2023-10-25 08:05:00 ET
Summary
- REITs have been negatively impacted by rising interest rates, but some oversold REITs, like W. P. Carey and Essential Properties Realty Trust, may be good buying opportunities.
- Both W. P. Carey and Essential Properties Realty Trust are triple net lease REITs, offering steady and predictable income streams for investors.
- We compare them side by side and offer our take on which is the better buy right now.
REITs ( VNQ ) - often viewed as bond proxies - have gotten crushed ever since the Federal Reserve began raising interest rates in early 2022:
However, we believe that some REITs - particularly those with robust business models and strong investment grade balance sheets - have been oversold in the process. In today's article, we will compare two of these REITs - W. P. Carey ( WPC ) and Essential Properties Realty Trust ( EPRT ) - side-by-side and offer our take on which is the better buy today.
WPC Stock Vs. EPRT Stock: Business Models
Both WPC and EPRT are triple net lease REITs. These REITs primarily invest in income-generating commercial properties, such as office buildings, retail centers, or industrial facilities that have triple net leases attached to them and often only have one tenant occupying each property. These leases, which require tenants to cover not only the base rent but also property taxes, insurance, and maintenance costs, are quite conservative in nature. This is because - in addition to being very long-term with contractual rental rate escalators and in many cases include bankruptcy protections for landlords - the tenants take on the responsibility for all property operating expenses, relieving the REIT of the financial volatility that comes with this side of being a landlord.
As a result, WPC and EPRT generate a very steady and predictable income stream for shareholders, with extremely high free cash flow conversion ratios from rent collected, which it can then payout to shareholders via dividends or reinvest to buy more properties and growth REIT's cash flows and dividends at an even more rapid pace. As a result, triple net lease REITs are in many ways a bond-like income investment while still offering a growth component, making them an ideal investment for risk-averse, income-focused investors who still want equity-like long-term total returns.
EPRT's portfolio is well-diversified with a total of 1,688 properties spread across 48 states in the United States and also boasts a very high occupancy rate that is consistently close to 100%. Its properties primarily consist of service-oriented, experience-based, and internet-resistant businesses. This strategic tenant mix ensures that the Trust's properties remain resistant to technological disruption and less susceptible to economic downturns. Its top industries by exposure are:
- Car Washes: 14.6%
- Early Childhood Education: 12.4%
- Quick Service: 11.4%
- Medical/Dental: 10.8%
- Auto Service: 8.3%
- Entertainment: 8.0%
- Casual Dining: 6.6%
- C-Stores: 4.7%
- Equipment Rental and Sales: 4.3%
- Health and Fitness: 4.1%
- Grocery: 3.1%
- Other Services: 2.4%
- Family Dining: 2.3%
- Other Industrial: 2.2%
- Pet Care Services: 1.5%
- Movie Theatres: 1.4%
- Building Materials: 1.2%
- Home Furnishings: 0.7%
Service-oriented industries make up 79.3% of the portfolio, Experience-based industries represent 13.5%, Retail industries account for 3.8%, and Industrial industries comprise 3.4% of the portfolio.
EPRT has almost entirely contractual fixed rent escalators, with 95% of its rate coming from this type of lease. Meanwhile, just 1.7% of its leases have no rent escalators and 2.8% of them are CPI-linked. Overall, its weighted average rent escalator is 1.6% annualized. Its weighted average lease term is approximately 13.9 years, giving it a high degree of cash flow visibility for years to come.
WPC's real estate portfolio, meanwhile, is also well diversified with 1,560 properties, primarily spread across North America and Europe, giving it global reach and diversified geopolitical and currency risk exposure. WPC also boasts an impressive occupancy rate of 99%.
Moreover, its tenant base is even more diverse than EPRT's, with its sector exposure is broken down as follows:
- Industrial: 29%
- Warehouse: 24%
- Retail: 17%
- Office: 16%
- Self-Storage: 4%
- Other: 10%
Furthermore, WPC's weighted average remaining lease term of approximately 11.2 years indicates that it enjoys significant cash flow visibility for years to come. With 54% of its rent coming from leases with CPI-linked rent escalators, WPC enjoys considerably stronger protection against inflation than many of its peers, while its 97% CPI plus fixed contractual escalator exposure indicates that WPC generates consistent organic growth even in environments when it is unable to make a lot of accretive acquisitions.
WPC Stock Vs. EPRT Stock: Balance Sheets
WPC has a strong investment grade balance sheet, with a BBB+ credit rating from S&P. It also has strong liquidity of $1.9 billion, fixed charge coverage of 5.2x, and a pro rata net debt to adjusted EBITDA ratio of 5.7x. Its weighted average debt term to maturity is a little bit on the short side, however, at 3.9 years, making it a bit sensitive to rising interest rates.
EPRT, meanwhile, has a weaker credit rating of just BBB-. However, it has a much lower leverage ratio of just 4.1x, its weighted average term to maturity is longer at 5 years, and it has ample liquidity of $775 million.
WPC Stock Vs. EPRT Stock: Valuation
In terms of valuation, EPRT currently offers a NTM dividend yield of 5.4%, a NTM P/AFFO of 12.49x, a NTM P/FFO of 11.87x, and a NTM EV/EBITDA of 14.05x. Meanwhile, its P/NAV of 0.96x indicates that EPRT is undervalued relative to the private market value of its real estate.
WPC currently offers a NTM dividend yield of 7.3%, a NTM P/AFFO of 10.63x, a NTM P/FFO of 10.81x, and a NTM EV/EBITDA of 14.09x. Meanwhile, its P/NAV of 0.86x indicates that WPC is undervalued relative to the private market value of its real estate.
EPRT trades at a meaningfully lower dividend yield and higher P/AFFO and P/FFO multiples than WPC does. However, when you take into account WPC's significantly higher leverage ratio, these differentials are largely accounted for. This bears out in the fact that WPC actually trades at a slightly higher EV/EBITDA than EPRT does. That being said, WPC's focus on industrial assets instead of lower quality retail and service-oriented assets such as what EPRT focuses on means that its properties generally command lower cap rates. As a result, its P/NAV is significantly lower than EPRT's is, indicating that it is truly trading at a cheaper valuation than EPRT is.
Investor Takeaway
Both EPRT and WPC offer investors attractive current income backed by solid balance sheets and defensive real estate portfolios. The main considerations to keep in mind when choosing between these two REITs are:
- WPC is about to spin-off part of its office assets and then focus on selling the remainder of them in the coming months. This will weigh on FFO per share in the near term and also result in a "reset" dividend. You can read more about this strategic plan and its implications for investors here .
- WPC has significantly greater exposure to CPI-linked leases. That being said, it also has significantly more leverage and significantly more debt maturing in the next few years. As a result, investors should weigh their outlook for inflation and interest rates over the next few years when comparing these two REITs.
- WPC has significant exposure to European real estate, whereas EPRT is a pureplay on U.S. triple net lease real estate.
- WPC has significantly more exposure to industrial and self-storage real estate than EPRT does. Instead, EPRT is focused primarily on various forms of retail and service-oriented real estate.
- Traditionally, EPRT has grown its dividend at a much faster clip than WPC has. However, with WPC's plan to reduce its dividend in order to get a much lower payout ratio, its dividend growth rate may accelerate in the coming years to get closer to EPRT's.
Overall, we think both of these REITs as attractive buys right now. However, if we had to pick one, it would be WPC because of its deeper discount to NAV, higher credit rating, higher cash flow yield, and overall higher quality real estate portfolio.
For further details see:
Buy The Dip In High Yield REITs: Essential Properties Stock Vs. W. P. Carey Stock