ADC - Slow And Steady Wins The Race

2023-12-16 07:00:00 ET

Summary

• Today REITs rallied after The Federal Reserve held interest rates steady and signaled inflation had improved more rapidly than anticipated, opening the door to rate cuts next year.
• Perhaps this one day move signals the opportunity set for a REIT Rally in 2024?
• In this article, I will highlight three REITs that I'm buying.

We all know the Magnificent Seven by now. Alphabet/Google ( GOOGL ). Amazon ( AMZN ). Apple ( AAPL ). Meta Platforms ( META ). Microsoft ( MSFT ). Nvidia ( NVDA ). Tesla ( TSLA ).

Most have been intensely influential companies for years now. Even decades. But gosh, has 2023 treated big tech well.

Last month, I quoted multiple news outlets saying how, without the seven’s AI-infused enthusiasm, the S&P 500 (SP500) would be about flat this year. As is, though, here’s where it’s at:

And where it’s at is up. A lot.

Every market analyst under the sun has commented on this development repeatedly this year, me included. But Morningstar had a very different take on Tuesday, December 12, writing:

“Monday marked the first time since 2012 that the Nasdaq 100 managed a positive close with all Magnificent Seven names… closing in the red.

“It could be nothing. But our call of the day from The Macro Tourist’s Kevin Muir has an explanation as he warns selling of those heavyweights may just be getting started.”

Interested?

I was, which is why I kept reading how:

“As Muir explains, the Nasdaq over the weekend announced final changes for its Nasdaq 100 rebalance or “reconstitution” that will kick in with Friday’s option expiration. The committee has recently flagged the Magnificent 7 groups’ heavy concentration and its methods of dealing with that, says Muir.”

And that, the article recounts, could lead to a very interesting 2024.

The Full Big Tech Rebalancing Story

Rebalancing itself isn’t anything new.

Indices do it every quarter.

What is new is such overwhelming dominance by a mere handful of stocks. Which is why the Nasdaq instituted a “special” round several months ago.

Morningstar adds that:

“Those company weights are capped at 20% of the index if they exceed 24%, with the combined weight of those exceeding 4.5% capped at 40% if it exceeds 48%... Muir flagged Barclays, which noted a ‘considerable surprise from the rebalance, saying those big stocks saw ‘aggregate downweights translating to roughly -$13bn in supply, in contrast with the anticipation according to index methodology that those names would see meaningful ($17 billion previously projected to buy) upweights.’”

The result, according to Muir, is a “monster” sale in the making.

It has to divest itself of:

• $4.7 billion of Apple stock
• $4.1 billion in Microsoft
• $2.26 billion in Amazon
• $2.51 billion in combined Alphabet A and C shares
• $1.76 billion in Nvidia
• $135 million in Meta.

Barclays will actually have to purchase $2.9 billion of Tesla, “but the bank notes $5.67 billion in buying was expected.”

It isn’t alone in this either, with JPMorgan’s estimated figures being roughly equivalent. And Muir expects more to follow.

As a result, he thinks “we will look back at this point as the start of [the Magnificent Seven’s] return to being much more normal performing stocks.”

If he’s right about that, then big tech is not the place to be in 2024, contrary to prevailing belief.

Of course, he could be wrong. I’m sure he’s a very smart guy, but even the smartest aren’t right every time.

Still, it is a cautionary view worth at least knowing about as you consider where to put your money… and where to avoid.

More Bad News for Big Tech

There were two other big tech stories that broke on Monday:

• Google losing its battle against Epic Games, which puts its $200 billion app store business model in jeopardy
• Oracle ( ORCL ) – not a Magnificent Seven member, but an honorary mention nonetheless – reporting less-than-anticipated quarterly cloud sales and an unimpressive forecast.

The latter’s stock price had dropped over 10% by noon on Tuesday.

Once again, I’m not saying big tech’s run is definitely over. Let’s turn back to that chart I introduced in the beginning of the S&P 500’s big-tech fueled rise:

It looked like it was in freefall in October – only to make one of the most fast and furious monthly rebounds the market has ever seen. However…

To quote Morgan Stanley from December 6 (emphasis in original):

“ Investors appear complacent. The CBOE Volatility Index, or VIX, a measure of implied market volatility, has plummeted to cycle lows not seen since January 2020. And options market data shows relatively low ‘put/call ratios,’ a widely used gauge of market sentiment, indicating there’s little interest among investors in trying to protect portfolios against declines.”

After November, they’ve got dollar signs in their eyes.

I understand precisely where they’re coming from. Because, hey, I like gains too!

Who doesn’t?

But I want to keep my gains, which is why I’m in full agreement with Morgan Stanley’s push to look “for investments that provide yield and companies that have quality cashflows and realistic earnings goals.”

Of course, I’m always onboard with that conclusion. I’m in no hurry to make money if that money is at constant risk of evaporating.

