Summary
- Your personal portfolio should probably be filled with tried-and-true investments that can withstand both good times and bad.
- Yet, we have found that stocks that "fly under the radar" are offer well-positioned for growth over the long term.
- We will be adding a new small-cap REIT tracker to iREIT on Alpha.
They say "the best things come in small packages." But I have to somewhat disagree.
It's not that I have anything automatically against the "small" designation. I don't, as this article will easily prove.
It's the "best" part of that statement I take issue with. Because the truth is there are some enormous things out there that definitely deserve that designation.
I've put together my short list below, but I'm sure you can easily add to it:
- The Grand Canyon
- A brilliant sunset
- Your sports team winning the big game
- An ice-capped mountain
- The Great Wall of China
- Seeing a wild elephant up close and personal on a safari (something I've never experienced)
- The ocean (any ocean)
- The Great Pyramid of Giza
- The Eiffel Tower (which I have actually seen in person).
How can you compare to any of those? I warrant you can't.
Then again, as any parent can tell you after holding their impossibly little newborn for the first time… small can be pretty amazing too. Even awe-inspiring. And definitely worthwhile. Those tiny little fingers and itty-bitty features are captivating.
(Though those relatively miniature lungs can pack quite the sound punch. There's no denying that.)
That's probably the most incredible example of small I can come up with, but there are a few runners-up. More than a few of which can be found in biology, such as the cell.
The Astounding Science of Small
Since I'm hardly a scientist, I'll let the National Library of Medicine do the talking about our biological breakdown. How:
"All living organisms are composed of cells, each no wider than a human hair. "
I'm going to stop right there. Because that's pretty tiny.
Yet we can get smaller than that still…
"Each of our cells contains the same complement of DNA constituting the human genome… The DNA sequence of every person's genome is the blueprint for his or her development from a single cell to a complex, integrated organism that is composed of more than 10 13 (10 million million) cells. Encoded in the DNA sequence are fundamental determinants of those mental capacities - learning, language, memory - essential to human culture."
How big is a strand of DNA, which is itself made up of smaller pieces? It's apparently 2.5 nanometers in diameter.
My source this time is the National Nanotechnology Initiative, which adds this information :
"Just how small is 'nano'? In the International System of Units, the prefix 'nano' means one-billionth, or 10-9; therefore one nanometer is one-billionth of a meter."
Then it adds these examples along with the already referenced DNA fact:
- A sheet of paper is about 100,000 nanometers thick.
- There are 25,400,000 nanometers in one inch.
- A human hair is approximately 80,000- 100,000 nanometers wide.
- A single gold atom is about a third of a nanometer in diameter.
- On a comparative scale, if the diameter of a marble was one nanometer, the diameter of the Earth would be about one meter.
- One nanometer is about as long as your fingernail grows in one second.
Knowing all that, how can you not be impressed with "small"?
Small-Cap Stocks Can Carry Big, Big Gains
In DNA's case, small remains small as far as I know. Again, I'm not a scientist, but I don't think it grows as we do.
But in the case of many other small wonders, they do, offering bigger wonders along the way. Take a seed, which is pretty pointless in its initial state. But under the proper conditions, it takes root, sprouts up, and develops until it's offering fruit or shade (and definitely oxygen) season after season.
In the same way, small-cap stocks can make a big impact over time. Better yet, they're cheap to pick up!
Again, this isn't to knock mid-cap or large-cap investments. As most of you know, my favorite real estate investment trust ("REIT") - and stock, bar none - is Realty Income Corporation ( O ). And that company has some weight to it.
It's been operating for 54 years, increased its dividend 119 times, declared 632 consecutive common stock monthly dividends… and owns 11,700 real estate properties. So it's no surprise that its market cap is 43.85 billion. That makes it a large-cap company.
Not a mega large-cap. There are plenty of stocks worth more. But Realty Income isn't a piker, all the same.
Your personal portfolio should probably be filled with tried-and-true investments like that. You want a solid core of assets to keep you moving forward in both good times and bad.
However, small-cap stocks like the ones I'm about to feature can offer amazing riches under the right circumstances. You obviously want to do your research and limit your positions more carefully to protect against the greater risks they present.
But when they're run by intelligent, ethical management teams that know their spaces and how to work them…
You can find yourself with gains that really could be in the running for "the best."
Small Cap #1: Clipper Realty Inc. ( CLPR )
Clipper Realty is an internally managed REIT with a market capitalization of $109.55 million. They are a diversified REIT that owns a portfolio of multifamily residential units and commercial real estate that consists of office and retail properties. While they are diversified in property type, they are geographically concentrated in New York, more specifically Manhattan and Brooklyn.
Some of their properties include the Tribeca House, which is a complex of luxury lofts in Manhattan with over 500 units and Flatbush Gardens which consists of 59 buildings that contain over 2,500 apartment units. In addition to their multifamily properties, they own several residential / retail mixed use properties and two office properties. In total, they have 66 buildings covering 3.3 million square feet that are 95.2% leased for the portfolio as a whole.
