2023-08-15 07:00:00 ET
Summary
- We discuss the concept of "elite" and how it applies to various industries and REITs.
- We emphasize the importance of quality in determining what's considered elite, using attributes such as earnings, dividends, balance sheets, properties, and management.
- The article highlights three REITs (Rexford Industrial, Alexandria Real Estate, and Camden Property Trust) that are considered elite based on their high-quality scores and wide margin of safety.
Elite, used as an adjective, means "the choicest or most select."
In the world of sports, most people consider Michael Jordan, Tiger Woods, and Tom Brady to be ideal candidates with the “elite” status.
In the investing world, these names come to mind: Warren Buffett, Benjamin Graham, and perhaps Michael Burry.
In terms of cars, elite cars made by Ferrari, Lamborghini, and McLaren are on my shopping (or dream) list.
How about luxury real estate?
That’s a 10,000 square foot mega mansion in the Hamptons that’s on the market for a cool $125 million. It comes with a salon, 16-car garage, rooftop retreat with a putting green, two bars and shuffleboard among its long list of amenities.
Now, with all of these “elite” examples, I’m sure you’re asking yourself, how is Brad going to select the three most elite REITs so that us ordinary shoppers can participate?
Great question.
It’s All About Quality
The term “elite” and “quality” are somewhat interchangeable. The common thread for all of these “elite” examples I just referenced is that they are all considered very high quality.
In other words, the “Oracle from Omaha” is not known for buying junk. One of the best Buffett quotes is as follows,
"It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
Now, in terms of REITs, how do we define quality?
Here’s how I do it?
- I look for quality earnings.
- I look for quality dividends.
- I look for quality balance sheets.
- I look for quality properties.
- I look for quality management.
Usually, you will find that all of these attributes are correlated.
In other words, a quality balance sheet typically drives quality earnings, that in turn power quality dividends, in which the revenue is supported by quality properties that are being operated by quality management.
If the balance sheet is bad, that typically means that management is bad.
If debt is elevated (bad balance sheet) that typically means earnings don’t grow and of course that also means the dividend doesn’t grow.
Now, there are exceptions to every rule, but for the large part, whenever there’s a weak link in any of these five attributes, the quality of the stock is lower.
We utilize our own proprietary quality scoring model (we call it the iQ model) in which we automatically score each REIT with a 0 to 100 scoring system. The purpose of course is to weed out the bad apples, so investors can focus on the good ones.
As you can see below, I used our tracker to screen for the highest-quality REITs and I’ve highlighted three of them that are trading with the widest margin of safety.
Let’s examine these three Elite REITs in more detail…
Rexford Industrial (REXR)
As seen above, REXR scores 99 out of 100.
REXR has quality earnings validated by 14% CAGR over the last seven years. We find this extremely attractive, and the REIT forecasted (by analysts) to grow by an average of 15% per year in 2024 and 2025.
REXR has quality dividends validated by the 16% annual dividend growth from 2016 to 2023. In addition, REXR’s payout ratio (based on AFFO per share) is around 83% and analysts forecast dividend growth in the high single digits for 2024 and 2025.
REXR has a quality balance sheet highlighted by the fact that the company had around 16% net leverage to total enterprise value (in Q2-23) with $1.9 billion of liquidity affording the company the ability to protect against economic uncertainty.
REXR has a 3.7x net leverage ratio, which is one of the lowest in the industry, with no major maturities in 2023 and a weighted average interest rate of just 3.6%. The weighted average maturity of its debt is 5.1 years. REXR is also rated BBB+/Baa2/BBB+ (S&P, Moody’s Fitch).
REXR has high-quality properties , over 44.5 million square feet, located in Southern California. Our team has covered the risks related to SoCal here and here .
REXR has a high-quality management team led by co-CEOs Michael Frankel and Howard Schwimmer. On the latest quarter earnings call, Frankel explained,
“I’d like to start by acknowledging our Rexford team for delivering an exceptional quarter, which included a 33% increase in quarterly earnings for FFO and a 10% increase in FFO per share over the prior year quarter. Our strong results were driven by value creation across all of Rexford Industrial’s internal and external growth strategies.”
Now, in terms of valuation , REXR is now trading at $52.87 per share with a P/AFFO of 31.1x. The normal P/AFFO is 35.5x and the current dividend yield is 2.9%. Prior to COVID-19 the P/AFFO was around 33.1x. We maintain a STRONG BUY.
Alexandria Real Estate (ARE)
As seen above, ARE scores 99 out of 100.
ARE has quality earnings validated by ~8% CAGR over the last seven years. We find this attractive, and the REIT is forecasted (by analysts) to grow by an average of 8.5% per year in 2024 and 2025.
