GMRE - Buy The Dip: 2 REITs Getting Way Too Cheap

2023-09-25 08:05:00 ET

Summary

• REITs are crashing hard right now.
• That's despite posting good quarterly results.
• We highlight two opportunities to buy the dip.

This is our fifth " buy-the-dip " article in less than 90 days.

That's rather unusual for us, but the market has been very volatile lately, and it has resulted in many investment opportunities.

REIT ( VNQ ) earnings season is now over and most of the news has been overwhelmingly positive. Rents keep growing at a good pace, which compensates for the rise in interest expense. Conservatively-financed REITs are still experiencing solid FFO per share growth, and even the more aggressively-financed REITs are able to maintain more or less stable FFO.

But the market does not seem to care.

The positive results coupled with negative price action make REITs compelling "buy-the-dip" opportunities. Of course, we cannot know how REITs or any stocks will perform over the short run, but today's valuations are starting to be reminiscent of the great financial crisis according to a recent study by the investment firm Janus Henderson. You can read it by clicking here.

Two of our holdings have recently dropped more than the rest and we bought the dip:

Safehold ( SAFE )

Safehold ( SAFE ) is the only REIT that specializes in ground lease investments.

In case you are not familiar with ground leases, we recommend that you watch the video below:

Ground leases are very sensitive to interest rates because their lease terms are up to 99 years long and the annual rent increases are fixed. This caused SAFE to sell off heavily in 2022/2023, but as inflation continues to cool down, we expect interest rates to eventually return to lower levels and this could lead to an epic recovery.

We discussed this in our recent Market Update and SAFE is arguably the best REIT to profit from this shift in market narrative.

Moreover, the company has recently announced a lot of good news, but despite that, its share price has kept on dipping lower:

• It closed its merger with iStar.
• It internalized its management.
• Moody's and Fitch put them a step closer to an A- credit rating.
• It secured a JV partner to access external equity and earn fees.
• It has made further progress on the monetization of caret units.
• It welcomed Michael Dell's family office as a new big investor.
• And finally, the company's CEO made the following comments and bought more shares himself:

We believe the current price of our shares is well below the intrinsic value of our business , and we will work to make that readily apparent as the business begins to expand again and market stabilize.

These purchases are very significant when you consider that he already has a lot of skin in the game. $40 million to be exact. This is the bulk of his net worth and he keeps buying more. That's how much he believes in the ground lease concept and we agree with him that it is likely to revolutionize the commercial real estate sector.

The business performed phenomenally well in the years prior to the crash of 2022/2023 and we think that as macro conditions normalize, things will get back to how they used to be.

Today, you have the chance to buy shares at a ~20% lower price than the CEO's latest purchases. We expect a doubling of the share price in the coming years and the 3.7% dividend yield should also be sustainable.

Global Medical REIT ( GMRE )

We initiated a position in GMRE back in October of 2022 after it had crashed by 60% for no good reason. Then shortly after, the share price rose by 50%, which prompted us to downgrade the stock, but since then, it has dropped right back to where it was in October.

This intense volatility is especially surprising coming from a REIT that invests in medical office buildings. Some investors perceive medical offices as " the safest commercial real estate investments " because your tenants are doctors and their underlying business is recession-resistant. Besides, rent coverage ratios are also typically high at around 3-5x. In comparison, senior housing facilities typically operate with just a 1.2-1.5x rent coverage ratio, leaving little margin of safety.

Last October, GMRE's sell-off was mainly due to a tenant bankruptcy. Pipeline Health announced its bankruptcy on October 3rd and this announcement as well as its anticipation were brutal on the stock. But shortly after, the market came back to its senses and recognized that this was a small tenant, and since the properties were profitable, the tenant would likely accept the lease in bankruptcy, and that's precisely what they did. The problem with this tenant was that it was operating some other properties that weren't profitable and on top of that it had too much leverage. It was forced into bankruptcy to get out of the unprofitable leases, which weren't those of GMRE.

Today, we are again faced with a similar situation.

Another one of GMRE's tenants, Envision, has filed for bankruptcy. This was announced already a while back but it appears to still affect its market sentiment.

But once more, this is a small tenant, even smaller than Pipeline. GMRE reports its top 10 tenants and it is not part of it, which means that it represents less than 2% of its revenue:

Moreover, most of GMRE's properties are highly profitable since they enjoy a 4x rent coverage ratio. The management has a great underwriting track record and so far, it has been able to resolve such tenant issues with very favorable outcomes.

Once more, it seems that Envision's issues are not related to GMRE's properties, but rather its debt. It is a private-equity-backed leveraged buyout and its press release states that it filed for bankruptcy protection to restructure its debt obligations. Ultimately, this could even benefit GMRE if its lease is accepted in court and the company emerges as a safer, more conservatively leveraged tenant.

It, of course, also doesn't help that GMRE is a small company with a bit more leverage than average. That's going to exaggerate the impact of any negative news on its stock.

But ignoring this one tenant bankruptcy, the company's latest results have been quite positive:

• The portfolio occupancy rate has kept rising and is now at 97%.
• The management is taking all the right steps: they did not issue any shares on their ATM, paused new acquisitions, and turned their focus to organic growth since the spreads aren't attractive.
• They are selling some properties to unlock value, pay off variable rate debt, reinvest at a positive spread, and prove to the market that their shares are discounted.
• They managed to privately issue some OP units at $11 per share which is 15% higher than today's share price.
• Rents keep rising by 2.1% annually according to their contractual lease escalations.

Yet, the shares are now again priced at a 9.3% dividend yield, about 9x FFO, and an estimated 35% discount to NAV. It goes without saying that there is no such thing as a perfectly safe 9.3% dividend yield, but the risk-to-reward is very compelling here.

Bottom Line

Seeing red colors may not feel pleasant at the moment, but it is thanks to this red color that we will earn even larger gains in the coming years.

We will ultimately profit from this short-term volatility just like we did in the aftermath of the pandemic.

For further details see: