2023-12-01 17:00:00 ET
Summary
- After the brutal sell-off of the last two years, REITs are poised for a surge.
- However, this upswing will not benefit all REITs equally.
- Cautious investors can now get about 5% with little or no risk, so why invest in a security yielding less than 5%, particularly if it has significant downside risk?
- This article identifies 11 REITs that are potentially overvalued by at least 10% while also yielding substantially less than 5%. Then it takes a closer look at the top 6 on the list.
After the brutal sell-off of the last two years, REITs are poised for a surge . There are dozens of quality REITs whose yields are at or near their all-time highs. Inflation appears to be under control , and nearly down to the Fed target of 2%. Interest rates will probably hold steady or drop in the foreseeable future. However, this upswing will not benefit all REITs equally, and there are some potential land mines in the REIT landscape.
Thanks to the numerous rate increases over the past two years, cautious investors can now get about 5% with little or no risk (and little or no upside). So what reason would you have, to invest in a security paying less than 5%, unless it has significant upside potential in the share price? Wouldn't there be even less reason to invest in one that has significant downside risk?
This is especially true when there are so many REITs yielding more than 5%, with significant upside built into the price. (In a recent article, I highlighted 10 such REITs .)
For the more risk-averse investors, value investors, and retirees who depend on dividend income, this article identifies 11 REITs that are potentially overvalued by at least 10% and yield substantially less than 5%. Then I take a closer look at the top 6 companies on that list.
The List
Here are the 11 REITs that fit the above criteria. In this table, "Premium" is the percent by which the current share price exceeds the merited buy price.
Company | Ticker | Sector | Premium | Yield |
Safehold | ( SAFE ) | Net Lease | 225% | 3.63% |
Industrial Logistics | ( ILPT ) | Industrial | 73% | 1.32% |
Franklin Street | ( FSP ) | Office | 63% | 1.64% |
Farmland Partners | ( FPI ) | Farmland | 58% | 1.90% |
DigitalBridge Group | ( DBRG ) | Data Center | 49% | 0.24% |
Urban Edge | ( UE ) | Strip Center | 30% | 3.80% |
Welltower | ( WELL ) | Medical | 29% | 2.72% |
Potlatch Deltic | ( PCH ) | Timber | 27% | 3.78% |
Americold | ( COLD ) | Industrial | 23% | 3.12% |
Iron Mountain | ( IRM ) | Data Center | 22% | 4.11% |
Empire State Realty | ( ESRT ) | Office | 14% | 1.63% |
Source: Hoya Capital Income Builder
Bird's Eye Overview
No company is perfect. Every company has issues, and every company has favorable aspects. A Buy case can be made for some of the companies on the list, and a Hold case can be made for still others. I will not attempt an exhaustive review of each company. Instead, I will take a snapshot of each of the top 6 REITs on the list, to highlight the problem areas that contribute to the risk that the company may be overvalued.
Here is the list again, with each company rated for 7 salient factors: FFO Growth, Dividend Growth, Dividend Safety, Balance Sheet, Valuation, NAV, and Profitability. Strengths are highlighted in green. Problem areas are flagged in red.
Ticker | FFO Growth | Div. Growth | Div. Safety | Balance Sheet | Valuation | NAV | Profit |
SAFE | |||||||
ILPT | |||||||
FSP | |||||||
FPI | |||||||
DBRG | |||||||
UE | |||||||
WELL | |||||||
PCH | |||||||
COLD | |||||||
IRM | |||||||
ESRT |
Source: Hoya Capital Income Builder and Seeking Alpha Premium
Next, let's take a closer look at the top 6, focusing only on the problem areas, to understand why they are flagged.
Safehold ( SAFE ) has problem areas in Dividend Safety, Balance Sheet, Valuation, NAV, and Profitability.
Seeking Alpha Premium assigns this company a Dividend Safety grade of F, indicating it is in imminent danger of a dividend cut , which would probably be followed by a swift and significant tumble in share price. This alarming rating is based primarily on the company's indebtedness and FFO/Debt ratios.
