WSR - Whitestone REIT: An Undervalued REIT With A 4.9% Yield

2023-09-06 08:28:02 ET

Summary

• Whitestone REIT focuses on open-air retail centers in Texas and Arizona, offering investors exposure to vibrant real estate markets.
• The trust has opportunities for growth through releasing activity, which can increase net operating income and funds from operations.
• Whitestone REIT has an attractive valuation based on funds from operations and offers a sustainable 5% dividend.

Whitestone REIT (WSR) is a well-managed and growing real estate investment trust that is focused on open-air retail centers in a small number of core markets in Texas and Arizona. The trust's core focus on a few markets translates into considerable concentration risk, but it also offers investors the opportunity to invest in very vibrant real estate markets.

Whitestone REIT has an opportunity to grow its net operating income as well as funds from operations through a number of measures, but particularly through releasing activity.

Furthermore, Whitestone REIT has an attractive valuation based on funds from operations and offers investors a well-covered 5% dividend that I view as sustainable.

Whitestone REIT's Portfolio Is Concentrated In A Small Number Of Growth Markets

As opposed to large-scale, nationally-presented REITs like Realty Income Corp. (O) or National Retail Properties Inc. (NNN) , Whitestone REIT is a small REIT with a focus on a small number of core markets such as Phoenix, Houston, Austin, or Dallas.

The trust's operating portfolio included 51 wholly-owned properties (leased to 1,466 tenants) with approximately 5.0 million square feet of gross leasable area and a total carrying value of $985.2 million.

In addition, Whitestone REIT owned five parcels of land with a carrying value of $21 million that are being held in the portfolio for future development. At the end of the second quarter, Whitestone REIT's portfolio was 93%.

What all the trust's core markets have in common is that they are major metropolitan areas that are growing and attracting a steady inflow of new residents. As such, these markets have the potential for above-average net operating income growth, which is driven by upside in occupancy as well as leasing activity.

Key To Net Operating Income Growth: Re-leasing Activity

There is one key lever here for Whitestone REIT to grow its net operating income as well as funds from operations in the long term.

Whitestone REIT exclusively invests in high-growth and high-income neighborhoods in Texas and Arizona and the trust, thus, has an opportunity to grow its net operating income and funds from operations organically through re-leasing activity.

Leasing spreads show the difference between old rents and new contractual rents after the property has either been released to a new tenant or a rental hike has taken place. Landlords in supply-constrained markets have robust pricing power and are capable of raising their rents more aggressively. Whitestone REIT's leasing spread in the second quarter was 18.7% and has consistently been in the double digits since 3Q-21.

Higher lease rates are a key driver for Whitestone REIT's net operating income. Whitestone REIT's operating portfolio produced $25.5 million in net operating income, reflecting 4% YoY growth in the second quarter.

Whitestone REIT sees same-store net operating income growth of 3.5% in 2023, which gives the REIT an advantage over other REITs with broader geographical footprints and larger operating portfolios.

For example, Whitestone REIT's same-store net operating income projection is more than double that of Kimco Realty Corporation (KIM), which expects a relatively modest increase of 1.5% in 2023. Same-store rents are used to ensure comparability in key metrics for REITs since they often make acquisitions to grow their portfolios.

Funds From Operations Guidance And Multiple, Implied Pay-Out Ratio

Whitestone REIT expects to produce between $0.90 and $0.94 per share in funds from operations in 2023. With a present stock price of $9.95, the REIT's valuation implies a fund from operations multiple of 10.8x.

Kimco Realty expects $1.55 to $1.57 per share in funds from operations, and with a present stock price of $18.88, the trust's funds from operations potential is valued at a 12.1x multiple. Realty Income, a nationally-positioned retail REIT, is valued at 13.7x (normalized) funds from operations.

With a midpoint funds from operations guidance of $0.92 per share and a present $0.04 per share monthly dividend, Whitestone REIT is on track to pay out a little more than half of the trust's funds from operations. The implied pay-out ratio is 52%, which indicates that Whitestone REIT should be able to maintain its dividend in the near future.

Whitestone REIT's Risk Profile

Whitestone REIT is a small REIT with concentrated exposure in a very small number of real estate markets, which comes with a certain amount of concentration risk that REITs can easily diversify away.

Put differently, smaller and less-diversified trusts have considerably more downside risk if something goes wrong in their core markets. However, they also have more upside potential than larger REITs and robust releasing activity could thus have a stronger impact on Whitestone REIT's total net operating income.

Realty Income, for example, has more than 13K properties in its real estate portfolio and has a presence across the United States. With such a broadly diversified portfolio, Realty Income, or any other nationally operating trust, has a higher ability to offset declines in local markets.

With a portfolio of just about 51 properties, Whitestone REIT is not only much more concentrated, but it only needs to make 1-2 acquisitions to lift its net operating income considerably. Realty Income sees 1.25% same-store rent growth in 2023, while Whitestone REIT is shooting for more than 3%.

Passive income investors also tend to value REITs with large, diversified real estate portfolios more during periods of market distress, which is when investors become more concerned with dividend safety than with upside potential.

Whitestone REIT suffered substantially more than Realty Income or National Retail Properties did during the Covid sell-off in 2020. Moving forward, I would expect Whitestone REIT to do exceptionally well during periods of economic expansion (a real estate boom in its core markets) and to suffer substantially more than Realty Income or National Retail Properties during a real estate recession.

My Conclusion

Whitestone REIT offers passive income investors not only a solid 5% dividend yield, which is covered by funds from operations, but also the potential for above-average net operating income and funds from operations growth (which in turn is driven by re-leasing activity) and a low funds from operations multiple relative to other retail-focused REITs.

Whitestone REIT is focused on a small number of core real estate markets, which translates to both risks and opportunities for passive income investors.

Since the trust only pays out a little more than half of its funds from operations, Whitestone REIT offers a safe dividend for passive income investors, in my view. Buy.

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