2023-04-26 07:00:00 ET
Summary
- This recession (if I’m right) will be much less severe than many think, and I’m betting it will be a garden style variety.
- What do I mean by “garden style”?
- That simply means that the recession impacts will be much less severe and short-lived than previous recessions.
A few days ago, I wrote an article titled “ Cash Is King ” in which I explained that:
“given where we are in this cycle, we believe that investors should begin to think about allocating more capital to the REIT sector but staying away from high-risk REITs.”
In that same article, one contrarian investor said:
I later commented on Twitter:
These days, I’m seeing more and more investors moving into cash, fearful of the dramatic shifts in monetary policy that has wreaked havoc in REIT-dom. In that same article I explained,
“Some of you are too young to remember the agony back then (Great Recession) – over 13 years ago – I have fond memories of the collapse of the financial tsunami that took out Lehman Brothers, Bear Stearns, and a host of other financial institutions.”
The odds are good that we’ll end up in a recession by the end of this year, especially since the strength of the labor market is giving the Fed incentive to keep tightening monetary policy to control inflation.
“When I first started writing on Seeking Alpha in 2010, there were very few REIT writers, and I spent the first few years trying to convince investors to get back in the game.”
I have vivid memories of the Great Recession.
My business partners were regional homebuilders back then, and I saw them liquidate an entire 500-home portfolio and over 3,000 lots in the course of 6 months. They had to file bankruptcy, and of course that’s when I began writing on Seeking Alpha.
This recession (if I’m right) will be much less severe than that one, and I’m betting it will be a garden style variety.
What do I mean by “garden style”?
That simply means that the impacts will be much less severe and short-lived. As Uma Moriarity, CFA, points out in her company’s 2023 REIT Outlook :
“…current demand for commercial real estate has surpassed levels many veterans have seen in their careers. As a result, vacancy rates across most core property types are fare lower today than during most downturns have faced in the past century.”
Clearly office vacancy rates are higher, but as Moriarty points out, “structural headwinds have been building here for years even before COVID.” She added,
“The pandemic-induced shift toward remote and hybrid work accelerated the rationalization of office space into new, high-quality, well-located assets. As a result, office vacancy levels across the country are higher than we have seen historically.”
But the other sectors are holding up just fine.
The other big difference with the Great Recession compared to the one we’re entering soon has to do with REIT leverage. Once again, Moriarity explains,
“…the capital management pf public REIT companies is superior to what it was going int the GFC. Leverage, as measured by debt to EBITDA or debt to asset value, is at much healthier and manageable levels…Given the strength of balance sheets, we’re not anticipating REITs to be forced to employ the same level of dilutive equity issuances to maintain operations as they did during the GFC.”
I find the above chart intriguing, especially the green box that I highlighted.
As you can see, in February 2007 REITs traded at 22.9x P/AFFO and they now trade at 18.9x. As Moriarity points out,
“…any negative impact on incomes due to a recession will pale in comparison to this dramatic shift in valuations caused by yield expansion. As a result, current valuations seem significantly more de-risked compared to the beginning of 2022…
REITs trading at such disconnected valuations compared to those of their underlying portfolios have historically been a harbinger for strong performance in the periods that follow.
After REITs trade below 85% of their underlying net asset values, the total return for REITs in the following year averaged 32.5% and the total return in the following three years has averaged 61.7%.”
While I certainly understand the fear of a looming recession, I’m very confident that the recovery could bring an enhanced opportunity to generate exceptional returns.
At iREIT we’re fixated on the highest quality companies (strong balance sheets) that are likely to generate above average dividend growth (5% or higher).
As Moriarity sums it up, “we anticipate this cycle will rhyme with history with an important positive caveat that REITs are far better positioned than during previous downturns.”
Camden Property Trust ( CPT )
Camden Property is a real estate investment trust (“REIT”) that specializes in multifamily properties that are primarily located in the Sunbelt region of the country. Their portfolio consists of 172 communities that contain 58,702 apartment homes with an average age of 14 years. CPT’s monthly revenue per occupied home averages $2,241 and their properties have an average occupancy of 96%.
