2023-09-18 07:00:00 ET
Summary
- REITs have underperformed in 2023, but their dividends remain consistent, and some are even raising their dividends.
- Quality REITs with a combination of quality and value could be a good investment opportunity.
- I believe that the Federal Reserve will start lowering interest rates soon, which could lead to a rise in REIT prices.
If you find this article’s title to be controversial, let me come right out and explain why I chose it.
Some people might accuse me of writing clickbait headlines. And, in this case, they’d be correct.
Hey, it made you look, right?
It also serves to introduce a controversial topic with an even more controversial association in order to make my actual controversial point sound less controversial. My hope is that, by the time you finish reading this, you’ll be completely calm – all your frustration vented right off the bat – allowing you to read all about how real estate investment trusts (REITs) are such great portfolio picks right now.
And without writing nasty comments once you’re done. Or at least not very nasty comments.
Of course, if you still think I’m insane and feel the need to tell me, that’s fine. I’m a big boy and can handle it.
Plus, I do understand why my premise might sound absurd. REIT share prices aren’t looking that great right now. It doesn’t take an expert to see that.
But it might take one to see that they’re not destined to stay down forever. In fact, the turnaround could be right around the New Year’s corner.
Just How Unflattering Today’s REIT Scene Really Looks
I’ve shown a year-to-date comparison of the Vanguard Real Estate Index Fund ETF Shares ( VNQ ) versus the S&P 500 before. But here’s where we’re at as of mid-September:
Clearly, the situation has gotten worse as the year progressed. And that’s on top of a lackluster 2022.
So why in the world do I still think REITs are worth it?
I’m sure a number of you already know the answer or at least part of it: dividends. The REIT sector is still paying out dividends just like always.
Many are even still raising their dividends just like always. Take the recent S&P Global report about “8 U.S. REITs” that just announced “dividend hikes in August.” The list consists of:
- Sunstone Hotel ( SHO ) – up 40%
- Terreno Realty ( TRNO ) – up 12.5%
- Iron Mountain ( IRM ) – up 5.1%
- Simon Property Group ( SPG ) – up 2.7%
- EastGroup Properties ( EGP ) – up 1.6%
- Gaming and Leisure Properties ( GLPI ) – up 1.4%
- Spirit Realty Capital ( SRC ) – up 1%
- Federal Realty Investment Trust ( FRT ) – up 0.9%.
The latter REIT, in case you didn’t know, has raised its dividend every year now for 56 years in a row. That’s the very definition of reliability right there.
Now, I’m not necessarily recommending any of them at the moment. There are multiple factors to consider, not just the dividends they pay out. For instance, who’s managing them… are their businesses well-placed in this post-Covid economy…
And what are they priced at compared to where they should be trading?
On that last one, we’ve already established that REIT shares overall aren’t well-loved in 2023. They’ve been floundering, lost, and forgotten by most investors in favor of artificial intelligence ((AI)).
And it doesn’t seem like there’s any end in sight to that slighting.
But in that case, keep in mind that appearances can be deceiving.
Quality and Value: The Perfect REIT Combination Could Be Yours
My regular readers know I require a solid combination of quality and value before I recommend a REIT.
If it’s a great company that’s trading at a premium, I’m going to be hard-pressed to buy it.
And if it’s selling on the cheap because it deserves to be selling on the cheap, it’s an easy pass for me.
So don’t think this next argument is my only one for liking the look of the REITs I’m about to write about. As I’ll display in each segment, the facts and figures behind them add up all around.
I’m also not one for market timing.
Again, if a quality stock is trading at a discount, then a quality stock is trading at a discount.
I don’t know if it’s bottomed out.
Nobody does.
And it could just as easily be headed higher – quickly.
So why waste time wondering when you can just get in on the good deal in front of you?
With that said, there are certain trading times that seem more compelling than others.
And I would argue that this is one of those times.
Because I believe the Federal Reserve will start lowering interest rates sometime soon.
Another controversial statement?
Here me out… by letting me quote Jared Dillian’s The 10th Man newsletter from September 14. Titled “The Fed Will Cut Rates in 2024,” it immediately clarifies:
“Given the uncooperative CPI reading we just got… it seems possible that the Fed will hike one more time before putting away the hiking boots. Or it might not. Either way, this rate hike campaign, notable for its speed and aggression, is close to being done.”
