2023-06-17 07:00:00 ET
Summary
- 'I don't get no respect' was Rodney Dangerfield's way of saying "no one liked me."
- I know what it feels like when nobody likes you, especially being a REIT analyst and investor.
- While Mr. Market gives REITs no respect, I certainly do, and I have a high level of confidence that they will not only survive but thrive in the months ahead.
This article was published on iREIT© on Alpha on Thursday, June 15, 2023.
I get no respect.
That's the iconic catchphrase that was at the centerpiece of Rodney Dangerfield's career and earned him respect as one of the most famous comedians of all-time.
'I don't get no respect' was Dangerfield's way of saying "no one liked me," which served as motivation for him as he grew up and was raised by a single mother.
I know what it feels like when nobody likes you, especially being a real estate investment trust ("REIT") analyst and investor. Just look at the performance of Vanguard Real Estate ETF ( VNQ ) year-to-date:
Boy have things changed.
The 10-year (US10Y) has moved from 1.5% to 3.8%, which means credit spreads have widened, making it harder for REITs to grow.
Yesterday, the Federal Reserve paused the rate hike cycle after 10 consecutive meetings of raising rates. That was somewhat expected…
However, odds are good that rates will rise again in July.
All eyes are on inflation and jobs, and the two-most important words spoken this week from Chairman Powell was "additional hikes."
Note: hikes is plural, meaning more than one.
The dot plot showed that the median expectation is now a fed funds rate of 5.6% by the end of 2023. The fed funds rate currently sits at 5-5.25%, which is back at the levels last seen in 2006/2007.
Also, during the Fed Chair's press conference, he noted that rate cuts are a "couple of years out."
You know now why REITs get no respect, and the bigger question is perhaps when will REITs gain respect?
REITs moved up in the morning and then sold off with the Fed's pause decision was released, but they clawed back to end the day (+.41%).
R-E-S-P-E-C-T That's What It Means To Me
Most (not all) REITs are well positioned to navigate in a more capital-constrained marketplace. They have stronger balance sheets as compared to where they were during the Global Financial Crisis - and the financing landscape is by no means as dire as what existed when capital dried up back in 2008.
Many of the REITs in our coverage spectrum have laddered out their debt maturities and reduced leverage, with less exposure to floating rate debt. As Mark Streeter, managing director and team leader in North American credit research at J.P. Morgan, explains,
"A lot of REITs have really cleared their debt maturity decks, particularly in 2019, 2020, and 2021 in the low yield environment."
During those 3 years, core property REITs (office, industrial, retail, residential, self-storage, health care, triple net) alone issued $115 billion in bonds, according to J.P. Morgan. A lot of REITs have not only addressed their 2023 maturities but also their 2024 maturities.
Fixed Versus Floating Rate Debt
Also, most bank lines of credit held by REITs are undrawn, so there is plenty of capacity for most REITs to wait out this environment if necessary. According to Rick Romano, managing director at PGIM real Estate,
"There were some lessons learned from the GFC where REITs did a better job of terming out their debt…They also didn't really reach for the low-hanging fruit of variable interest rate debt as much, although some companies did that."
According to Nareit,
"leverage remained modest with a weighted average of debt-to-market assets at 33.9% for equity REITs as of the 2023 first quarter. In addition, 87% of the debt REITs were carrying was fixed rate, with a weighted average term to maturity of 82 months or nearly seven years."
In addition, "debt to EBITDA ratios averaged 5.9x for all equity REITs as compared to levels of 8x during the GFC." Romano says,
"Those metrics are pretty good given an environment with tighter liquidity and higher rates."
Secured and Unsecured Debt
We believe the winners will be the REITs that have the strongest balance sheets and are able to issue unsecured debt (75% or total REIT debt is unsecured).
Being able to access unsecured debt is a key competitive advantage, which is a reason we emphasize investment grade credit ratings.
While there's no way to know precisely when rates will pause, the REITs that can maintain financial flexibility should be able to navigate the environment and continue to generate earnings and dividend growth.
While I don't know when we'll be out of the tunnel, I can see the light at the end of it. Most Fed officials expect the central bank's benchmark rate to top out at 5.6% at the end of 2023, according to the central bank's Summary of Economic Projections published on Wednesday.
That's 50 basis points (two rate hikes) higher than the 5.1% projected peak logged in the March outlook.
Rate cuts will likely start in 2024, with the median dot for that period also raised to 4.6% from 4.3% in March, as inflation, albeit easing, proved stickier than some policymakers had anticipated.