CPT has excellent debt metrics with a long-term debt to capital ratio of 39.68% and a net debt to adjusted EBITDA of 4.1x. Their debt is 82.6% fixed rate and has a weighted average interest rate of 4.1% and a weighted average to maturity of 6.2 years. Plus they have plenty of dry powder with $1.1 billion available to them under their credit facility.
Over the last 10 years CPT has an average adjusted funds from operations (“AFFO”) annual growth rate of 5.05% and a compound dividend growth rate of 5.32%. Analysts expect AFFO to increase by 5% in 2024 and 7% in 2025. They pay a 3.75% dividend yield that is well covered with an AFFO payout ratio of 65.28%.
As seen above, Camden Property is currently trading at a P/AFFO multiple of 18.3x which is well below their long-term average P/AFFO multiple of 21.2x. If Camden’s stock gets back to its 5-year normal multiple over the next two years the stock would deliver a 17.5% annual rate of return (“ROR”). At iREIT, we rate Camden Property a BUY.
Realty Income Corporation ( O )
Realty Income is a triple-net lease REIT that specializes in single tenant, free-standing commercial properties that are located in all 50 states, the U.K., Spain, and Italy. They have 12,237 commercial properties that cover approximately 236.8 million leasable square feet and have 1,240 tenants that operate in 84 separate industries.
The majority of Realty Income’s portfolio consists of retail properties (81.9%), followed by industrial (13.3%) and gaming (2.9%). The industries they target are e-commerce resistant with grocery, convenience, and dollar stores representing their top 3 industries. Realty Income is also diversified by tenant with their top tenant (Dollar General) contributing only 4.0% to their annualized base rent (“ABR”).
Realty income has strong credit metrics with an A- credit rating, a net debt to pro forma adjusted EBITDAre of 5.3x and a fixed charge coverage ratio of 5.2x. Their debt is 85% fixed rate, 95% unsecured and has a weighted average term to maturity of 6.2 years. Plus, they have plenty of flexibility with $1.7 billion in total liquidity.
Over the last decade, Realty Income has an average AFFO growth rate of 6.99% and an average dividend growth rate of 5.76%. They pay a 4.93% dividend yield that is well covered with an AFFO payout ratio of 75.69%. Analysts expect AFFO to increase by 4% in 2024 and 7% in 2025.
Over the long-term Realty Income has traded at an average P/AFFO multiple of 18.9x but they are currently trading at a discount with a P/AFFO of 15.8x. If Realty Income gets back to their 5-year normal P/AFFO, it would deliver a 20.09% annual rate of return over a two-year holding period. At iREIT, we rate Realty Income a BUY.
Alexandria Real Estate Equities, Inc. ( ARE )
Alexandria Real Estate is an office REIT with a focus on life science properties. ARE is not a typical office REIT as they lease space to pharmaceutical, biotechnology, life science, and medical device companies. These tenants use ARE’s properties to conduct research and development in a laboratory setting, which are tasks that cannot be done from home.
Think of lab coats and beakers instead of desks and cubicles. Alexandria’s portfolio consists of 64 operating properties as well as development projects that are primarily located in Boston, New York City, San Diego, San Francisco, and Maryland.
ARE has approximately 850 tenants that includes names like Bristol-Myers, Moderna, and Eli Lilly, and had an occupancy rate of 94.8% as of December 31, 2022. ARE is well-diversified by tenant, with its top tenant (Bristol-Myers) only contributing 3.6% to their annual rental revenue and their top 20 tenants only contributing 31.7%.
Alexandria has outstanding credit / debt metrics with a credit rating of BBB+, a net debt and preferred stock to adjusted EBITDA of 5.3x and a fixed charge coverage ratio of 5.0x. ARE’s debt is 96.1% fixed rate and has a weighted average interest rate of 3.73% and a weighted term to maturity of 13.4 years. They have no debt maturities until 2025 and $5.3 billion in total liquidity.
ARE released 2023 first quarter results on April 24 and reported funds from operations as adjusted of $373.7 million for Q1-23, compared to $324.6 million in the first quarter of 2022.
