2023-08-12 07:00:00 ET
Summary
- English teachers teach the persuasive power of the number three, which is prevalent in art, math, and literature.
- Proper portfolio diversification requires more than just three REITs.
- We recommend Realty Income, Prologis, and American Tower as top real estate investment picks.
Three is an awesome number.
Just ask any elementary, middle, or high school English teacher. They train children to write reports with three supporting points of whatever thesis they choose.
"I like dinosaurs. They have funny sounding names. They look so different than most animals today. Some of them were big and scary."
Or:
"We need to remember our war heroes. They fought for our freedom. They have unique experiences worth considering. They can help us understand what causes conflict and how to better avoid it in the future."
English teachers teach that because of the persuasive capability of that number. After all, one is just a standalone fact and once is just an occurrence. Two doesn't command our respect, apparently, and twice could be a coincidence.
But three times?
That's a pattern.
It's compelling.
It says something.
Besides, three is such a prevalent number.
In art, there are three primary colors and three secondary colors. In math, three lines are the minimum necessary to form a full shape. And it shows up repeatedly in literature and storytelling too, from ancient mythology's three fates to Goldilocks and the Three Bears to science-fiction TV shows in the form of Charmed .
There's just something to be said about three.
Almost everyone seems to agree.
In which case, I want in on the action with my top three real estate investment picks… if I had to choose.
Proper Portfolio Diversification Requires a Whole Lot More Than 3
Ancient Greeks like Pythagoras - the man behind the Pythagorean theory, involving triangles - believed that the number three was the perfect number.
It was the number of the divine, representing harmony, wisdom, and understanding. Not to mention how it encapsulated time: past, present, and future. Birth, life, and death.
With all due respect to the ancient Greeks, I do have to say I'm very happy I don't have to choose just three REITs. A proper portfolio just isn't complete with such a small number.
As I state in Chapter 10 of my upcoming REITs for Dummies book:
"If you're working with a limited amount of money or want to ease into REIT ownership slowly, six separate stocks should provide a decent amount of sector diversification.
I'd say that's the minimum amount to achieve diversification, but it suffices nonetheless. You can better your odds further by perhaps selecting one (intelligently investigated) REIT from each major sector - apartment, retail, office, and industrial - and one from two newer sectors such as cell towers, self-storage, hotels, gaming, or the like.
"With that said, holding 8-10 REITs would be better. Because of course, the more (intelligently investigated) assets you can hold, the less likely you are able to catch a bad break.
"It also allows you to expand into other sectors and subsectors. Or you can choose different geographical focuses within sectors you already bought into. Suppose you have one apartment REIT that focuses on the U.S. East Coast. Well then, you can buy another that focuses on the Sunbelt so that, if some area-specific issue comes up in one place, your 'other place' holding will balance it out."
This just makes sense - perhaps even more so than listing three reasons to make a solid argument.
Another Disclaimer About Diversification Before I Detail My Top 3
I had to add the disclaimer above, and not just to cover my back.
I truly believe every word of what I wrote above.
Intelligent investing demands proper diversification.
So, unless you're Warren Buffett, that means holding a variety of assets across different sectors, subsectors, weightings, and geographies.
The multi-billionaire has waved away the concept of diversification before, calling it "protection against ignorance." To that, he added how the practice "makes little sense if you know what you are doing."
He believes the key to success is thoroughly knowing the investments in questions. And, to be fair, he's one of the Top 10 richest people in the entire world.
But, honestly, who knows if Buffett could be even more successful if he would diversify more. After all, he's not in the top three richest men anymore.
Would he be if he followed a different philosophy?
Ultimately, we don't know. Maybe Buffett is an exception to the rule.
However, what we do know is that the vast majority of investors who don't properly diversify don't do well. Whereas the vast majority of investors who do properly diversify enjoy comfortable retirements.
With all that said, if I had to own just three REITs… they would be very easy to pick.
Realty Income (O)
Realty Income has generated positive cash flow and has paid monthly dividends to their shareholders since their formation in 1969 after acquiring a single Taco Bell. They began trading on the New York Stock Exchange ("NYSE") after their public listing in 1994 with gross real estate assets valued at $450.7 million.
As of the end of 1995, their gross real estate assets grew to $515.4 million with approximately 686 properties located in 42 states covering 4.6 million square feet.