72% of CLPR's annual base rent ("ABR") comes from their multifamily properties, 24% of their ABR comes from their office properties, while their retail properties makes up 4% of their ABR. As previously mentioned, all their properties are located in New York, with 65% of their ABR coming from properties located in Brooklyn, and 35% of their ABR coming from properties located in Manhattan.
CLPR - 2021 Investor Presentation
Clipper Realty has averaged a 2.08% growth rate in their funds from operations ("FFO") since 2018. CLPR went public in 2017, so there is not a lot of information to go off of, but they showed good FFO growth between 2018 and 2019 with an 11% increase, but then had a significant drop in FFO in years 2020 and 2021.
It should be no surprise that Clipper Realty suffered during those years due to the pandemic and the impact it had on New York, but nevertheless CLPR had declines in FFO of 24% and 64% in the years 2020 and 2021 respectively.
Analysts project a 158% increase in FFO in 2022 (from $0.14 to $0.35) but that number does not represent their typical growth rate, it only reflects the rebound to more normal levels from their 2021 low of $0.14 FFO per share. In 2023 analysts project FFO to come in at $0.43 which would be a 23% increase and would get them close to their 2018 FFO levels.
FAST Graphs (compiled by iREIT)
Clipper Realty's dividend has remained mostly flat since their public listing. They raised the dividend from $0.37 to $0.38 in 2018, but since that time the dividend has remained at $0.38 per share. Similar to their FFO growth, we don't have a lot of dividend history to go off of.
From 2018 to 2019 they kept the same dividend rate, but by doing so they got their AFFO (Adjusted FFO) payout ratio to a more reasonable level of 76%. It makes sense that they would not raise the dividend during 2020-2021 due to the decline in earnings and a payout ratio of over 100%.
In 2022 the expected AFFO payout ratio is 80.85% which covers the dividend and is a marked improvement over their payout levels in the previous two years. It should also be noted that CLPR did not cut their dividend during the pandemic.
Clipper Realty does not provide their debt ratios in their presentations, but from their latest Form 10-Q it appears they have a heavy debt burden. As of September 30, 2022, they list their Notes Payable at $1.15 billion and their EBITDA for the three months ended September 30, 2022, at $14.94 million. Annualizing the three month EBITDA results in a latest quarter annualized ("LQA") EBITDA of $59.77 million. This gives us a Debt to Adjusted LQA EBITDA of 19.35x, which is very high.
CLPR - Form 10-Q (compiled and calculated by iREIT)
Similarly, they have a low interest cover ratio. From their 3Q22 Form 10-Q they list their interest expense at $10 million for the three months ended September 30, 2022, and their EBITDA over that same period at $14.94 million which gives them an interest coverage ratio of 1.48x.
CLPR - Form 10-Q (compiled and calculated by iREIT) CLPR - 3Q22 Form 10-Q CLPR - 3Q22 Form 10-Q FAST Graphs (CLPR total debt / EBITDA)
Currently CLPR is trading at a significant discount with a P/FFO multiple of 18.94x vs their normal P/FFO multiple of 23.77x. Their growth in FFO is a mixed picture with positive growth prior to the pandemic, large declines during the pandemic, and projected high FFO growth over the next year.
Likewise, their dividend history is a mixed picture with very little growth in the dividend, but no cuts during the pandemic and a reasonable AFFO payout ratio. My largest concern is the level of debt the company carries with outstanding debt of around $1.1 billion for a company with annualized EBITDA of approximately $59.77 million. We rate Clipper Realty a SPEC Buy .
Small Cap #2: Sachem Capital Corp. ( SACH )
Sachem Capital is a mortgage REIT ("mREIT") that specializes in originating and servicing a portfolio of first mortgage loans. Their typical loans are short-term, normally between 12 to 36 months, and are secured by real estate collateral.
They lend to real estate investors to enable them to acquire, improve, or develop residential or commercial properties and have loans funded in 14 states, with the majority of their loans funded in Connecticut, Florida, and New York.
Since their inception, SACH has originated loans totaling over $860 million, with more than 1,830 transactions completed. Their average loan size is $940 thousand, with an average yield of 11.3%, and 83% of their loans have a term period of less than one year.
SACH has increased its total assets from $86 million in 2018 to $417.9 million in 2021. As of September 30, 2022, their total assets stood at $562 million. Similarly, SACH's cumulative loan originations grew from $70 million in 2018 to a cumulative total of over $860 million as of the third quarter in 2022. The number of loans in their portfolio went from 403 in 2018 to 520 in 2021 and their weighted average term dropped from 11 to 8 months.