On a per share basis FFO as adjusted came in at $2.19 per share vs $2.05 for the same quarter in the previous year. Alexandria updated their full year 2023 guidance for FFO as adjusted to come in at $8.91 to $8.96 vs their initial guidance of $8.86 to $9.06. The FFO as adjusted midpoint remains unchanged at $8.96.
Over the last 10 years ARE has an average AFFO growth rate of 4.78% and an average annual dividend growth rate of 8.62%. AFFO is expected to increase by 11% in 2023 and 7% in 2024. The currently pay a dividend yield of 3.90% that is secure with an AFFO payout ratio of 71.30%.
Currently ARE is trading at a P/AFFO multiple of 18.2x which is well below their long-term normal AFFO multiple of 21.5x. Over a two-year holding period, if ARE gets back to its 5-year average multiple it would result in a total annual rate of return of 25%. At iREIT, we rate Alexandria Real Estate a STRONG BUY.
Digital Realty Trust, Inc. ( DLR )
Digital Realty Trust is a data center REIT with a portfolio that consists of 316 data centers with over 200,000 cross connects. DLR has a global presence that serves over 4,000 customers with data centers located in the U.S., Europe, Latin America, Africa, Asia, Australia and Canada.
Their portfolio has a total of approximately 50.8 million rentable square feet that includes 9.2 million square feet of properties under development and 3.4 million square feet of space held for development. In 2022 DLR had an occupancy rate of 84.7% and has guided for occupancy to range between 85.0% to 86.0% in 2023.
DLR has a BBB credit rating and reasonable debt metrics with a net debt to adjusted EBITDA of 6.9x and a fixed charge coverage ratio of 4.9x. Their debt is 81% fixed rate, 97% unsecured and has a weighted average interest rate of 2.7% and a weighted average maturity of 5.2 years. Additionally, they have a well-laddered debt schedule with no significant maturities until 2024.
DLR has an average AFFO growth rate of 5.74% and an average dividend growth rate of 5.29% over the past decade. Analyst expect AFFO growth of 3% in 2023 and 6% in 2024. Their long-term P/AFFO multiple is 18.7x which compares favorably to their current AFFO multiple of 15.9x.
Plus, DLR pays a 5.01% dividend yield that is well covered with an AFFO payout ratio of 81.33%. At its current price, DLR could return 19.3% annually over a two-year holding period if it reverts to its 5-year P/AFFO. At iREIT, we rate Digital Realty a STRONG BUY.
Federal Realty Investment Trust ( FRT )
Federal Realty Investment Trust is a shopping center REIT that owns and manages retail and mixed-use properties located in the Mid-Atlantic and Northeast regions of the U.S. as well as California and Florida.
FRT owns or has an ownership interest in 103 properties that covers 25.8 million square feet and has approximately 3,300 commercial tenants and include around 3,000 residential units. FRT’s properties are 94.5% leased and 92.8% occupied as of year-end 2022.
Federal Realty was founded in 1962 and has paid quarterly dividends without interruption since that time. They are one of the few publicly traded companies that are considered a Dividend King with 55 consecutive years of dividend increases. Over that time period the have delivered a compound annual dividend growth rate of 7%.
FRT has a credit rating of BBB+ and solid debt metrics with a net debt to EBITDA of 6x and a fixed charge coverage ratio of 4x. Their debt is 86% fixed rate and their weighted average interest rate is 3.7%. Federal Realty has plenty of flexibility with $86 million in cash and $1.25 billion available to them under their credit facility.
Federal Realty has an average AFFO growth rate of 3.33% over the past 10 years and has expected AFFO growth of 4% in 2023 and 6% in 2024. FRT pays a 4.50% dividend yield, but the 91.86% AFFO payout ratio is higher than I’d like to see.
It is worth mentioning that the payout ratio has improved over the past three years so with the expected growth in AFFO this trend is likely to continue. FRT is trading a P/AFFO multiple of 20.29x, which is a significant discount to their normal P/AFFO multiple of 28.36x.
If the stock trades back to its 5-year normal AFFO multiple, it would result in a 30% total annual return over a 2-year holding period. At iREIT, we rate Federal Realty Investment Trust a BUY.
In Closing...
As always, thank you for reading and commenting and happy SWAN Investing!
For further details see:
I'm Rooting For A 'Garden Style' Recession