Disagree?
You’re more than welcome to.
But I think his rationale is still worth listening to.
Down With the Rate Hikes! Down With the Rate Hikes!
Dillian points out how:
“With real rates positive and inflation down significantly from the highs, the Fed will recognize that it has done enough (for now) and will pause. For sure, there will be some language in the directive that says it will remain vigilant on inflation and is prepared to hike rates more if necessary. But the Fed pretty much has to put that in there. For all intents and purposes… it should be done.”
He also points out how “the Fed has never maintained rates at the peak for more than nine months.” And how “the banking system is under an enormous amount of stress” – a well-known fact.
I can’t help but agree.
In fact, I had this article – title and all – planned out days before reading Dillian’s take.
Like him, I’m confident that, when rates start falling, prices should start rising.
I’ll just add that the biggest profits should come from the most unloved quality stocks available now.
I’m not saying AI companies won’t gain further on the announcement.
The chances are very high they will.
Note: I’m long Digital Realty ( DLR ), Equinix ( EQIX ), Iron Mountain, and American Tower ( AMT ) – all four REITs own Data Centers.
However, they’ve run long and far already.
They just don’t have as much to give percentage-wise.
In case you need the reminder, here’s VNQ vs. S&P 500 again:
So, here’s my bottom line : Like Dillian, I ultimately don’t know if the Fed has another hike in store for us or not.
I can’t predict the future.
But that handicap doesn’t bother me one bit.
I’m reading the signs and interpreting them as best as I can.
And even if I’m dead wrong in my conclusion?
These quality REITs are bound to bounce back strong from here eventually. And I’m not willing to waste the opportunity they present today.
4 Great American REITs
Now let’s dig into some Great American REIT Apple Pie…
I like the following REIT slices, and I think you will too!
Alexandria Real Estate ( ARE )
Alexandria Real Estate is a real estate investment trust (“REIT”) that specializes in life science office properties. ARE is a pioneer in the space and is the longest-running developer, owner, and operator of life science real estate since its formation in 1994.
Life science properties differ from traditional office space in that they lease out laboratory space to drug companies and research institutions rather than the normal office building filled with cubicles for staff workers.
ARE has properties in Boston, San Francisco, San Diego, New York City, Seattle, Maryland, and the Research Triangle and targets AAA innovation cluster locations to promote collaborative work and research environments.
ARE has a total asset base of 74.9 million square feet in North America that consists of 41.1 million rentable square feet (“RSF”) of operating properties, 14.7 million RSF of properties under construction or in development, and 19.1 million square feet of future development projects.
Alexandria has around 825 tenants that include multinational pharmaceutical companies, life science products and device companies, biotechnology companies, and academic/medical research institutions.
They have high-quality tenants and are well diversified with their top tenant, Bristol-Myers Squibb, only contributing 3.5% of their annual rental revenue, followed by Moderna, which contributes 2.6% and Eli Lily, which contributes 2.5%. 16 out of ARE’s top 20 tenants have investment-grade credit ratings and in total their top 20 tenants only contribute 31.4% of their annual rental revenue.
ARE has a weighted average remaining lease term of 7.2 years and a 93.6% occupancy rate for their operating properties.
Alexandria has an investment grade balance sheet with a BBB+ credit rating from S&P and a Baa1 credit rating from Moody’s.
They have excellent debt metrics including a net debt and preferred stock to adjusted EBITDA ratio of 5.2x, a fixed charge coverage ratio of 4.7x, and a long-term debt to capital ratio of 38.85%.
Their debt is 99.2% fixed rate with a weighted average interest rate of 3.69% and a weighted term to maturity of 13.4 years. Additionally, ARE has $6.3 billion of liquidity and no debt maturities prior to 2025.
Since 2013 ARE has had an adjusted funds from operations (“AFFO”) growth rate of 5.47% and an average dividend growth rate of 8.62%. Analysts expect AFFO to increase by 8% in 2023, and then by 9% and 8% in the years 2024 and 2025 respectively.
