properties here in my metro area, Greenville, Spartanburg market. Terrific management team, a lot of experience, fortress balance sheet.

When I say fortress, I know that term is overused or misused, but look, A- rated balance sheet, that's a fortress balance sheet. The company worked really hard to get that cost of capital down and that A- rating validates that point.

I f you look at the company, you can see historically, they've been able to grow earnings every single year. And when I say earnings, I'm using adjusted funds from operations. So very, very stable, very predictable.

Again, going to Chuck Carnevale, again, earnings determine market price in the long run. This company right now, analysts are forecasting growth of 5%, 2%, and 7%, that's ‘23, ‘24, ‘25. So we definitely see earnings continuing to grow, dividend will continue to grow.

Let's go to my favorite cell tower REIT. Again, I mentioned there are three, American Tower, which by the way, I know it's confusing. American Tower invests in America and outside of America and Crown Castle only invests in America. And then there's the third player, CBAC.

Now we just wrote a deep dive on Seeking Alpha on Crown Castle and American Tower, mostly focused on Crown Castle because their earnings just came out. They actually did perform well. And we actually said the earnings were not going to perform well. We were projecting modest earnings for the company, in fact, negative earnings, which is, in fact, what they are – what analysts are forecasting for Crown Castle, negative earnings.

I like the company, it's a deep value play, but I like American Tower better because you also – you get deep value, plus you get a very high-quality company with, again, much better earnings profile than you get with Crown Castle.

The other thing I get with American Tower is data centers. I don't get that with Crown Castle. So you can take your pick. American Tower doesn't pay as high of a dividend, doesn't have a high of yield, but the payout ratio is much lower. Crown Castle's payout ratio is elevating, it's moving up. It'll probably hit 90% next year if analysts are correct with their forecast.

So I like American Tower, it's a much safer bet with a much better earnings profile and very good management team. Crown Castle does as well.

Moving on to my favorite data center REIT. Now, I want to highlight this. I'm not going to buy Digital Realty today. We got Digital Realty a hold. We had Digital Realty as a buy when there was a short sell, a short attack, maybe actually there's been multiple. We navigated through all of that. We had buys and strong buys on Digital Realty. Today, we've got a hold.

The company has actually moved into sound value. Obviously, artificial intelligence has been a catalyst for this sector, in this particular REIT. I like this REIT the best.

Again, let's go back to their earnings history. Very, very strong, stable earnings and dividend history. We think that will continue. We like the new management team. It's a younger management team and a younger Board, which we think there's also – shuffling is really good to have some from time to time within the Board and the management team.

BBB-rated company. Trading at pretty much a sound value, fair value today. So wouldn't go hand over fist with Digital. We're definitely going to continue to own it. We think it's got more room to run. Analysts are forecasting 6% growth in ‘24 and ‘25.

Now let's move over to Prologis. Prologis, I mentioned earlier, no need to go into that. They have really – their earnings was really good. Again, their same store numbers are excellent, their occupancy is excellent, development pipeline, A-rated balance sheet, so certainly can call that fortress. In terms of valuation, shares are trading at 22.2x. Their normal valuation is 27.9.

Now I know you may be asking yourself, what about normal? What is the new normal? I mean, obviously, we've got higher rates right now. That's absolutely true. And again, the best indicator of that is earnings. Now in the year 2023, analysts are estimating negative one earnings or growth in 2023. Same for 2024, but here's the thing.

When that development pipeline kicks out, hold on to your seatbelt. Growth for ‘25 is 20% growth, analysts forecast. So again, deep value pick. We know it's going to take some time.

And again, once rates pause, and this is the key word, I don't know when, I don't know when rates will pause, we'll probably have another one more rate increase. But at that point, I think we'll be moving into that pause category. And that's to me going to be the number one of the first catalysts we see. It's really going to start moving share prices in a big way.

I'm going to keep buying these companies as long as I can at these prices, because eventually, I do believe these earnings will continue to generate more dividend growth ahead for Prologis.

DS: People want to understand better, why do you look at the AFFO numbers of the last 10 years when the cost of capital was cheap from the interest rate rise? I think everybody's focused on that now.

