2023-07-26 07:00:00 ET
Summary
- For industrial REITs the strong fundamentals (fueled by growth in online sales) bode well for the continuation of excellent tenant demand and strong rent increases.
- We also remain bullish on data center REITs because demand prospects are improving (e.g., bookings of new leases and rent pricing).
- For cell towers, we remain positive on the long-term secular growth trends underpinning wireless.
Co-produced with Leo Nelissen.
Back in 2022, we provided members with our 2023 REIT (real estate investment trust) Roadmap and explained:
For Industrial REITs strong industrial fundamentals is likely to persist into 2023 and beyond supporting attractive earnings growth prospects for REITs... a slowdown in development deliveries and potential delays of construction projects will potentially ease supply risks in 2023."
Tower REITs "remain a core sector for iREIT and heading into 2023 we anticipate a strong fundamental year for tower companies as carrier 5G deployment capex hit its stride and international markets blossomed. 2023 should remain a strong domestic carrier 5G deployment year.
We remain bullish on Data Center REITs looking ahead to 2023 because of continued secular demand growth and improving pricing dynamics which emerged in late 2022. After years of declining releasing spreads, both Digital Realty ( DLR ) and Equinix ( EQIX ) have described rapidly improving pricing power allowing them to aggressively raise prices in key markets across the world.
Now, halfway through 2023, our OVERWEIGHT allocations in these sectors are paying more than dividends.
For industrial REITs the strong fundamentals (fueled by growth in online sales) bode well for the continuation of excellent tenant demand and strong rent increases for industrial REITs.
We also remain bullish on data center REITs because demand prospects are improving (e.g., bookings of new leases and rent pricing), construction is moderating due to higher costs, and valuations are discounted relative to recent data center acquisitions.
And for cell towers , we remain positive on the long-term secular growth trends under-pinning wireless including strong secular growth expectations for mobile data usage, 5G technology, autonomous cars, connected homes, and 3D video; all of which will require increased wireless bandwidth and increased spending by mobile carriers.
My overweight exposure to these sectors has generated +11.8% returns YTD led by the following holdings:
- Iron Mountain ( IRM ) +27.3%
- Digital Realty Trust, Inc. ( DLR ) +23.3%
- STAG Industrial ( STAG ) +18.6%
- Prologis, Inc. ( PLD ) +10.5%.
Biggest underperformer has been American Tower Corporation ( AMT ), which we’ve doubled down on.
Now that we’re halfway thru the year, I wanted to share with you some of my top picks within the Tech Trifecta category.
The Tech-Trifecta
Digital Realty Trust
Digital Realty invests in data centers that offer a full spectrum of services including colocation interconnection, dedicated data halls for hyperscale customers, and enterprise hybrid solutions.
DLR is a global company that serves approximately 5,000 customers with data centers located in the United States, Europe, Canada, Asia, Latin America, Africa, and Australia. They own or have an ownership interest in over 310 data centers with more than 214,000 cross connects that provide solutions for a variety of customers including cloud providers, business enterprises, and network service providers.
The majority of their annualized base rent (“ABR”) comes from North America at 53% and cloud providers makes up their largest customer base at 39% of their annualized recurring revenue (“ARR”). They own the majority (86%) of the data centers in their portfolio and about half of their customers are investment grade or equivalent.
Digital Realty has reasonable debt metrics and is investment grade with a BBB credit rating. DLR has a first quarter net debt to adjusted EBITDA of 7.1x, slightly up from their previously reported leverage ratio of 6.9x, and a fixed charge coverage ratio of 4.4x, which is down from 4.9x as of the end of 2022. Their debt is 97% unsecured and 81% fixed rate with a weighted average term to maturity of 5 years.
Additionally, they have minimal debt maturities in 2023 and $1.3 billion available to them under their credit revolver.
Over the last 10 years, DLR has delivered an average adjusted funds from operations (“AFFO”) growth rate of 5.37% and an average dividend growth rate of 5.29%.