Let's take a closer look at the debt picture. SAFE has an exceedingly high Debt Ratio of 65%. (The formula for Debt Ratio is Total Debt divided by Total Assets.) The average Debt Ratio for REITs as a whole is currently just 30%.
Company | Debt Ratio | Debt/EBITDA | Variable Rate |
SAFE | 65% | 10.0 | 0.0% |
Source: Hoya Capital Income Builder
Making matters worse, the company's ability to pay its way out of debt with its earnings is poor, as reflected by a 10.0 Debt/EBITDA ratio, compared to the REIT average of 6.3. SAFE's FFO/share fell this year by almost 70%. Whether it recovers soon enough to preserve the dividend remains to be seen.
As a result of the dive in revenues, the Seeking Alpha Quant Ratings system also sees profitability as a problem for SAFE, assigning a profitability grade of D and a Sell rating.
SAFE is currently priced at a stratospheric 40.0x FFO '23. Meanwhile, the company's share price reflects only a (-2.1)% discount to the estimated NAV, while the average REIT is selling for a discount of (-18.0)%.
Company | Price/FFO '23 | Premium to NAV |
SAFE | 40.0 | (-2.1)% |
Source: Hoya Capital Income Builder
Industrial Logistics (ILPT), which is externally managed by RMR Group, has growth and balance sheet issues. Its FFO per share has collapsed over the past two years, currently standing at about 25% of its 2020 levels.
ILPT | 2020 | 2021 | 2022 | 2023 |
FFO/share | $1.86 | $1.89 | $1.17 | $0.48 |
% change YoY | -- | 1.6 | (-38.1) | (-59.0) |
Source: Hoya Capital Income Builder
This has led to drastic dividend cuts and a lot of red ink on the balance sheet. The quarterly dividend, which was unfazed by the pandemic, was slashed from $0.33 to just $0.01 in July of 2022 and remains at that level today.
Meanwhile, its Debt Ratio of 86% and Debt/EBITDA of 16.7 are formidable problems, to say the least, and the company holds a horrifying 53% of its debt in variable-rate instruments, so it is paying high interest rates.
Company | Debt Ratio | Debt/EBITDA | Variable Rate |
ILPT | 86% | 16.7 | 53.2% |
Source: Hoya Capital Income Builder
Franklin Street Properties ( FSP ) has FFO growth, Dividend growth, balance sheet, and valuation issues, starting with a drastic decline in FFO. From $0.75 per share in 2020, it has steadily dropped all the way to $0.29 per share this year.
FSP | 2020 | 2021 | 2022 | 2023 |
FFO/share | $0.75 | $0.55 | $0.40 | $0.29 |
% change YoY | -- | (-26.7) | (-27.3) | (-27.5) |
Source: Hoya Capital Income Builder
As with ILPT, this has led to drastic dividend cuts and balance sheet issues. The quarterly dividend was cut in July 2022, from $0.09 to just $0.01, where it remains today.
Debts have piled up, resulting in a very high Debt Ratio of 60% and Debt/EBITDA of 16.0, abysmal even by Office REIT standards. An alarming 53.0% of the FSP's debt is held at variable rates. Even if the Fed stops raising rates, these variable rate instruments typically carry much higher interest rates than fixed-rate debts.
Company | Debt Ratio | Debt/EBITDA | Variable Rate |
FSP | 60% | 16.0 | 53.0% |
Source: Hoya Capital Income Builder
Although FSP's Price/FFO and discount to NAV are in line with the beaten-down Office REIT sector, the Seeking Alpha Quant ratings system assigns the company a D- for valuation.
This is based partly on its very low dividend yield, as well as its Price/Cash Flow of 14.48 and its forward Price/AFFO of 48.80, both of which are far above the sector average.
Farmland Partners ( FPI ) is also facing FFO growth, Dividend growth, balance sheet, and valuation issues. Like ILPT and FSP, these begin with a substantial decline in FFO, from $0.43 in 2020 to $0.17 in 2023.