In 1996 they received an investment grade credit rating from all three major rating agencies and in 2015 they were added to the S&P 500 index and achieve the status of a Dividend Aristocrat in 2020 after 25 consecutive years of dividend increases.
Fast forward to the present, and Realty Income now has gross real estate assets totaling $47 billion with 13,118 properties located in all 50 states, the U.K., Spain and Italy that covers approximately 255.5 million leasable square feet.
The vast majority of their properties are freestanding commercial buildings leased to a single-tenant on a long term, triple-net basis.
In addition to their vast array of properties, Realty Income has 1,303 tenants doing business in 85 separate industries with a weighted average lease term of 9.6 years and a portfolio occupancy of 99%.
It is their sound business model, property and tenant diversity that has allowed them to deliver growth in their adjusted funds from operations ("AFFO") in 26 out of the last 27 years with a median AFFO growth rate of 5% since 1996.
Their consistent and dependable rental income has supported their monthly dividend, which has been increased for 29 consecutive years with 637 monthly dividends declared and 103 consecutive quarterly increases.
Realty Income released second quarter 2023 earnings results on Aug. 2 and reported total revenue of $1.02 billion for the three months ended June 30, 2023, vs. $810.4 million for the same period in 2022.
Funds from operations ("FFO") came in at $688.0 million, or $1.02 per share, compared to $608.8 million, or $1.01 per share in the second quarter of 2022. AFFO increased to $671.7 million, or $1.00 per share, compared to $583.7 million, or $0.97 per share in the second quarter in the previous year.
During the quarter they invested $3.1 billion in 710 properties at a weighted average cash lease yield of 6.9% and raised $2.2 billion from the sale of stock and approximately $1.0 billion through the issuance of senior unsecured notes.
Their financial position remains strong with a net debt to pro forma adjusted EBITDAre of 5.3x, a fixed charge coverage ratio of 4.6x, and $3.5 billion in total liquidity.
Over the past 10 years Realty Income has had an average AFFO growth rate of 6.14% and an average dividend growth rate of 5.76%. Analysts expect AFFO to increase by 2% in 2023 and then by 4% in both 2024 & 2025.
They pay a 5.10% dividend yield that is well covered with an AFFO payout ratio of 75.69% and currently trades at a P/AFFO of 15.15x, which is a discount to their normal AFFO multiple of 18.86x.
We rate Realty Income a Buy.
Prologis (PLD)
Prologis is a behemoth in the industrial space with a market cap of $113 billion which is more than all the other industrial REITs combined. As a point of comparison, the next largest industrial REIT is Rexford Industrial (REXR) which has a total market cap of $10.9 billion.
Prologis is a global leader in logistics real estate with 5,563 industrial properties that cover 1.2 billion square feet across 19 countries and four continents. The majority of their net operating income ("NOI") is derived from the U.S. at 85%, followed by Europe at 9%, South America at 4%, and Asia at 2%.
PLD's properties serve approximately 6,700 tenants that includes well established businesses such as Amazon, Home Depot, UPS, DHL, and FedEx and is critical to international trade as $2.7 trillion, or 2.8% of global GDP runs through their distribution centers.
In addition to their portfolio of industrial properties, PLD has over $38 billion invested in build out land for future development.
In addition to revenue generated from lease payments, PLD earns ancillary income through its Prologis Essentials program which is a value-add service they offer to help streamline and optimize their tenants operations. Through their Essentials program PLD offers racking, forklifts, generators and even furniture to provide turn-key access to their operators.
They also offer workforce training, robotics and improved automation to help optimize their tenants' processes. One of the more interesting aspects of their Essentials program is their energy and sustainability platform which includes solar paneling, fleet electrification, and EV charging stations which are located at their facilities.
Due to the enormous square footage that their properties encompass, PLD has a very long runway for rooftop solar installations and the resulting energy that can be captured, stored, and distributed to their tenants through their EV charging stations.
PLD is the second largest corporation with on-site solar in the U.S. and currently has 409 megawatts of generating capacity with a goal to hit 1 gigawatt worldwide by 2025.
Prologis recently announced second quarter operating results and reported core funds from operations ("CFFO") at $1.83 per share compared to $1.11 per share for the same period in 2022 and same store NOI growth of 8.9% on a net effective basis.