ARE has quality dividends validated by the 6.2% annual dividend growth from 2016 to 2023. In addition, ARE’s payout ratio (based on AFFO per share) is around 70% and analysts forecast dividend growth of around 6.7% for 2024 and 2025.
ARE has a quality balance sheet highlighted by the fact that the company recently closed on a $1 billion line of credit accordion add-on, expanding the credit facility to $5 billion.
ARE has no debt maturities prior to 2025 and has a weighted average debt term of 13.4 years with an average interest rate of 3.69%. ARE is rated BBB+ by S&P and Baa1 by Moody’s.
ARE has high-quality properties through a “cluster model” in which it owns and operates life science/technology campuses in markets that it believes have the location, capital, talent and infrastructure to support a successful life science industry.
These clusters include Greater Boston, the San Francisco Bay Area, San Diego, Seattle, Maryland, and North Carolina’s Research Triangle. Nearly three-fourths of exposure comes from its three biggest markets: Boston, Bay Area, and San Diego. See my latest arti cle here i n which I highlight ARE’s business model in more detail.
REXR has a high-quality management team led by founder and Chairman Joel Marcus, and in the latest quarter he explained ,
“We had strong FFO per share growth in both the second quarter and the first half approximating 7%, especially in a continuing challenging macro and nicely beating consensus. Strong leasing quarter at 1.3 million rentable square feet ahead of the historical run rate of about 1.1 million square feet and NOI was up nicely, almost $200 million for the quarter.”
In terms of valuation , ARE trades at $122.12 per share with a dividend yield of 4.1%. The P/AFFO Is 17.8x compared with the normal P/AFFO of 25.8x. Excluding the COVID-19 period, ARE traded at an average multiple of 20.0x. We maintain a STRONG BUY.
Camden Property Trust (CPT)
As seen above, CPT scores 97 out of 100.
CPT has quality earnings validated by 6.4% CAGR over the last seven years. We find this attractive, and the REIT is forecasted (by analysts) to grow by an average of 5.5% per year in 2024 and 2025.
CPT has quality dividends validated by the 4.5% annual dividend growth from 2016 to 2023. In addition, CPT’’s payout ratio (based on AFFO per share) is around 67% and analysts forecast dividend growth of around 5.0% for 2024 and 2025.
CPT has a quality balance sheet highlighted by strong leverage metrics such as 4.2x net debt-to-annualized Adjusted EBITDAre, 5.8x total fixed charge coverage ratio, and 3.5x unencumbered real estate assets (at cost) to unsecured debt ratio. CPT has just 2.0% total secured debt to total assets and is rated A3 (Moody’s), A- (Fitch) and A- (S&P).
CPT has high-quality properties with nearly 59,000 apartment homes located in 15 major markets in the U.S. As a percentage of NOI, CPT’s top 5 markets are Washington, D.C., at 12.6%, Houston at 10.8%, Dallas at 8.2%, Atlanta at 8.2%, and Phoenix at 8.1%.
The properties in their portfolio have an average age of 15 years, average monthly rent of $1,966, and an average occupancy rate of 95%. The majority of their properties are class B (63%), are low-rise buildings (60%), and are located in suburban areas (59%).
CPT has a high-quality management team led by founder, Chairman and CEO, Rick Campos. On the latest (Q2-23) earnings call he explained,
“Our business continues to be strong. Market conditions continue to moderate from the post-COVID unprecedented housing boom that we all knew would happen. The transaction market is still quiet and with 70% decline from last year, new permits are starting to fall given the difficult financing environment and increased cost of capital. This should bode well for our markets as supply is absorbed over the next 18 months. Move-outs devising family homes to continue to trend lower than past years and quarters.”
In terms of valuation , CPT trades at $107.86 per share with a dividend yield of 3.7%. The P/AFFO Is 18.2x compared with the normal P/AFFO of 21.6x. Excluding the COVID-19 period, ARE traded at an average multiple of 21.1x. We maintain a BUY.
In Closing…
All three of these “super elite REITs” are constituents in our 100 Index and we select from this pool for our new REIT ETF Index.
iREIT®-MarketVector™ Quality REIT Index
The Index provides exposure to the highest quality US-listed common and preferred equity securities while ensuring sector diversification. As you can see (above), the three “super elite REITs” referenced in this article are included in the Index because they screen well for quality and value.
Quality is the root of our investment services, and as Warren Buffett explains,
'Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down'
I’ll rephrase it,
“Whether we’re talking about real estate or REITs, I like buying high quality properties when they’re marked down.”
Happy SWAN investing!
For further details see:
3 Super Elite REITs That Are Hard To Beat