2023-04-03 08:00:00 ET
Summary
- A FROG is a REIT that shows a Fast Rate of Growth and a strong balance sheet.
- This article discusses how to identify a FROG, and lists all the FROGs as we head deeper into 2023.
- We also give attention to several near-FROGs, as well as some Tadpoles that would be FROGs, if only they were a little larger.
- Finally, we discuss how the FROG-hunting mindset differs from the more common REIT investment approach.
There are two kinds of real estate investment trusts, or REITs, that investors are constantly seeking. One is COWs (Cash Only Wanted), where the object of the game is to milk the company for its safe, above-average dividend Yield. The other is FROGs (Fast Rate of Growth), where the object of the game is to maximize total return by maximizing share price Gain.
Historically, since the invention of REITs about 60 years ago, the average Yield on a REIT is about 4%, (give or take a fraction of a point), and the average total return is about 12%, so the average share price Gain is about 8%.
Total Return = Gain + Yield.
The Yield you sign up for tends to be the Yield you get, at least in the first year. Gain is much less predictable, but there is no limit on how high the Gain can go. In a good year, a well-chosen FROG can gain 30% or more. That is many years' worth of dividends!
Yield and Gain tend to move in opposite directions. As Hoya Capital says in a seminal article ,
The highest-yielding REITs have persistently underperformed while the lowest-yielding REITs have delivered outperformance by roughly 3.6% per year over the REIT average.
So higher Yield usually means lower Gain, and vice-versa. Otherwise, REIT investing would be easy. We would just pick the REITs with the highest Yield.
As a REIT investor, you can focus on Yield, to maximize your dividend cash stream, and that's what many professional REIT investors do . But they usually sacrifice a significant measure of Gain in the process, and end up with inferior total returns.
2022 Was an Anomaly
Hunting FROGs gave me nice results for the first few years. Last year was an exception. Thanks to the spike in inflation at the start of 2022, yield-dependent investors stampeded to high yield securities, dumping their shares of healthy, lower-yielding companies. Thus, 2022 was one of the rare years in which lower Yield also meant lower Gain. 2022 was brutal to REITs in general, and even a little worse for FROGs.
Through December 26 of last year, the Equity REIT Index was down (-28.68)%. Nearly all the major indices lost ground last year, but not as badly. By comparison, the S&P 500 shed (-19.38)%, and the Dow only (-8.64)%. Only crude oil, commodities, and the U.S. dollar gained ground.
Hoya Capital Income Builder
The list of FROGs I published going into last year is shown below, along with their 2022 returns.
2021 | 2022 | Yield | Gain | Total | |
Company | Close | Close | 2022 | 2022 | Return |
( IIPR ) Innovative Industrial Properties | $262.91 | 101.35 | 2.70 | -61.45 | -58.75 |
( EPRT ) Essential Properties | $28.83 | 23.47 | 3.73 | -18.59 | -14.86 |
( PLD ) Prologis | $168.36 | 112.73 | 1.88 | -33.04 | -31.17 |
( LSI ) Life Storage | $153.18 | 98.50 | 2.72 | -35.70 | -32.98 |
( REXR ) Rexford Industrial | $81.11 | $54.64 | 1.55 | -32.63 | -31.08 |
( EGP ) EastGroup Properties | $227.85 | $148.06 | 2.06 | -35.02 | -32.96 |
( INVH ) Invitation Homes | $45.34 | $29.64 | 1.94 | -34.63 | -32.69 |
( AMH ) American Homes 4 Rent | $43.61 | $30.14 | 1.65 | -30.89 | -29.24 |
( TRNO ) Terreno | $85.29 | $56.87 | 1.74 | -33.32 | -31.59 |
( CUBE ) CubeSmart | $56.91 | $40.25 | 3.13 | -29.27 | -26.15 |
( ARE ) Alexandria Real Estate | $222.96 | $145.67 | 2.12 | -34.67 | -32.55 |
( STAG ) STAG Industrial | $47.96 | $32.31 | 3.04 | -32.63 | -29.59 |
( SUI ) Sun Communities | $209.97 | $143.00 | 1.68 | -31.90 | -30.22 |
( VICI ) VICI Properties | $30.11 | $32.40 | 4.98 | 7.61 | 12.59 |
( DLR ) Digital Realty | $176.87 | 100.27 | 2.76 | -43.31 | -40.55 |
( MPW ) Medical Properties Trust | $23.63 | $11.14 | 4.91 | -52.86 | -47.95 |
Average | $116.56 | $72.53 | 2.66 | -33.27 | -30.61 |
Source: MarketWatch.com, Seeking Alpha Premium, and author calculations.
