- Modiv recently transformed itself from a private REIT to a public one.
- While I can't complain about the moves that management has made this year, it's undeniable that they have one hand tied behind their backs by a high cost of equity.
- The preferred stock's dividend is higher yielding and safer than that of the common stock.
Thesis: The Preferred Stock Is Still Preferable
Modiv Inc. ( MDV ) is a newbie net lease real estate investment trust ("REIT") that just IPO'd in February of this year. Formerly, it operated as a private REIT called "Rich Uncles."
In my first article on MDV, I described it as an " Intriguing, High-Yielding, Small Cap Net Lease REIT With A Disadvantage ." That disadvantage - a high cost of capital - is still there. In this article, I want to discuss updates on MDV and show why I still only own the preferred stock instead of the common shares.
With the midpoint of MDV's AFFO per share guidance set at $1.31, MDV's share price of $15.95 (as of this writing) marks a price to AFFO of 12.2x. That is quite cheap, well below the average valuation for net lease REITs. But as we'll see below, it is cheap for a reason.
MDV offers a 7.2% dividend yield, paid monthly. But the preferred stock has an even higher yield and is far safer than the common dividend.
Update On Modiv
MDV owns a tiny portfolio of 48 properties across 16 states, and the stock's market cap is a mere ~$120 million. The portfolio breaks down by property type in the following way:
- Industrial: 51%
- Office: 30%
- Retail: 19%
Though this year so far has been one of major transformation for MDV (private to public in addition to portfolio turnover), it's worth noting that the REIT has managed to turn in pretty decent adjusted funds from operations ("AFFO") per share numbers in the midst of it:
Q2 2022 AFFO/sh Growth | 2022 YTD AFFO/sh Growth | |
Agree Realty ( ADC ) | 10.4% | 13.3% |
EPR Properties ( EPR ) | 73.2% | 94.3% |
National Retail Properties ( NNN ) | 5.2% | 4.6% |
Realty Income ( O ) | 10.2% | 12.1% |
STORE Capital ( STOR ) | 16% | 19.6% |
VICI Properties ( VICI ) | 4.3% | 0% |
W. P. Carey ( WPC ) | 3.1% | 6.4% |
Modiv Inc. | 2.9% | 8.5% |
Compare MDV to VICI Properties ( VICI ) in particular, which has undergone similarly major transformation this year with the $17 billion acquisition of a fellow casino REIT. Now, VICI's portfolio transformation is arguably greater than MDV's, but it does demonstrate that MDV has managed to keep growing in the midst of turbulent markets, an IPO, and heavy portfolio turnover.
This growth did come with a lot of equity issuance, admittedly.
Though MDV's total AFFO increased 18.3% YoY in Q2, AFFO per share increased only 2.9%, from $0.34 last year to $0.35 this year.
Likewise, though total AFFO increased 24.6% YoY for the first six months of 2022, AFFO per share only increased 8.5%.
So, fundamental performance has been decent, but how about stock price performance? Since the IPO, MDV's stock really has not been able to gain much traction.
The chart below is admittedly messy, but it shows MDV's stock price performance (in purple) since March (when the REIT's post-IPO volatility cooled down) compared to that of many net lease REIT peers.
As you can see, MDV has been the second worst performer, behind only STORE Capital ( STOR ). This, I suspect, is due largely to three things:
- Micro-cap size
- 30% single-tenant office exposure
- Relatively high debt
We'll touch on point #3 below, but as for the office exposure, it's worth briefly pointing out that management is taking strides to decrease its office real estate holdings. During the summer months, for instance, MDV has sold two office properties for an average cap rate of 7.56%. Since September 2021, office exposure has come down by 20 percentage points.
MDV has purchased several industrial properties along with a KIA dealership to help shrink the office portion of the portfolio. As far as I can tell, these acquisitions appear to be smart ones, although their initial, cash cap rates average a mere 6.43%, which is a thin spread over my estimated weighted average cost of capital of about 6%.
Fortunately, these acquisitions do have above-average annual rent escalations, so the effective investment spread should increase over time.
Balance Sheet
MDV obviously does not have a credit rating yet. It would not be a good use of time or money to pursue one at this point. But let's just say that, as the portfolio remains in transition, so also does the balance sheet.
We can see this by observing the fluctuations of net debt to EBITDA by quarter:
- Q2 2021: 8.3x
- Q3 2021: 5.2x
- Q4 2021: 6.8x
- Q1 2022: 6.7x
- Q2 2022: 6.9x
When you are as small as MDV, any changes in the balance sheet - any debt paid down from a sold property or new loan entered into - will make a big difference.
I was intrigued to find that MDV's debt balance has shifted from primarily mortgages at the end of 2021 to primarily a credit facility as of Q2 2022 (left column below).
The Q2 10-Q explains what happened here:
On January 18, 2022, we used funds from our initial borrowing from our Credit Facility to pay off 20 existing property mortgages on 27 properties, the $36,465,449 mortgage on the KIA auto dealership property which we acquired on January 18, 2022 and repayment of our Prior Credit Facility and related interest, aggregating $153,428,764.
This refers to a new credit facility initiated in January 2022 for a four-year, $100 million credit revolver in addition to a five-year, $150 million term loan. The credit revolver bears interest at 3.96% and is floating, while the term loan pays a fixed rate of 3.86%.
This shift proved shrewd, as it lowered interest costs by shifting most of the mortgage debt onto a lower cost term loan. Why it is called a "credit facility term loan" when it is fixed for five years, I am not sure.
Modiv's Preferred Equity Is My Preference
Modiv's Series A Preferred ( MDV.PA ) pays an annual dividend of $1.84, and the shares currently trade just under $24 (4.4% under the redemption value of $25), which puts the dividend yield at 7.7%. But is that high yield safe?
Let's do some investigating.
Preferred dividends amount to $921,875 per quarter - or $0.92 million.
For the second quarter of 2022, I subtract all cash expenses (G&A, interest expense, property expenses) without subtracting the non-cash expenses to arrive at $5.62 million. As such, the preferred dividend payout ratio amounts to a mere 16.4%. That's a 6.1x preferred dividend coverage ratio.
That is what I would call a highly safe preferred dividend.
Bottom Line
I really don't have any gripes about the way management has navigated portfolio transformation or balance sheet tuning this year. Even so, MDV's common stock is unloved by the market for reasons that are unlikely to change anytime soon. It's a microcap stock with significant office exposure and relatively high debt.
And though one could argue that at 12.2x AFFO and a 7.2% dividend yield, that is already priced in. But for net lease REITs that are heavily reliant on the ability to issue low-cost equity for growth, problems being priced in equates to a higher cost of equity, making it harder for the company to remedy its problems. This negative, self-perpetuating cycle is a dangerous one for net lease REITs, precisely because it can be so hard to escape.
I have little confidence that MDV will be able to escape this cycle and earn a higher valuation from the market anytime soon, which makes the preferred stock and its higher yield a much more attractive holding in my opinion.
For further details see:
Modiv: Executing Well But Hampered By 3 Problems