2023-07-03 07:00:00 ET
Summary
- I can’t argue with Mr. Munger in terms of the troubled office buildings, and specifically, the large number of debt maturities rolling over the next 24 months.
- Another billionaire that’s become more vocal in the commercial real estate sector is Elon Musk.
- There are many billionaires who are telling us to avoid commercial real estate.
- So, why am I loading up on these REITs?
I find it interesting that quite a few billionaires are sounding the alarm bell for commercial real estate.
Take 99-year-old Charlie Munger for example, who said that “ a lot of real estate isn’t so good anymore. We have a lot of troubled office buildings, a lot of troubled shopping centers, a lot of troubled other properties. There’s a lot of agony out there.”
Source: www.livemint.com
I can’t argue with Mr. Munger in terms of the troubled office buildings, and specifically the large number of debt maturities rolling over the next 24 months.
Keep in mind that the billionaire ( $2.5 Billion according to Forbes ) is also on Costco’s ( COST ) board, so I hope he’s not suggesting that retail is also in the tank.
Another billionaire that’s become more vocal in the commercial real estate sector is Elon Musk who recently tweeted,
“Commercial real estate is melting down fast. Home values next.”
He elaborated on the ominous forecast during an interview with former Fox News personality Tucker Carlson in April.
“We really haven’t seen the commercial real estate shoe drop. That’s more like an anvil, not a shoe. So the stuff we’ve seen thus far actually hasn’t even — it’s only slightly real estate portfolio degradation. But that will become a very serious thing later this year, in my view.”
Musk, worth $219 billion ( according to Forbes ), was obviously referring to the office sector, which as Munger explained, is “troubled”. I find it interesting that Twitter has not paid rent on its offices since November 2022 .
Goldman Sachs is part of a group of banks that made a $1.7 billion loan to the Columbia Property Trust, that owns several of Twitter's office space properties.
Yet, another multi-millionaire ($400 million according to infotainmentbeats ) who took a shot at commercial real estate is shark tank host, Kevin O’Leary, who said,
"No matter how much you talk up your real estate book around office, the world has changed. Not only are rates up, but people don't want to work in a cubicle anymore.”
I used to work in a cubicle, it was my very first job after I graduated from college. I liked working in my cubicle.
One final billionaire ($2.2 billion according to Forbes ) signaling doom and gloom is Howard Marks, co-founder of Oaktree Capital.
"Higher interest rates call for higher demanded capitalization rates (the ratio of a property's net operating income to its price), which will cause most real estate prices to fall.”
He added,
“The possibility of a recession bodes ill for rental rates and occupancy, and thus for landlords' income.”
So, there you go, three billionaires and one multi-millionaire who are telling us to avoid commercial real estate.
Don’t get me wrong, I respect all of these wealthy men, but you should remember how they got where they are today.
I’ll sum it up with another billionaire quote…
“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful. Warren Buffett
Finally, A Billionaire Who Gets It
Seth Klarman, co-founded Baupost Group, one of the world’s largest hedge funds with nearly $30 billion under management. According to Forbes he’s worth around $1.3 Billion.
Klarman recently wrote the introduction to the seventh edition of the seminal value-investing text “Security Analysis” first published by Benjamin Graham and David Dodd in 1934 (I just ordered a copy on Amazon). On a recent CNBC interview Klarman said,
“I think there are hunting grounds where one would want to look. We think real estate is an area that’s full of so many fundamental challenges…there might be opportunities to buy.”
A person smiling in front of a screen Description automatically generated with low confidence Source: marketcapisbingoman.blogspot.com
One of my favorite Klarman quotes,
“You must buy on the way down. There is far more volume on the way down than on the way back up, and far less competition among buyers . It is almost always better to be too early than too late , but you must be prepared for price markdowns on what you buy.”
Another Klarman quote that resonates is as follows,
“Ultimately, nothing should be more important to investors than the ability to sleep soundly at night.”
As my readers on Seeking Alpha know, I didn’t coin the “SWAN” term, although I did include it in the glossary inside my new REITs For Dummies book (available September 2023).
So without further ado, let me tell you about three of my favorite “sleep well at night” picks…
Alexandria Real Estate ( ARE )
ARE is a life science REIT that owns 64 properties with a total asset base in North America that covers 74.6 million square feet. I’ve already covered the latest short report ( by Land & Buildings) and I plan to publish a “series 2” version later this week (after my interview with the CEO this week).
Investors should keep in mind that ARE does now own traditional office buildings, a majority of the space is considered lab space. In addition, scientific degrees and job creation across all major and secondary markets foresee 22-32% growth over the next 5 years – and those are current projections – post pandemic.
As seen below, ARE is extremely from a fundamental lens: rates BBB+ by S&P with average annual dividend growth rate of 5.4% (over last 5 years). The dividend is well-covered (AFFO payout ratio is 71%) and analysts forecast 8% growth in 2024 and 10% in 2025. The iREIT© quality score is 99 (out of 100).
In terms of valuation, we can also see that ARE is cheap based on all metrics: The P/AFFO multiple is 16.9x, compared with 15.9x in the GFC and an average of 22.6x from 2012-2021.