The growth in loan originations has translated into strong growth in their Adjusted Operating Earnings with an average growth rate of 7.23% in operating earnings since 2020. Analyst project operating earnings of $0.46 in 2022 for a 5% increase over the prior year, and $0.56 per share in 2023 for a 21% increase in operating earnings.
FAST Graphs (compiled by iREIT)
SACH currently pays a 13.47% dividend yield and has an average growth rate of 13.89% since 2020. Sachem's payout ratio when based on operating earnings per share has been over 100% since 2020, but keep in mind that they are required to pay out 90% of accounting earnings and most mREITs pay out 100% or more of their earnings.
Additionally, in 2023 operating earnings is expected to increase 21% to $0.56 per share, while the dividend per share is expected to remain flat at $0.52 per share. If these projections hold up the payout ratio will be approximately 93% in 2023.
Sachem Capital is trading well below its normal multiple with a current Price to operating earnings of 8.18x vs their normal P/E of 10.40x. The stock has declined approximately 23% over the last year, which has pushed its earnings yield up to 12.23%, its dividend yield up to 13.47%, and its operating earnings multiple down to 8.18x.
This is a small cap stock with a total market capitalization of $156.66 million so some volatility should be expected, but at these levels this could be a good entry point. At iREIT we rate Sachem Capital a Spec BUY .
Small Cap #3: BRT Apartments Corp. ( BRT )
BRT Apartments is an internally managed REIT that specializes in the ownership, operation and development of Class B and better multifamily properties primarily located in the Sun Belt region. BRT is a small cap stock with a total market capitalization of $398.88 million.
BRT investment strategy includes acquisitions of multifamily properties that are stabilized but under-managed, where they can add value with better hands-on management and capital improvements. Additionally, they seek properties in areas that show signs of population growth, increasing demand for shelter, and catalysts for employment such as locations near universities, airports, hospitals, and business centers.
As of their latest investor presentation in June 2022, BRT had 33 properties containing 8,985 units in 11 states. Their average rent per unit is $1,215 and they have a 96.4% average occupancy. The average age of their properties is 20 years and the first quarter revenue when annualized is estimated to be $111 million for the full year 2022.
BRT went through a rough patch starting in the Great Financial Crisis of 2007-2009 where they experienced significant losses. In their 2010 Annual Report they reported their cumulative operating loss at $72 million and announced they were suspending the dividend.
The tax laws in place allowed them to "carry-forward" their operating loss which in effect would allow them to offset future taxable income against the operating loss carry-forward. The end result was that they suspended their dividend from 2010 up until 2017.
Of course, investing is forward looking and since they resumed the dividend, they have delivered strong growth in both funds from operations and the dividend payout, but I thought it was important to point out their past history for perspective.
FAST Graphs BRT - 2012 Annual Report
When looking at BRT from 2018 to the present, the numbers paint a much better picture. Since 2018 BRT delivered an FFO growth rate of 12.77% and an average dividend growth rate of 7.28% over the last four years. Additionally, they pay a 4.74% dividend yield that is well covered with an AFFO payout ratio of just 67.59%.
BRT has reasonable debt metrics with a Long-Term Debt to Capital of 64.28%, a weighted average interest rate on property debt of 3.94%, and a weighted average term to maturity of 8.5 years.
They have well laddered debt maturities with the majority of their principle due in 2026 or thereafter. Additionally, as of November 2022 they had $14.9 million in cash and cash equivalents and $41.0 million available to them under their credit facility for a total of $55.9 million in liquidity.
BRT - Investor Presentation
BRT is currently trading at a P/FFO of 17.54x, which is in-line with their normal multiple. They pay a higher yield than many of their peers in the multifamily space that is very well covered by their adjusted funds from operations.
Over the last several years they have delivered strong FFO and dividend growth and are expected to continue that trend with expected FFO growth of 21% in 2023. We're upgrading BRT to a "spec buy" .
In Closing…
The tradeoff for investing in large-cap stocks can be easily traced back to the institutional buyers - led by exchange-traded funds and mutual funds -- that have a higher degree of analyst coverage and much lower risk tolerances.
Conversely, the small-cap REITs lack the same Wall Street coverage and investor interest can result in shares remaining undervalued -- especially in down markets -- for extended periods of time.
So these under-analyzed small-cap REITs flying under the radar can offer better potential for growth over the long term. Due to decreased institutional support, there's a better chance that small-cap REITs will have lower valuations that result in an underestimation of a company's operational health and prospects for growth.
Twitter: @rbradthomas
Remember that small-cap stocks are more susceptible to wide swings in price due to lower trading volumes. This greater volatility deters action and often provokes fear more readily.
Yet, we have found that stocks that "fly under the radar" are offer better positioned for growth over the long term. Due to the decreased institutional support, there's a better chance that the operational health and prospects of these small caps will be underestimated.
We will be adding a new small cap REIT tracker to iREIT on Alpha…
Stay tuned…
For further details see:
3 Small-Cap REIT Treats