It comes down to this: The “enjoy your retirement” race is one I aim to win. That’s why I love strong, dividend-paying real estate investment trusts (REITs) like the following…

Agree Realty Corporation ( ADC )

Agree Realty is a real estate investment trust (“REIT”) that specializes in the acquisition and development of commercial properties which are net-leased to leading omni-channel retail tenants.

ADC owns or has an ownership interest in 2,084 commercial properties which are located in 49 states and cover approximately 43.2 million SF of gross leasable space.

ADC has best-in-class tenants which include top retailers such as Walmart, Kroger, Lowe’s, Home Depot, Sherwin-Williams, and Dollar General.

Their top tenant (Walmart) makes up approximately 6.2% of ADC’s annualized base rent (“ABR”) and their top 20 tenants combined make up roughly 66% of their ABR.

Agree Realty has one of the highest quality tenant rosters in the net-lease space and receives approximately 69% of their ABR from investment-grade retail tenants.

ADC targets retail properties used in industries that are resistant to ecommerce and recessions including convenience stores, dollar stores, auto part stores, auto service, and grocery stores.

As a percentage of its base rent, ADC’s largest retail sector is grocery stores which makes up roughly 9.7%, followed by home improvement and auto service, which make up 8.6% and 8.5% of their base rent respectively.

Agree Realty’s net-lease portfolio is 99.7% leased and has a weighted average lease term (“WALT”) of approximately 8.6 years as of their most recent update.

Agree Realty has an investment-grade balance sheet with a BBB credit rating and excellent debt metrics, including a long-term debt to capital ratio of 30.42%, a fixed charge coverage ratio of 5.1x, and a net debt to EBITDA of 4.5x.

Additionally, ADC has a weighted average term to maturity of almost 7 years and no significant debt maturities until 2028.

At the end of the third quarter , ADC had $6.4 million of cash and $951.0 million available to them under their revolving credit facility for total liquidity of $957.4 million.

In November Agree Realty declared a monthly dividend of $0.247 per share, or $2.964 annualized, which represents an almost 3% increase over the annualized dividend amount of $2.88 per share paid in the fourth quarter of 2022.

ADC has had a very consistent dividend track record since 1994 when the company filed its initial public offering (“IPO”).

The net-lease REIT originally paid a quarterly dividend before moving to a monthly dividend. From 1994 to 2020 ADC paid a quarterly dividend for 107 consecutive quarters. The chart below shows the quarterly dividend paid from 2013 to 2020.

In 2021 ADC changed its dividend policy to make monthly distributions, and since that time the company has paid 35 consecutive monthly dividends .

Over the last 10 years ADC has had an adjusted funds from operations (“AFFO”) growth rate of 5.52% and an average dividend growth rate of 5.79%.

While ADC and REITs in general do not have hyper growth rates like Nvidia or Tesla, this net-lease REIT has been very consistent, growing its AFFO per share each year from 2013 to 2022.

Analysts expect AFFO per share to increase by 4% in 2023, and then increase by 3% and 2% in the years 2024 and 2025 respectively.

Similarly, ADC has increased its dividend each year since 2013, even during the pandemic in 2020.

ADC pays a 5.00% dividend yield that is well covered with an AFFO payout ratio of 73.24% and currently trades at a P/AFFO of 14.98x, compared to their 10-year average AFFO multiple of 17.76x.

(Note: I have an interview on Friday, December 15th with ADC's CEO, Joey Agree.)

We rate Agree Realty a Buy.

Rexford Industrial Realty, Inc. ( REXR )

Rexford Industrial is a REIT that specializes in the acquisition, ownership, redevelopment, and operation of industrial assets in Southern California (“SoCal”) infill markets.

REXR defines infill markets as high-barrier-to-entry markets with a lack of developable land and growing population centers with a high concentration of jobs, housing, residents, and consumer spending.

Investing in industrial properties located exclusively in SoCal infill markets is a critical part of REXR’s core strategy.

SoCal has some of the most attractive industrial markets in the world due to the size of its economy and its natural supply constraints. SoCal is the largest regional economy in the U.S., and by square feet, it is the fourth largest industrial market in the world.

To put it in perspective, when measured by square feet, the SoCal industrial market is larger than any other global market except for the entire countries of China, Japan, and the United States.

Furthermore, within the U.S., the SoCal industrial market represents approximately the same economic value as the next 4 to 5 largest markets within the U.S. combined.

REXR’s stated goal is to generate attractive returns by providing investors with superior access to industrial properties within SoCal infill markets. REXR’s portfolio is comprised of 371 properties totaling 45.0 million rentable square feet (“RSF”) with an average same property portfolio occupancy of 97.8% as of the end of the third quarter.

Within the SoCal infill market, REXR operates in 5 major sub-markets including Los Angeles, Orange, San Diego, Inland Empire West, and Ventura.

Los Angeles is their largest sub-market with 223 properties totaling roughly 25 million square feet, which represents approximately 55% of the total square footage in REXR’s portfolio.