The FROGs as a group slightly underperformed the dismal (-28.68)% posted by the Equity REIT Index, returning an average of (-30.61)%. This underperformance came in spite of stellar operating results for most of these companies, which continued their rapid growth in revenues, cash flow, and dividends.
Only VICI, CUBE, and EPRT outperformed, and that is no accident. They were 3 of the 4 highest-yielding FROGs when 2022 began.
How do you identify a FROG?
That question is answered in detail in my December 2021 article . For now, suffice it to say, you can do it with just 14 commonly available data points and a few simple calculations in a homemade spreadsheet. You are looking for 6 key numbers:
- Funds From Operations per share ((FFO)) growth rate (at least 10%, preferably 20%)
- Total Cash From Operations ((TCFO)) growth rate (same levels as FFO growth)
- Liquidity ratio (Assets/Liabilities) (at least 1.66, preferably 2.0)
- Dividend growth rate (the faster, the better. Average is currently 9.4%)
- Market cap (at least $1.4 billion, with sweet spot $4-$10 billion)
- Price Gain (the bigger, the better).
Once you have identified the REITs that pass the criteria above, add their 3-year Price Gain CAGR to their dividend score (which combines current Yield with dividend growth rate, projecting the Yield on cost 3 years from now) to arrive at a Modeled Return. If that Modeled Return exceeds the 3-year total return for the Vanguard Real Estate ETF ( VNQ ) (currently 8.87), then the company is a FROG. The more the Modeled Return exceeds the VNQ's return, the better the chance the REIT in question will outperform in the coming year.
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Welcome To The FROG Pond, 2023
Here are the 17 REITs that currently meet or beat all the above-listed criteria, in order by Modeled Return:
Company | Price Grwth | FFO Grwth | TCFO Grwth | Liq. Ratio | Modeled Return |
VICI Properties ( VICI ) | 24.9 | 17.6 | 41.8 | 2.40 | 32.9 |
CubeSmart ( CUBE ) | 19.1 | 16.6 | 21.2 | 1.81 | 25.5 |
Essential Properties ( EPRT ) | 17.8 | 10.6 | 33.3 | 2.65 | 24.2 |
Weyerhaeuser ( WY ) | 18.6 | 16.6 | 43.1 | 2.73 | 22.8 |
PotlatchDeltic ( PCH ) | 17.0 | 25.6 | 52.4 | 2.76 | 21.6 |
Independence Realty ( IRT ) | 19.3 | 17.3 | 49.3 | 2.23 | 21.6 |
Public Storage ( PSA ) | 14.4 | 11.6 | 14.7 | 2.35 | 21.2 |
First Industrial ( FR ) | 16.8 | 9.9 | 18.7 | 1.99 | 20.8 |
American Homes ( AMH ) | 8.8 | 12.9 | 13.3 | 2.14 | 19.9 |
EastGroup Prop. ( EGP ) | 14.8 | 12.7 | 17.4 | 1.94 | 19.8 |
Invitation Homes ( INVH ) | 12.4 | 11.2 | 15.7 | 2.25 | 18.7 |
Prologis ( PLD ) | 13.9 | 15.0 | 22.2 | 2.54 | 17.8 |
Rexford Industr. ( REXR ) | 12.9 | 21.4 | 32.8 | 3.43 | 17.6 |
Mid-America Apartment ( MAA ) | 10.0 | 13.2 | 10.7 | 2.16 | 16.0 |
Terreno Realty ( TRNO ) | 9.2 | 16.9 | 14.6 | 3.38 | 13.2 |
Camden Property ( CPT ) | 5.3 | 12.3 | 10.3 | 2.15 | 10.6 |
Innovative Industrial Properties ( IIPR ) | (-2.1) | 55.1 | 73.3 | 5.33 | 10.3 |
Source: Hoya Capital Income Builder, TD Ameritrade, and MarketWatch .
