2024-01-15 07:00:00 ET
Summary
- A catalyst refers to an event that has occurred in a company that would significantly increase its valuation.
- The value of a company is based on its future ability to generate free cash flow.
- We're continuing to buy shares in these three REITs recognizing that their growth prospects are sustainable and that their valuation is attractive.
I don’t suppose you remember what you were doing on December 6, 2017.
But according to On This Day, you might have been listening to Post Malone’s “Rockstar” on the radio. It was No. 1 on the U.S. music charts at the time, after all.
(If you live in the U.K., it would have been Camila Cabello’s “Havana.”)
Maybe you were reading the news about how:
- Andrej Babiš was sworn in as prime minister of the Czech Republic.
- Rogerio da Silva, the infamous Brazilian drug lord, was arrested in Rio.
- I-405 in the Los Angeles, California, area was shut down and thousands were forced to evacuate due to yet another wildfire.
- Starbucks opened a 30,000 square-foot café in Shanghai, China, its largest café worldwide (at least at the time).
- President Donald Trump officially recognized Jerusalem as Israel’s capital and announced plans to move the U.S. embassy there.
Really, if you do an online search for “December 6, 2017,” that last story will dominate your results.
What you’ll be more pressed to find is “ A Textbook Catalyst That Should Move This REIT’s Multiple .” That was my Seeking Alpha article of the day, which detailed the value of a good stock catalyst.
Now, I never recommend buying a stock based on catalyst predictions alone. You always want investments that can stand on their own even in the ho-hum of normality.
But if you can own a faithful company before powerfully positive news hits…
Well, why would you pass that up?
Catalysts in Detail
I, for one, don’t like to ignore that kind of opportunity. And I don’t like you to either.
While I know not every catalyst is right for everyone to act on, I at least want you to know what’s available. That’s why I made sure to define what a catalyst is in that 2017 article.
“A catalyst refers to an event that has occurred in a company… that would significantly increase its valuation.
“The value of a company is based on its future ability to generate free cash flow. Therefore, a catalyst usually improves free cash flow, resulting in a higher implied valuation both because of the better future performance and because of a better implied multiple.”
In short, it’s good news that propels a business forward in terms of marketing, capability, and/or income.
Now, there are catalysts and potential catalysts. Many a dollar has been made on the former and many a dollar has been lost on the latter when the “potential” doesn’t materialize. That’s why I added how:
“As a REIT analyst, I focus on fundamentals that could materially drive earnings and dividend growth. To be considered a true catalyst, there must be justification to validate the sentiment, not just a suspicion or wild guess.”
This is very, very important to keep in mind. And I must also point out that even when all logical indicators point to a catalytic conclusion…
Something can still go wrong. Which brings me back to what I said in the introductory paragraphs: that “I never recommend buying a stock based on catalyst predictions alone.” And that “you always want investments that can stand on their own” regardless of what may or may not come.
That’s precisely why the following stocks looks like such a great play.
Potential Pushes to Power Profits
Catalysts came up a few times when Seeking Alpha interviewed me at the very end of October 2023. I got the opportunity to mention how huge artificial intelligence has been for data center REITs. And I’m not saying that train doesn’t still have room to run.
But at least some of that momentum – both realized and potential – has already been factored into connected companies’ share prices. So, investing in them now would come with more limited rewards from that one (still powerful) driving force.
In order to truly capitalize on a catalyst, you have to get in before it even happens. Which means you need to know what to look for and how to analyze it.
Sometimes it’s going to be something that smells like a merger in the making. This aroma can be subtle… but distinctive nonetheless once you get a good whiff.
It’s how I was able to predict in late August that Realty Income ( O ) would acquire Spirit Realty ( SRC )… which it went on to announce just about two months later.
It’s also how I saw Healthpeak ( PEAK ) going after Physicians Realty ( DOC ), another real estate investment trust ('REIT') merger announcement made in H2-23.
Other times, it’s changes in management that could catapult a share price into bigger and better profits. Or some other internal force in the making like a big, new contract or global expansion. But external economic charges can do the trick just as nicely.
Knowing all of that, here’s what’s on my REIT radar right now. I see current strength that shouldn’t be shaken if everything stays the same.
But if the changes I expect to come do in fact occur, then we should see even more meaningful growth I can’t help but tell you about.
VICI Properties ( VICI )
Speaking of catalysts for growth, this gaming REIT went public in 2018 and just several years later in 2022, VICI had achieved an investment-grade credit rating and inclusion into the S&P 500 , making it possibly the fastest REIT to achieve these milestones.