Rexford has an investment grade balance sheet with a BBB+ credit rating from S&P Global. The company has a conservative amount of leverage with a net debt to adjusted EBITDA of 3.7x, a long-term debt to capital ratio of 24.23%, and an EBITDA to interest expense ratio of 7.92x.

REXR’s debt is 100% fixed rate with a weighted average interest rate of 3.6% and a weighted average term to maturity of 4.8 years.

Additionally, they have approximately $1.5 billion in liquidity and no material debt maturities until 2026 when including REXR’s extension options.

Since 2016, Rexford Industrial has delivered superior growth in its AFFO and its dividend with an average AFFO growth rate of 14.57% and an average dividend growth rate of 14.05%.

Analysts expect continued high growth with AFFO per share projected to increase by 16% in 2024 and 19% in 2025.

REXR is in the enviable position of having a lock on some of the most critical industrial real estate in SoCal.

Given the size of the SoCal economy and the scarcity of supply within the region, REXR enjoys some of the best releasing spreads in the industry.

In the third quarter, comparable rental rates for new and renewal leases increased by 51.4% on a cash basis. This enables REXR to generate internal growth as in-place leases convert to market rates. The conversion of below market leases drives internal growth for REXR without the need to raise debt or equity capital.

This industrial powerhouse pays a 2.88% dividend yield that is well covered with an AFFO payout ratio of 80.25% and trades at a P/AFFO of 30.79x, compared to its average AFFO multiple of 38.95x.

We rate Rexford Industrial a Strong Buy.

VICI Properties Inc. ( VICI )

VICI is a triple-net lease REIT that invests in experiential real estate with one of the largest portfolios of gaming, hospitality, and entertainment destinations.

If you are looking to invest in trophy properties, look no further, as VICI owns some of the most iconic trophy properties, many of which are on the Las Vegas Strip. Some of VICI’s more notable properties include:

• Caesars Palace Las Vegas
• The Mirage
• Harrah’s Las Vegas
• The Venetian Resort
• Excalibur
• Mandalay Bay, and
• MGM Grand.

VICI owns 92 experiential assets covering approximately 125 million square feet across 26 states and Canada, which consist of 54 gaming facilities and 38 non-gaming experiential properties.

Their gaming properties contain approximately 4.2 million SF of gaming space and feature more than 60,000 hotel rooms and roughly 500 restaurants, nightclubs, bars, and sportsbooks.

VICI’s 38 non-gaming experiential properties consists of bowling entertainment centers they recently acquired in a sale-leaseback (“SLB”) transaction with Bowlero ( BOWL ).

To round it all off, VICI also owns 4 championship golf courses located in Nevada, Mississippi, and Indiana, and approximately 33 acres of developable land next to the Las Vegas Strip.

At the end of the third quarter, VICI’s portfolio had a 100% occupancy rate and a WALT of 41.5 years when factoring in tenant renewal options.

2022 was a hallmark year for VICI, as it achieved S&P 500 (SP500) inclusion and an investment-grade credit rating. VICI is currently rated BBB- by S&P Global and Fitch and Ba1 by Moody’s.

They have solid debt metrics including a net leverage ratio (net debt / adj EBITDA) of 5.7x., a long-term debt to capital ratio of 42.02%, and an EBITDA to interest expense ratio of 4.07x.

Additionally, VICI’s debt is 83% unsecured, 99% fixed rate, and has a weighted average term to maturity of 6.1 years.

At the end of the third quarter, VICI had approximately $3.7 billion in liquidity, which consisted of $510.9 million in cash and equivalents, approximately $2.3 billion available to them under their revolving credit facility, and an estimated $807.2 million in net proceeds related to an outstanding forward sale agreement.

VICI doesn’t have as much history to go on as the companies previously discussed, but since its IPO in 2018, the company has delivered positive AFFO growth in each year.

Since 2019 VICI has had an average AFFO growth rate of 7.22% and an average dividend growth rate of 10.80%.

Analysts expect AFFO per share to increase by 11% in the current year, and then increase by 5% and 4% in the years 2024 and 2025 respectively.

VICI pays a 5.39% dividend yield that is well covered with an AFFO payout ratio of 77.72% and trades at a P/AFFO of 14.40x, compared to its average AFFO multiple of 16.29x.

We rate VICI Properties a Buy.

In Closing

Today, REITs rallied after The Federal Reserve held interest rates steady and signaled inflation had improved more rapidly than anticipated, opening the door to rate cuts next year.

Perhaps this one-day move signals the opportunity set for a REIT Rally in 2024?

As for me, I will stick with my tried-and-true plan of buying the best quality REITs with a definitive margin of safety.

There's absolutely no need to be a market timer.

After all, I like making money while I sleep.

Be patient.

Be disciplined.

Be humble.

Slow and steady wins the race.

As always, thank you for reading and Happy Holidays!

For further details see:

Slow And Steady Wins The Race