FPI | 2020 | 2021 | 2022 | 2023 |
FFO/share | $0.43 | $0.25 | $0.30 | $0.17 |
% change YoY | -- | (-41.9) | 20.0 | (-43.3) |
Source: Hoya Capital Income Builder
Dividend growth has been laconic, with only one dividend increase in the past 5 years (from $0.05 to $0.06). Worse, FPI earns a Dividend Safety grade of D from the Seeking Alpha Quant Ratings system, indicating a significant risk of a dividend cut .
The lapse in revenues has caused the bills to pile up, with Debt/EBITDA of 14.9 choking the flow of dividends and investment capital, and the relatively high 12.4% of debt held at variable rates leeching yet more FFO.
Company | Debt Ratio | Debt/EBITDA | Variable Rate |
FPI | 36% | 14.9 | 12.4% |
Source: Hoya Capital Income Builder
FPI investors will tell you promptly that this is an investment in the underlying value of the land, so traditional REIT metrics are less important. So let's look at NAV. While FPI's peer Gladstone Land ( LAND ) is priced at a (-12.8)% discount to the estimated NAV, FPI is priced at 5.3% premium. So shares seem a bit overpriced, even compared to the value of the land.
Company | Price/FFO '23 | Premium to NAV |
FPI | 40.0 | 5.3% |
Source: Hoya Capital Income Builder
The Seeking Alpha Quant Ratings system assigns FPI a grade of F for valuation.
DigitalBridge Group ( DBRG ) is facing dividend growth, balance sheet, and valuation issues. The company completely discontinued its dividend during the pandemic, which is not unusual, but waited until September of 2022 to resume paying dividends, slashing from the original $0.11 per share, down to just $0.01, where it remains.
Meanwhile, debts have piled up. The Debt Ratio for DBRG is 1590 basis points higher than the REIT average of 30.0%, and Debt/EBITDA is also a bit troubling at 8.0.
Company | Debt Ratio | Debt/EBITDA | Variable Rate |
DBRG | 45.9% | 8.0 | -- |
Source: Hoya Capital Income Builder and author calculations
Price/FFO '23 on DBRG is a whopping 40.0 . Meanwhile, DBRG is selling at a sizzling 19.4% premium to the estimated NAV, whereas the average REIT is currently selling at an (-18.0)% discount .
Company | Price/FFO '23 | Premium to NAV |
DBRG | 40.0 | 19.4% |
Source: Hoya Capital Income Builder
Seeking Alpha Quant ratings system assigns DBRG a grade of F for valuation.
Urban Edge Properties ( UE ) arguably has balance sheet and valuation issues. The company's Debt Ratio is 2200 basis points above the REIT average, and its Debt/EBITDA is also somewhat elevated, at 8.2.
Company | Debt Ratio | Debt/EBITDA | Variable Rate |
UE | 52% | 8.2 | 4.7% |
Source: Hoya Capital Income Builder
That is troublesome for a REIT growing FFO at only 2.5% per annum.
UE | 2020 | 2021 | 2022 | 2023 | 2024 |
FFO/share | $0.88 | $1.09 | $1.21 | $1.24 | $1.27 |
% change YoY | -- | 23.8 | 11.0 | 2.5 | 2.4 |
Source: Hoya Capital Income Builder
Although the company's Price/FFO is in line with the Shopping Center REIT sector, shares are selling at a discount to the estimated NAV of only (-2.1)%, which is 1590 basis points more expensive than the average REIT.
Company | Price/FFO '23 | Price/FFO '24 | Premium to NAV |
UE | 13.4 | 13.2 | (-2.1)% |
Source: Hoya Capital Income Builder
Seeking Alpha Quant Ratings system assigns UE a valuation grade of D+.
The Bottom Line
I am not necessarily advocating a Sell on any of these companies. However, I am advocating a strong note of caution if they are on your watchlist, or if you are long in any of these, with large allocations. There seem to be many better alternatives for your money at the present time. But that's just my opinion.
As always, the opinion that matters most is yours. Because it's your money.
For further details see:
Hot Potatoes: 6 Potentially Overpriced REITs Yielding Less Than 5%