(Price Gain and TCFO Growth = 3-year CAGR. FFO Growth = per-share 3-year simple average).
All these companies have made investors money over the past 3 years. The new King of the FROGs is VICI Properties, a casino REIT.
This ends the two-year reign of cannabis REIT Innovative Industrial Properties. Despite IIPR's spectacular plunge in share price caused by concerns about tenant solvency, IIPR remains a FROG, however. Its 3-year FFO per share growth rate has moderated, as it was bound to, but still comes in at a sizzling 55.1%, and its extraordinary dividend growth rate kept the company in the FROG pond, albeit in last place.
New to the list this year are timber companies WY and PCH; apartment landlords IRT, MAA, and CPT; storage company PSA; and industrial FR. Gone are Life Storage ( LSI ), Alexandria ( ARE ), STAG Industrial ( STAG ), Sun Communities ( SUI ), Digital Realty ( DLR ), and Medical Properties Trust ( MPW ). This is the largest annual turnover the Frog Pond has seen in its brief history.
Near FROGs
Companies that nearly made this list this year include:
- Realty Income ( O ), which failed only on FFO growth rate, at 7.60%
- Equinix ( EQIX ), which narrowly missed on Liquidity at 1.61, and on Modeled Return at 7.34
- Agree Realty ( ADC ), which failed on FFO growth rate at 8.50%, and on Modeled Return at 7.87.
- Rayonier ( RYN ), which failed only on TCFO growth, at 7.92%.
- Sun Communities ( SUI ) and Postal Realty ( PSTL ), which failed only on Modeled Return, at 5.93 and 4.29, respectively.
Tadpoles
There are 3 companies that qualify as FROGs in every respect except size. Since small-cap REITs fight an uphill battle with cost of capital, a company must cross the $1.4 billion market cap threshold to be considered a full-fledged FROG.
If a fast-growing company with a strong balance sheet sports a market cap under $1.4 billion, then I call it a Tadpole. Tadpoles may merit an investment at a reduced allocation. There are 3 exciting Tadpoles this year:
The truth about price
Many investors, particularly COWhands, judge a REIT price by its Price/FFO ratio. I don't. "Cheap" REITs are usually cheap for a reason, and tend to stay cheap, while expensive REITs tend to stay expensive.
My definition of an overpriced REIT is one that underperforms the market. My definition of an underpriced REIT is one that outperforms the market. Outperformers usually live above the average P/FFO ratio, ironically, which currently resides at about 17.4x. (Only 6 of this year's 17 FROGs sell below that level.) Although price matters, bargain hunting is usually self-defeating, if you are investing for total return.
However, it is prudent to keep an eye on the average P/FFO for REITs in general. Near the end of 2021, that number had climbed to 26.2, much higher than its usual 18 - 20 range. That portended a sell-off, not just in FROGs, but in REITs across the board.
Some FROGs sport unmistakably high P/FFO ratios. This is usually because their growth prospects are so exceptionally strong. David Gardner, the legendary growth stock investor of the Motley Fool, says it is common for great growth stocks to be perceived as "overpriced." If you go along with the crowd and avoid such stocks, you often miss out on spectacular returns.