VICI holds a portfolio of some of the top gaming, hospitality, and entertainment destinations with trophy properties such as Caesars Palace, The Mirage, MGM Grand, and The Venetian Resort, all of which are located on the Las Vegas Strip.
VICI owns or has an ownership interest in 54 gaming properties that contain 4.2 million SF of gaming space and features over 60,000 hotel rooms, close to 500 retail outlets, and more than 500 restaurants, bars, sportsbooks, and nightclubs.
The gaming REIT also owns 4 championship golf courses and more than 30 acres of developable land next to the Las Vegas Strip.
In addition to its core gaming properties, VICI also invests in non-gaming experiential real estate that primarily consists of 38 family entertainment bowling centers which they acquired from Bowlero ( BOWL ) in 2023.
In total, VICI has a 127.0 million SF portfolio that consists of 54 gaming properties and 39 experiential non-gaming properties for a total of 93 experiential assets located in across 26 states and 1 Canadian Province.
We see several possible catalysts for VICI including the continued growth of Las Vegas (26 acres of undeveloped land strategically located adjacent to The LINQ and behind Planet Hollywood as well as 7 acres of Strip frontage property at Caesars Palace) and VICI’s expansion into other experiential categories.
Also, VICI has entered into several right of first refusal and put/call agreements that provide the opportunity for embedded growth - a pipeline that creates “low-hanging fruit” and provides VICI with visibility for future growth.
Las Vegas is one of the largest tourism cities in the world with 41 million visits as of the last twelve months (“LTM”) ending September 2023. Visitor spending during 2022 was recorded at $45.0 billion and 2022 gross gaming revenue was at an all-time annual record at $8.3 billion.
In addition to gaming, Las Vegas offers many other forms of entertainment including an up-and-coming sports presence with the recent addition of the Las Vegas Raiders, a new Formula-1 Racing site, the first NBA In-Season Tournament, and last but certainly not least, hosting the 2024 NFL Super Bowl.
More traction and growth in the region should be a positive catalyst for VICI as 47% of their gaming properties are in Las Vegas, and a good percentage of tourists go to Las Vegas to gamble. Or at least that would be my bet!
Additionally, VICI has been expanding into other experiential categories outside of casinos to diversify their revenue stream and gain a presence in states where gambling is not permitted.
In 2023, VICI acquired a portfolio of bowling entertainment centers that are located in 17 states, 11 of which VICI did not formerly have a presence in.
Since 2019 VICI has delivered an average AFFO growth rate of 7.23% and an average dividend growth rate of 10.11%. Analysts expect AFFO per share to increase by 11% in 2023, and then increase by 5% and 4% in the years 2024 and 2025 respectively.
Currently VICI pays a 5.27% dividend yield that is well covered with an AFFO payout ratio of 74.88% and trades at a P/AFFO of 14.64x, compared to its average AFFO multiple of 16.29x.
We rate VICI Properties a Buy.
Safehold ( SAFE )
SAFE is a ground lease REIT that provides long-term capital to commercial building owners and developers through sale-leaseback (“SLB”) transactions structured on a triple-net basis.
Like any other net lease REIT, Safehold will provide capital in exchange for the real estate. However, unlike traditional net lease transactions, SAFE looks to acquire the ground that the commercial property sits on, rather than the building itself.
Safehold has a $6.2 billion ground lease portfolio with a weighted average extended lease term of 92 years. Its largest market is Manhattan, which holds 10 assets and makes up approximately 23% of its gross book value. SAFE’s assets in Manhattan have an average rent coverage of 3.1x, and an average ground lease to property value (“GLTV”) of 48%.
SAFE’s typical or target ground lease ranges from $15 million to $500 million in transaction size, has a GLTV between 30% and 45%, and a ground lease rent coverage ranging between 3.0 times and 4.5 times.
SAFE’s ground leases have several distinct characteristics such as extremely long lease terms and residual rights.
Their ground leases are typically structured to range between 30 and 99 years and contain residual rights which allows SAFE to take both the ground and the commercial property once the lease expires or if the building owner defaults on the ground lease.
Since SAFE will receive ownership of the commercial building at some point (upon default / or lease expiry), they track the value of the property and treat any appreciation above their ground lease cost basis as Unrealized Capital Appreciation (“UCA”).
In the second half of 2018, SAFE formed a subsidiary called Caret which is intended to reflect the UCA above their ground lease cost basis. The value of SAFE’s UCA is monetized into a Caret Unit which has been used as part of their employee incentive plan and has been sold to outside investors as well.