Their second quarter occupancy averaged 97.5% and their customer retention was reported at 70.5%. Additionally, PLD's balance sheet remains very strong with a debt to EBITDA of 4.2x and approximately $6.4 billion of liquidity.
Since 2013 PLD has delivered an average AFFO growth rate of 12.28% and an average dividend growth rate of 11.13%. Analysts expect AFFO to increase by 1% in both 2023 and 2024, and then by 17% in 2025.
While the AFFO growth forecast for the current year is much lower than their average growth rate, it is being compared against their 2022 AFFO per share which increased from $3.34 to $4.63, for a 39% increase in 2022.
Prologis pays a 2.8% dividend yield that is very well covered with an AFFO payout ratio of 68.27% and trades at a P/AFFO of 26.70x, which compares favorably to their normal AFFO multiple of 27.95x.
We rate Prologis a Buy.
American Tower (AMT)
While not quite as large as Prologis, American Tower is one of the largest REITs within our coverage with a market cap of approximately $85 billion. AMT is a global cell tower REIT that specializes in multi-tenant communications real estate that is leased to wireless service providers and television and radio broadcast companies.
Their portfolio consists of approximately 226,000 communication sites located in 25 countries that span across six continents.
In addition to their portfolio of cell towers, AMT recently entered into the data center space with their 2021 acquisition of CoreSite Realty and generates additional revenues through services they provide including rooftop and tower site management for third parties and tower-related services in the U.S. including structural analysis, construction management, and zoning and permitting.
American Tower released 2023 second quarter financial results on July 27 and reported second quarter revenue of $2.77 billion, which was a 3.6% increase over the revenue generated in the second quarter of 2022.
Property revenue increased by 4.4%, to $2.73 billion and adjusted EBITDA was reported at $1.74 billion for a 4.7% increase when compared to the same period in 2022.
However, AFFO per share in the second quarter came in at $2.46 which represents a 2% decline when compared to the second quarter of 2022.
During the second quarter AMT acquired 60 communication sites and other communications infrastructure assets primarily located in France and Spain for $30 million and completed the sale of its subsidiary, ATC Poland, for approximately $7.2 million.
AMT provided an update on their financial position with a net leverage ratio (net debt / adjusted EBITDA) of 5.3x and approximately $8.2 billion of total liquidity as of June 30, 2023.
Additionally, AMT provided updated full year 2023 guidance and raised the midpoints from their initial 2023 guidance on property revenue by $125 million and AFFO per share by $0.05.
Over the last decade American Tower has delivered impressive growth rates. Since 2013 they have had an average AFFO growth rate of 10.98% and an average dividend growth rate of 20.70%.
Analysts expect a slight decline in AFFO per share in 2023 but expect AFFO per share to increase by 8% in both 2024 and 2025. AMT pays a 3.36% dividend yield that is very secure with an AFFO payout ratio of 60.04% and currently trades at a P/AFFO of 18.83x, which is discount to their normal AFFO multiple of 23.19x.
We rate American Tower a Strong Buy.
What If I Owned Just 3 REITs...
Assume that I owned just three REITs and they were Safehold (SAFE), Medical Properties (MPW) and Innovative Industrial (IIPR)?
Do you think I would have any followers on Seeking Alpha?
The fact is, I do own these three REITs, however I've maintained responsible diversification and I've dollar cost averaged into shares. As Sir John Templeton explained,
"Diversification is a safety factor that is essential because we should be humble enough to admit we can be wrong."
The large majority of my holdings consist of high-quality REITs like the ones that I'm recommending in this article.
Sir John, coined "the world's greatest stock picker of the century" by Money magazine, was only right 66% of the time. So, if the greatest stock picker in the world needs to be diversified to protect against losses, the average investor can surely benefit from the practice of diversification too.
As a huge proponent of diversification, as he explained (in July 1949):
Diversification should be the cornerstone of your investment program. If you have your wealth in one company, unexpected troubles may cause a serious loss; but if you own the stocks of 12 companies in different industries, the one which turns out badly will probably be offset by some other which turns out better than expected.
As always, thank you for reading and commenting.
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.
For further details see:
If I Were To Own Just 3 REITs, It Would Be These