ARE pays a 4.35% dividend yield that is well covered with an AFFO payout ratio of 72.17% and is currently trading at a P/AFFO of 16.56x which is a significant discount to their 10-year average AFFO multiple of 24.21x.
At iREIT, we rate Alexandria Real Estate a Strong Buy.
Realty Income ( O )
Realty Income is a REIT that specializes in acquiring and leasing single-tenant, free-standing commercial properties on a triple-net basis. Their portfolio consists of more than 13,000 commercial properties covering approximately 255.5 million square feet that are spread out geographically with properties in all 50 states and international properties in the United Kingdom, Italy, Spain, and Ireland.
Realty Income looks to acquire properties in e-commerce-resistant industries through sale-leaseback transactions. As a percentage of their annualized contractual rent, their largest industry is convenience stores at 11.1%, followed by grocery stores at 9.9%, and dollar stores at 7.1%.
By property type, the majority of their portfolio consists of retail properties, which make up 82.5% of their rent, followed by industrial properties which contribute 13.1%, and gaming properties, which make up 2.7% of their annual rent.
As of the end of the second quarter, Realty Income’s properties were leased to over 1,300 tenants doing business in 85 industries, with a portfolio occupancy of 99.0% and a weighted average remaining lease term of approximately 9.6 years.
Realty Income is a Dividend Aristocrat with a track record of 29 consecutive years of dividend growth. Through multiple recessions and other significant economic disruptions, they have not only sustained their dividend but have increased it as well.
Realty Income has declared 638 consecutive monthly dividends and issued its 104 th consecutive quarterly dividend increase on September 12. In total, they have increased the dividend 122 times since their IPO in 1994.
Realty Income is one of only 8 REITs in the S&P 500 with an A-/A3 credit rating or better from S&P and Moody’s and has solid debt metrics including a net debt to pro forma adjusted EBITDAre of 5.3x, a long-term debt to capital ratio of 40.64%, and a fixed charge coverage ratio of 4.6x.
Their debt is 96% unsecured, 92% fixed rate, and has a weighted average term to maturity of 6.7 years. Additionally, they have minimal debt maturities in 2023 and $3.5 billion of liquidity as of the end of the second quarter.
Realty Income has an excellent track record of stable and dependable earnings and has delivered positive AFFO growth in 26 out of the last 27 years with a median AFFO growth rate of approximately 5% since 1996.
Since 2013 they have delivered a blended average AFFO growth rate of 6.14% and an average dividend growth rate of 5.76% and analysts expect 2% AFFO growth in 2023 and then 4% in both 2024 & 2025.
Realty Income pays a 5.57% dividend yield that is well covered with an AFFO payout ratio of 75.69% and currently trades at a P/AFFO of 13.89x which is a steep discount to their 10-year average AFFO multiple of 18.86x.
At iREIT, we rate Realty Income a Buy.
VICI Properties ( VICI )
VICI Properties is a triple-net lease REIT that specializes in experiential real estate including gaming properties, hospitality, and entertainment destinations.
Their portfolio consists of 54 gaming properties located in 15 states and 1 Canadian Province and includes iconic destinations such as Caesars Palace Las Vegas, MGM Grand, and the Venetian Resort Las Vegas.
Their gaming properties cover approximately 124 million square feet and feature roughly 60,300 hotel rooms, around 500 retail outlets, and over 450 nightclubs, restaurants, and bars.
Additionally, VICI owns 4 championship golf courses and 33 acres of undeveloped land adjacent to the Las Vegas Strip that can be used for future development projects.
VICI leases its properties to leading gaming and hospitality operators such as Caesars, MGM Resorts, and Penn Entertainment. They have 11 tenants, but the vast majority of their rent comes from their top 2 operators with Caesars making up 40% of their annual cash rent and MGM Resorts contributing 36% of their annual cash rent.
When including all tenant renewal options, VICI’s top tenant Caesars has a weighted average lease term of 32.1 years and their second largest tenant MGM Resorts has a weighted average remaining lease term of 51.8 years.
VICI is investment-grade with a BBB- credit rating from S&P Global and a Ba1 credit rating from Moody’s. They have solid debt metrics including a net leverage ratio of 5.6x, a long-term debt-to-capital ratio of 42.32%, and an EBITDA to interest expense ratio of 3.92x.