A SAFE ground lease and its unique features is relatively new to the investment world. As companies have become more educated on ground leases, the demand for it has grown. Since SAFE’s IPO, their ground lease asset count has grown from 12 in 2017 to 135 by the third quarter of 2023.
Additionally, the estimated value of SAFE’s UCA has increased 23x since their IPO, with UCA estimated at $0.4 billion in 2017, compared to approximately $10.0 billion today.
SAFE IR
We believe the lack of understanding about ground leases and the monetization of UCA via their Caret units can be a catalyst for SAFE.
As businesses become more informed about ground leases and the advantages they offer, demand should continue to grow. Safehold has a lot of value in its UCA that we don’t believe is reflected in the stock price.
Along with the increasing demand for ground leases, SAFE’s subsidiary “Caret” could potentially be spun off, which would be a significant catalyst for value creation.
We rate Safehold a Strong Buy.
Realty Income ( O )
Realty Income is the largest net lease REIT with market cap of almost $43.0 billion and a 263 million SF portfolio that consists of single-tenant, free-standing commercial properties which are leased on a triple-net basis.
O owns or has an ownership interest in approximately 13,282 commercial properties located in all 50 states, the United Kingdom, Spain, Italy, and Ireland.
Their properties are leased to around 1,324 different tenants that operate across 85 separate lines of trade and their portfolio holds retail, industrial and gaming properties.
At the end of the third quarter, approximately 82.6% of their total portfolio rent came from retail properties, 13.1% came from industrial properties, while 2.6% of their portfolio rent came from gaming properties.
The company’s portfolio had a physical occupancy of 98.8% and a weighted average remaining lease term of roughly 9.7 years at the end of 3Q23.
When people hear Realty Income, the first thing they think of is its monthly dividend that has been consistently paid over its 54-year operating history.
Realty Income and its monthly dividend are so closely associated that the net lease REIT trademarked and is known as “The Monthly Dividend Company”.
Realty Income has increased its dividend 123 times since its public listing in 1994 and has increased its dividend for the last 105 consecutive quarters. In total, Realty Income has a remarkable record of 29 consecutive years of dividend growth and is recognized as a S&P 500 Dividend Aristocrats member.
We see Realty Income as a consolidator in the fragmented net lease space. A recent example of this is their proposed acquisition of both Spirit Realty ( SRC ) and Vereit.
The company estimates that the global net-lease addressable market is approximately $12 trillion and believes it has limited direct competition with its publicly traded net-lease peers.
All publicly traded net-lease REITs can enter into a sale-leaseback (“SLB”) transaction, but no other publicly traded net-lease REIT has the same size and scale that O has.
This gives Realty Income a broader set of SLBs to select from and allows them to take advantage of opportunistic deals that may be too large for other net-lease REITs to absorb.
We feel that opportunistic SLBs can be a catalyst for Realty Income given that S&P 500 companies in O’s addressable universe have more than $1.2 trillion of debt maturing between 2024 and 2027.
Given the current interest rate environment SLBs should continue to be an attractive source of financing and we expect Realty Income to continue to be a leader in the fragmented net-lease space.
Since 2014 Realty Income has had an average AFFO growth rate of 5.27% and an average dividend growth rate of 3.92%.
Analysts expect AFFO per share growth of 4% in 2024 and then 3% in 2025. Currently the stock pays a 5.21% dividend yield that is well covered with an AFFO payout ratio of 76.08% and trades at a P/AFFO of 14.72x, compared to its average AFFO multiple of 18.78x.
We rate Realty Income a Buy.
In Closing
We view rate decreases as the biggest catalyst for REITs as their cost of capital will be the key driver.
Given the volatility in the capital markets, incrementally a lower 10-year is a benefit to 2024 and beyond for growth.
The Fed has signaled that rate hikes are largely over and as I posted on X (formerly Twitter), "we continue to see the first rate cut of the cycle coming in May."
@rbradthomas
As REIT investors, a lower cost of capital is supportive of earnings growth.
In addition, we like these three REIT consolidators because they will be able to continue to grow their respective portfolios. The net lease and ground lease sectors are highly fragmented and as consolidation unfolds these REITs will continue to generate scale advantages.
Thus, we're continuing to buy shares in Realty Income, Safehold, and VICI Properties recognizing that their growth prospects are sustainable and that their valuation is attractive.
As always, thank you for reading and 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:
It's All About The Catalysts