So going into this new environment, maybe you could share some of the ways that you're thinking about the new interest rate environment and the cost of capital for these companies?

BT: Yeah. So, again, this is a great topic. And I want to go back to my career as a developer. So when I built back in the 1990s and early 2000s, and I would go build an Advance Auto Parts store. Typically back then, I don't know what rates are. I remember financing, one of my first stores at about, I think, the interest rate was 9% or 10%. And – but I always looked for that cost of capital. What is the bank going to charge me? What is the equity?

And by the way, I didn't put a lot of equity in the deal. So most of my cost of capital is where the bank would charge. But then you look at that going in cap rate or that yield on cost, and that's really critical. So whether you're buying a freestanding property, an apartment complex or developing, whatever you're doing, it’s – the name of the game is to – it's a spread investing business.

So you're absolutely right. The cost of capital is elevated and these cap rates are now catching up to the cost of capital. So we've got to see that these companies are growing accretively. They're able to generate positive earnings during this high interest rate environment, which we – which you point out and many people point out, these rates may continue for a while.

Nobody knows how long these rates are going to hold up. I mean, if we – obviously, if a recession would cause rates to come down, but we can't bet on a recession. If we had to bet on a recession, we would have lost already, because everybody was thinking, recession is going to hit.

And so I think we've got to look at it along those perspective of, we look for those companies and try to stress test, Daniel, the companies that are able to generate earnings growth in utilizing their cost of capital they have right now and what are their investments spread today and how are they going to be able to create earnings going forward?

Again, that's where I think the real key is. But in terms of valuation, using those valuation numbers, what I try to do, and I didn't have time to go through this on this call, but I also look at what did the company trade at 10 years ago?

I mean, I don't really believe in this. I mean, one metric is let's look at their average or normal valuation over the last 10 years, but then you've got to also factor out the COVID environment, because there was a lot of euphoria. People were ready to get out of the house and get into real estate. So all of a sudden, share shot up in just about every REIT. That's why in 2021, we saw what it was.

So what is the new norm? I think that is the key question. What is the new norm in valuation? And I wrote a recent article , Daniel, called, The Answer Is 8. And what's really interesting about that article, I was actually alluding to an article that I read when I was in college. And it was written in 1970, and it was called The Answer Is 9 .

And it was written about a Harvard professor who was teaching a class. And what he would do, he put up number 9 on the screen, on the chalkboard and all the students were looking out and saying, “What does that mean?” He said that is going to be the answer on your exam. That is the average cap rate for all property sectors back in that period of time.

And the more I think about it, I'm thinking, well, we're probably getting ready to move and back to that, I need to write the answer is 9, not 8, not 7. So cap rates are definitely moving up.

And I think now more important than ever, it's important to focus on quality management and quality balance sheets and quality real estate. Those companies can still navigate through this environment, whether it's another year or two years, I don't care. We're laser focused on those balance sheets right now because those balance sheets are going to be the key to unlock value.

And we've got to make sure these companies are able to continue to generate those positive investment spreads even in this environment we're in today. And again, at the end of the day, this is just real estate. I really feel like from a valuation perspective, we're just not – could it get cheaper?

Yes, it could get cheaper. But at some point, we're going to have normalization within most of those sectors. Office is a totally different category. We can save that one for another day.

DS: Yeah, there's a lot still to unpack. And I just want to take a second real quick and encourage everybody, Brad is offering everybody for the basic service of iREIT on Alpha right now the price is $49. That's only through this next month I think we agreed it'll run through Cyber Monday. So at the end of November, that is a limited time discount.

If you want to grab the full service is there if you want to get into that as well, which offers a whole different side of the platform where you're interacting with Brad and being able to ask questions and the analysts, I mean, everything is just included, a wealth of information. Check out iREIT on Alpha.

Brad Thomas, thank you so much. Anything else you want to say before we go?

BT: No, just thank you again, Daniel. Thanks, Seeking Alpha. Again, it's a great platform. And 13 years, I'm looking forward to another 13 years, God willing.

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