2023-07-17 08:05:00 ET
Summary
- Most REITs have been rising lately.
- But a few exceptions have dropped significantly.
- We highlight two new 'buy-the-dip' opportunities.
We have not posted quite as much many "buy the dip" articles in recent weeks.
This is because for most of June, REIT ( VNQ ) share prices were moving higher and I was running low on cash.
Besides, I was also busy at the NAREIT Conference, meeting REIT management teams and learning new things so I decided to be patient.
I am glad that I did because a few of our favorite holdings have become even more opportunistic in recent weeks.
Sometimes, you get unlucky with the timing of your investments. This time, the luck was on our side.
Of course, I still can't predict how any of these investments will perform over the short run, but I am glad to get the chance to buy more shares at these low valuations:
W. P. Carey ( WPC )
WPC is a large net lease REIT that invests primarily in industrial buildings such as the 3M ( MMM ) distribution center that you see below:
W.P. Carey
We think that now is a good time to buy more shares of WPC because it has recently massively underperformed the average of the REIT sector for no apparent reason:
YCHARTS
As a result of this drop, WPC is now priced at just 12.8x AFFO and a 6.2% dividend yield - which is very reasonable for a REIT that's commonly perceived to be a blue-chip:
- Strong BBB+ rated balance sheet
- Multi-decade track record of steady dividend growth
- History of significant market outperformance since IPO
- Primarily invested in rapidly growing industrial properties
- Unique capability to originate its own net lease deals with superior terms
- Sector-leading lease quality with CPI adjustments resulting in rapid organic growth in today's high inflation world:
We have previously argued that the market will likely reward WPC with a materially higher valuation in the coming years as it:
- continues to increase its industrial exposure
- unwinds the rest of its small asset management business
- and accelerates its dividend growth rate
Getting the U-Haul ( UHAL ) headwind out of the way should also help its market sentiment. Its lease will expire next year and it includes an option for U-Haul to buy back these assets at an 8.2% cap rate. The market knows that it is likely to exercise this option, reducing WPC's rent by 2.7%.
But this isn't the significant headwind that the market makes it seem to be.
WPC has been getting 7.2% cap rates on its transactions so far this year and it is today already buying replacement properties with its credit facility, increasing leverage, which it will then pay down next year with the proceeds from U-Haul. So the difference is not even 100 basis points since WPC will earn some cash flow between now and then and the rents of these new acquisitions will also be hiked by then.
It seems to us that the market is overreacting by pricing such a high-quality REIT at a lower valuation than the average of the REIT sector and we think that as interest rates return to lower levels and WPC finishes its transformation, the market will reprice it at closer to 18x AFFO, potentially unlocking up to 44% upside from here.
This is particularly compelling when you consider that you also earn a 6.2% dividend yield that's been growing since 1998.
But don't take it just from me: a director just recently made a purchase in the open market. Since then, the share price has dropped by another 10%:
Healthcare Realty ( HR )
HR is the largest owner of medical office buildings in the USA and we own a position in our Retirement Portfolio at High Yield Landlord:
We think that it is particularly opportunistic right now because its stock has sold off to a 12-year low and as a result, its valuation has become very opportunistic relative to the rest of the REIT sector:
Why is it down so much?
We believe that there are two mains reasons:
First, leverage is a bit on the high side at 6.6x net debt to EBITDA, which makes rising interest rates a headwind.
Two, the REIT completed its merger with HTA last year and it appears to have exacerbated the sell-off as many former shareholders of HTA had no interest in owning HR and sold it irrespective of its fundamentals.
But here's why I think that the sell-off is way overdone:
Firstly, the leverage really isn't that high when you consider that HR owns highly defensive medical office buildings. This is a recession-resistant sector with high occupancy rates and steadily rising rents. Today, their same-property NOI growth is about 3% and they expect this to accelerate to 4-6% in 2024 and possibly even higher in 2025 as they bump up their occupancy rates on the back of strong demand for medical office buildings.
It shows you that when you own great properties, you can afford to have a bit more leverage and this explains why the rating agencies still give it an investment-grade rating. The higher leverage is a near-term headwind as rising interest rates hurt its growth, but I don't see it as a long-term issue. The rapid same-property NOI growth is going to organically drive the leverage lower over the coming years and reduce the worries of the market. Eventually, interest rates will also likely head to lower levels, benefiting HR.
Secondly, the HTA merger appears to have depressed the valuation, but it is actually expected to yield significant synergies in the coming years. Here is what the management said about these assets in the most recent conference call :
"Certainly, we saw a lot of opportunity within the HTA portfolio, their multi-tenant occupancy being materially lower than ours. But we also see the power of the combination through market scale, extended scale in those markets, building on our cluster thesis, our strong -- adding to our strength, historically, Healthcare Realty strength to the relationships that HTA had and putting that together to drive additional momentum."
They think that the combination of cost savings, increased scale, and better leasing practices will lead to 5-7% FFO per share growth next year - even without any improvement in interest rates - which could serve as an additional catalyst. And the growth could be even more significant in 2025:
I believe that as this growth materializes, HR's valuation will rise a lot higher because it will remove the concerns over leverage and prove to the market that HR isn't just an income investment with no growth.
Today, it is priced at just 11.6x FFO, an estimated 35% discount to NAV, and a high 6.7% dividend yield because the market is missing this growth story and it provides a window of opportunity for us to accumulate shares at a historically low valuation.
Here again, the company just recently announced a $500 million buyback program to take advantage of this discount and a director has also been buying a lot of shares in the open market:
We think that the risk-to-reward is very compelling here.
To recap: this is a large REIT that owns defensive medical office buildings and has an investment-grade-rated balance sheet, but it is temporarily discounted due to unfair reasons and has a growth catalyst to unlock value for shareholders. You earn a generous yield while you wait.
Bottom Line
REITs are today priced at their lowest valuations in many years with some blue-chip REITs yielding over 6% even as they continue to grow steadily.
We are loading up on these opportunities at High Yield Landlord because we don't know for how long these opportunities will last.
For further details see:
Buy The Dip: 2 REITs At An Unbeatable Price