Their debt is 82% unsecured, 99% fixed rate, and has a weighted average term to maturity of 6.4 years. Additionally, VICI has no debt maturities in 2023 and approximately $4.0 billion of liquidity as of the end of the second quarter.
Since 2019 VICI has delivered an average AFFO growth rate of 7.29% and an average dividend growth rate of 10.80%. Analysts expect AFFO to increase by 11% in 2023 and then by 5% in both 2024 & 2025.
VICI pays a 5.27% dividend yield that is well covered with an AFFO payout ratio of 77.72% and trades at a P/AFFO of 15.20x, which compares favorably to their average AFFO multiple of 16.29x.
At iREIT, we rate VICI Properties a Buy.
American Tower
American Tower is a cell tower REIT that invests in multitenant communications assets that are leased to wireless service providers and television/radio broadcast companies. AMT has a global presence with approximately 226,000 communication assets located across 25 countries and on 6 continents.
They have approximately 43,000 cell towers located in the U.S. and Canada and approximately 181,000 international towers. In addition to their cell tower sites, AMT has approximately 1,700 distributed antenna systems as well as 28 data centers that are primarily located in U.S. metropolitan areas.
AMT derives the majority of its revenues through its long-term lease agreements, but it also generates additional revenue through provided services including third-party rooftop & tower site management and other related services including construction management, structural analysis, and construction site zoning and permitting services.
AMT received approximately 42% of its second quarter U.S. property revenue from its 3 largest tenants which are T-Mobile, AT&T, and Verizon. T-Mobile contributed 16% of their U.S. property revenue, followed by AT&T which contributed 14%, and Verizon which contributed 12% of their U.S. property revenue.
30% of their revenue is derived from international tenants and 8% of their revenue is generated by their portfolio of data centers. AMT’s leases typically include an initial non-cancellable term ranging from 5 to 10 years and generally offer multiple 5-year renewal periods.
Their leases have embedded escalators which are normally fixed at an average of 3% for their U.S. assets while their international assets escalators are generally based on local inflation indices. Additionally, only 6% of their leases need to be renewed in 2023 and the majority of their leases (73%) do not need to be renewed until 2027 or later.
American Tower is investment-grade with a BBB- credit rating from S&P Global. They have solid debt metrics including a net leverage ratio of 5.3x, a long-term debt-to-capital ratio of 82.49%, and an EBITDA-to-expense ratio of 6.54x.
As of June 30, 2023, AMT’s debt was 85.4% fixed rate, an improvement over their 2022 year-end fixed rate debt of 77.5%, and they have a weighted average term to maturity of 6.1 years.
Additionally, AMT has a ton of dry powder with approximately $8.2 billion of liquidity which consists of roughly $2.0 billion in cash and equivalents and $6.2 billion of availability under their revolving credit facility.
American Tower has some of the most impressive growth rates in the REIT sector and has delivered a blended average AFFO growth rate of 10.98% since 2013 and an average dividend growth rate of 20.70% over the past 10 years.
The stock pays a 3.40% dividend yield that is very secure with an AFFO payout ratio of 60.04% and trades at a P/AFFO of 18.58x which is a large discount to their 10-year average AFFO multiple of 23.19x.
At iREIT, we rate American Tower a Strong Buy.
You know me, I’m always looking for a catalyst to support a buy or sell recommendation.
And when it comes to REITs, I consider a Fed rate pause to be the perfect signal.
As viewed below, REITs have performed remarkably well when rate-hiking cycles have ended.
And when the Fed pauses rate hikes, that has historically been a critical inflection point; on average, REITs have returned 15.8% in the first 6 months after the Fed has stopped raising rates.
Furthermore, REITs have strong balance sheets, with average loan-to-values of less than 35%, and more than 86% of their debt is fixed for a term of more than 6 years.
This puts them in a position of strength and helps mitigate the impact of rising interest rates .
In closing, we believe that there are favorable entry points for REITs and investors should be considering the sector that promises above-average price appreciation over the next 3 to 6 months.
As always, thank you for reading and I look forward to your comments below.
For further details see:
Make American REITs Great Again