The dividend yield is 4.4% which is attractive given the fact that R&D companies VERY rarely go BK – based upon the true value in these companies is not predicated upon widget sales or “tech trends”- that are tied to consumer spending. It’s their IP and tied to their IP research which is contained within their facilities- literally and metaphorically.
Finally, ARE is one of iREIT©’s high conviction picks that we believe has solid potential: we forecast shares to return ~30% annually over the next 2 years. As Seth Klarman said, “You must buy on the way down”.
Realty Income ( O )
O is a net lease REIT that owns over 12,400 free-standing properties in all 50 states, Puerto Rico, Italy, Spain and the U.K.
Size, scale, and access to capital are O’s primary competitive advantages that have fostered the firm to increase its dividend 121 times since the company listed in 1994. O is a Dividend Aristocrat and as viewed below, the company has maintained an impressive earnings (AFFO per share) record (26 out of 27 years in a row of positive AFFO per share).
In addition, O has a “fortress” balance sheet: A- rated by S&P and A3 by Moody’s that validates the strength and consistency of earnings. O ‘s payout ratio is 76.5% (based on AFFO) and analysts forecast 4% growth in both 2024 and 2024.
In terms of valuation, O is cheap. Shares are trading at 15.1x P/AFFO, compared with 14.8x during the GFC and an average of 18.8x from 2011 to 2019.
What’s interesting is that O has evolved into a “blue chip” name by increasing the size of its footprint and lowering its cost of capital, while shares remain deeply discounted. Also, O’s dividend yield is 5.1%, and as noted earlier, well-covered by AFFO (76.8% payout ratio).
O also remains an iREIT© high conviction pick as we forecast shares to return 25% annually over the next two years. I’m backing up the truck and I’m quite content with holding more than 7% in my retirement account.
American Tower ( AMT )
AMT is a cell tower REIT that owns approximately 226,000 communication sites that includes over 43,000 properties in the U.S. and Canada and over 182,000 sites internationally.
As viewed below, you can see that AMT has solid fundamentals that include an investment grade balance sheet (BBB- with S&P) and consistent earnings history - over the last 10 years AMT has had an average AFFO growth rate of 12.8%.
The demand for the tower sector is rooted in forecasted smartphone data usage: from 2023 to 2028 usage is expected to grow significantly across the globe with an expected compound annual growth rate of 18.7% in the U.S., 16.2% in Germany, France, and Spain, 12.6% in India, 12.3% in Brazil and Mexico, and 19.6% in South Africa and Nigeria.
As viewed below, AMT has a well-covered dividend, with a payout ratio (based on AFFO) of 67% and attractive AFFO per share growth (forecasted by analysts of 9% in 2024 and 2025.
I also own Crown Castle ( CCI ) – a direct peer to AMT – however I’m not as “super” bullish (with CCI) as I am with AMT. For comparison, CCI’s growth forecast is -1% in 2024 and -3% in 2025. CCI’s payout ratio is higher (83%) which is why the dividend yield is higher (5.5%).
In terms of valuation, AMT is also attractive, shares are trading at 19.9x, compared with 23.4x during the GFR and 21.6x from 2015 to 2020. Ss noted earlier, AMT’s yield of 3.2% is lower than CCI, but the payout ratio is much lower, which suggests AMT has plenty of cushion to keep boosting its payout.
iREIT© sees the margin of safety with AMT which is also why I’m “buying more when it drops”..like right now.
As shown below, we believe that this gem is positioned to also generate annual returns of around 25% over the next two years.
Ignore the Headlines
I respect all the wealthy gentlemen I referenced in this article, and who knows, hopefully one day I can meet them all in person.
And it just so happens that I agree with most of them - that the office sector is in for my pain (especially in San Francisco, Elon).
However, my background in both the public and private real estate sectors gives me incredible insight.
While I’m certain that the lack of bank lending for small and mid-size landlords will create volatility over the next few quarters, the larger landlords – especially REITs – are in a great position to benefit.
Like Howard Marks, I see tremendous opportunity in distressed debt, which is why our team is laser-focused on commercial mortgage REITs like Blackstone Mortgage ( BXMT ), Starwood Property ( STWD ), Ladder Capital ( LADR ), and Arbor Realty ( ABR ).
By the way, OakTree recently announced $2.3 Billion in a life science focused private credit fund. (Hint, hint: ARE is a Strong Buy).
The Federal reserve expects to continue hiking interest rates between now and year-end, even though it skipped an interest rate hike at its June FOMC meeting. The next interest rate decision will come in July.
At some point, there will be a permanent pause (in rate increases), and if I had to guess I would argue that will be sooner than later…
In the interim, I see absolutely nothing wrong with planting a few seeds with ARE, O, and AMT.
As I said earlier, Seth Klarman is one billionaire that appears to be aligned with my way of thinking.
“Value investing is the discipline of buying shares at a significant discount from their current underlying values and holding them until more of their value is realized. The element of a bargain is the key to the process.” Seth Klarman
As always, thank you for the opportunity to be of service.
Happy SWAN Investing!
Note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.
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I'm Ignoring These Billionaires And Loading Up On REITs