From there, the rate is expected to fall to 3.4% (vs. 3.1% in March view) and the median long-term dot was unchanged at 2.5%.
3 REITs Worth Respecting
Now let's examine a few REITs that are on our high conviction list. The common denominator for these (3) REITs is that they all generate very high-quality earnings - repeatedly.
In addition, all of these REITs are A-rated, which is certainly correlated to the consistent cash flow and dividend growth for these companies.
First up is Realty Income Corporation ( O ), a net lease REIT, that has exceptionally high-quality earnings based on its diversification attributes: by geography (12,400 properties in 50 states and Europe), by industry (non-discretionary, low price point, and / or service-oriented component to their business.), and by lease structure (WALT is ~10 years).
As referenced earlier, we're focused on REITs with fortress balance sheets, and Realty Income checks that box. In 2009 (annual report) the company was rated BBB+ (Fitch) and BBB (by S&P) and now the company is rated A-. As you can see below, Realty Income's payout ratio (based on adjusted funds from operations, or AFFO) was 93% in 2009 and is a comfortable 77% today.
What this means is that the mousetrap has improved, and this blue-chip REIT is positioned to navigate the current high-rate cycle. Although Mr. Market gives "no respect" to "the monthly dividend company," I certainly do.
Shares are trading at $61.18 with a P/AFFO multiple of 15.5x (normal is 19.2x). The dividend yield is 5.0% (well-covered) and iREIT© forecasts shares to return over 20% annually.
Next up is Camden Property Trust ( CPT ) is a sunbelt-focused apartment REIT that also has an exceptionally high-quality earnings stream. The company owns 172 communities (58,700 homes) in 15 major markets: DC, Raleigh, Charlotte, Nashville, Atlanta, Orlando, Tampa, South Florida. Dallas, Austin, Houston, Denver, Phoenix, San Diego, and LA.
The balance sheet is also a "fortress" with debt metrics that include 82.4% fixed rate debt, 91.3% unsecured debt, 6 years weighted average maturity of debt, and 4.3x net debt-to-Annualized Adjusted EBITDAre. In 2009, CPT was rated BBB (by S&P) and Baa1 (by Moody's) and currently enjoys an A- rating.
Once again, CPT's balance sheet is in much stronger shape today and is well-positioned to navigate the current cycle. Shares are now trading at $111.76 with a P/AFFO multiple of 19.0x (normal range is 20.6x). The dividend yield is 3.6% (well-covered), and iREIT© forecasts shares to return over 20% annually.
Finally, we have Alexandria Real Estate Equities ( ARE ), an office REIT that focuses on the life science sector within advanced technology cluster locations.
The company targets markets such as Greater Boston, the San Francisco Bay Area, New York City, San Diego, Seattle, Maryland, and Research Triangle. The REIT generated high quality earnings from over 850 tenants, with an asset base in North America of 75.6 million square feet.
Alexandria has a very strong balance sheet with $5.3 billion in liquidity, and no debt maturities until 2025. The company has a very low and conservative FFO payout ratio, 55% for Q1-23 annualized, with 5.3% increases in common stock dividends over the last 12 months.
The company has projected $375 million in net cash flows from operating activities after dividends for reinvestment. At this rate, this represents over $1.1 billion of capital for reinvestment over the next three years.
The company was not rated in 2009 and received a BBB- rating in 2011 that was upgraded in 2017 to BBB. The company is now rated BBB+ by S&P.
Once again, what makes the ARE REIT attractive is the fact that it delivers very predictable earnings that grow over time. As seen above, analysts forecast growth of 8% in 2024 and 10% in 2025. Shares are now trading at $121.92 with a P/AFFO multiple of 18.2x (normal is 28x). The dividend yield is 4.1%, and iREIT© forecasts shares to return over 25% annually.
In Closing…
In general, the most important takeaway from this article is that growth and ROIC are the key drivers of value.
Specifically, earnings growth is created when development and acquisitions generate ROIC greater than its cost of capital. The amount of value they create is the difference between cash inflows and the cost of the investments made.
Even though rates have moved higher (and faster than many forecasted), all three of the REITs have been able to generate accretion because of their conservative capital structures.
As mentioned, these three REITs are in much better shape in 2023 than they were in 2009 due to their conservative risk management practices.
While Mr. Market gives them (REITs) no respect, I certainly do, and I have a high level of confidence that they will not only survive but thrive in the months ahead…follow the money!
For further details see:
REITs Get No Respect