Above average in dividend Growth, not dividend Yield
Because of their rapid growth in FFO and cash flow, FROGs tend to grow their dividends at above-average rates. Yield at purchase is usually the Yield you get for the first year. After that, dividend growth can dramatically influence your Yield on Cost, which is the Yield you actually experience as an investor.
To illustrate this, here is an extreme example. Innovative Industrial Properties sported a Yield at purchase of just 3.0% a few years ago, and in late 2021, its Yield at purchase was still an uninspiring 2.34%. But its 4-year dividend growth rate was a spectacular 81.74%. Shares bought at $45 with a 3.0% yield in 2017 yielded a whopping 13.33% on cost by late 2021. Thus, many FROGs begin with below-average dividend Yield at purchase, but quickly close the gap with superior dividend Growth. (Though rarely as fast as IIPR does!)
Similarly, since IIPR has raised its dividend further, in spite of a difficult 2022, shares are currently yielding 9.66%, even at purchase.
FROGs did especially well in 2020 , another recent year in which there was a deep selloff. In part, this was because FROGs rarely cut their dividends. While most REITs slashed to the bone in 2020, most FROGs actually increased their dividends.
So with all that in mind, here is a breakdown of our FROGs, showing market cap (billions), dividend growth rate, and P/FFO ratio.
VICI | $31.7 B | 4.8% | 7.5% | 16.9 |
CUBE | $10.6 B | 4.3% | 13.8% | 18.1 |
EPRT | $3.8 B | 4.5% | 5.8% | 15.6 |
WY | $21.9 B | 2.5% | 14.2% | 17.7 |
PCH | $3.9 B | 3.7% | 3.8% | 15.9 |
IRT | $3.5 B | 3.0% | (-3.8)% | 14.7 |
PSA | $52.4 B | 4.0% | 14.5% | 20.7 |
FR | $6.8 B | 2.4% | 8.6% | 23.0 |
AMH | $11.0 B | 2.8% | 53.3% | 20.3 |
EGP | $7.1 B | 3.1% | 16.5% | 23.4 |
INVH | $18.7 B | 3.4% | 20.1% | 18.1 |
PLD | $110.0 B | 2.8% | 14.5% | 23.9 |
REXR | $11.4 B | 2.6% | 20.9% | 29.7 |
MAA | $17.1 B | 3.7% | 11.6% | 17.7 |
TRNO | $5.1 B | 2.5% | 12.6% | 32.1 |
CPT | $11.0 B | 3.8% | 6.4% | 15.8 |
IIPR | $2.2 B | 9.6% | 17.2% | 9.9 |
FROG Median | $10.7 | 3.5% | 13.8% | 18.1 |
REIT average | -- | 3.9% | 9.4% | 17.4 |
Ticker | Market Cap | Yield | Div. Growth | P/FFO |
Source: Hoya Capital Income Builder and TD Ameritrade.
You might notice that the average rate of dividend growth for these 16 FROGs is 13.8%, which is considerably faster than the REIT average of 9.4%. Because of this, FROGs are often better dividend payers than they appear at first blush. Meanwhile, Yield at purchase is 3.5% for the FROGs, compared to 3.9% for the average REIT.
Note that just because a company is a FROG, that does not mean I will necessarily invest in it. This article does not constitute a Buy recommendation on every REIT listed here, and Modeled Return is not an attempt to predict total return. Not every REIT listed here will outperform the market in 2023 (probably), and I'm sure there are other REITs not listed here that will!
Investor's bottom line
How well FROGs do going forward depends on the conditions for growth stocks and commercial real estate in general. If inflation continues to outpace Yield, this inhibits Gain for the FROGs, and Fed interest rates higher than the Yield tend to attract investors into debt instruments. For the time being, growth is out of favor. But when it comes back into style, FROGs will leap to the front. In the meantime, the dividend income stream will likely fatten. RIBBIT!
For further details see:
17 Fast-Growing REITs With 17 Strong Balance Sheets