Analysts expect AFFO to increase by 3% in the current year and 7% in 2024. They have increased their dividend for 17 consecutive years and currently pay a 4.03% dividend yield that is well covered with an AFFO payout ratio of 81.33%.
The stock is trading at a P/AFFO of 19.9x, which is slightly above their 10-year normal AFFO multiple of 19.15x (Fair Value).
We rate Digital Realty Trust a Buy (not a Bargain).
American Tower Corp
American Tower invests in wireless and broadcast communications real estate that consists of approximately 226,000 communications sites that includes more than 181,000 international cell towers and around 43,000 cell towers located in the U.S. and Canada.
AMT has a global presence with communication infrastructure located in 26 countries that span 6 continents, and is one of the largest real estate investment trusts with a market capitalization of approximately $85 billion.
AMT primarily specializes in cell towers but also has a portfolio of more than 1,700 distributed antenna system networks and 28 data centers. In addition to the cell tower space they lease, AMT also manages rooftop sites and provides services including construction management, structural analysis, and zoning and permitting.
America Tower is investment grade with a BBB- credit rating and has solid debt metrics including a net leverage ratio of 5.2x and an interest coverage ratio of 6.78x.
Their debt is almost 80% fixed rate with a weighted average remaining term of 5.8 years, and they have $7.7 billion of liquidity available to them as of the end of the first quarter.
As seen below, AMT’s first quarter financing activities both reduced their floating rate debt exposure as well as extended their debt maturities.
Since 2013, AMT has had an average AFFO growth rate of 11.08% and an average dividend growth rate of 20.70%. Analysts project AFFO to fall by 1% in 2023, but then to increase by 9% in both 2024 & 2025.
They pay a 3.26% dividend yield that is very secure with an AFFO payout ratio of just 60.04% and trade at a P/AFFO of 19.43x, which is well below their normal AFFO multiple of 23.19x.
We rate American Tower a Strong Buy.
Prologis
Prologis is a global industrial REIT that specializes in logistics real estate in high-growth markets that are leased to a customer base of approximately 6,700 who primarily use their properties for business-to-business and online fulfillment.
PLD’s portfolio consists of approximately 5,563 industrial properties that have a weighted average lease term of approximately 4 years and an occupancy rate of 97.5%. In total PLD’s portfolio encompasses roughly 1.2 billion square feet with industrial properties located in 19 countries and across 4 continents.
Their global scale is so large that 2.8% of global GDP, or $2.7 trillion, passes through their distribution centers each year. In addition to the massive scale of their real estate, PLD also has $38.3 billion invested in land banks that can be used for future development.
On July 18 Prologis reported their 2 nd quarter earnings results. Net earnings per diluted share came in at $1.23 for the 2 nd quarter vs $0.82 for the same period last year and core funds from operations ("CFFO") in the 2 nd quarter was reported at $1.83 per diluted share compared to $1.11 in the 2 nd quarter of 2022.
The current 2 nd quarter results include $0.58 per share from net promote income from PLD’s Strategic Capital business, which was not included in the CFFO figure from 2022. Additionally, they reported same store growth in net operating income (“NOI”) increased 8.9% on a net effective basis and 10.7% on a cash basis.
PLD reported a 2Q23 average occupancy of 97.5%, down from 98.0% in 1Q23 and slightly down from the 97.6% average occupancy reported for the same period in the prior year.
Likewise, customer retention was reported at 70.5% in 2Q23, which is down from 77.2% in 1Q23 and down from 78.6% in the same period last year.
Prologis increased guidance for GAAP earnings to come in between $3.30 and $3.40 per share and increased CFFO guidance (excluding promotes) to range between $5.06 and $5.10 per share with the midpoint representing more than 10% growth on an annual basis.
PLD also highlighted that after $4 billion of investment during the 2 nd quarter, their balance sheet remains strong with approximately $6.4 billion of liquidity and a debt to EBITDA of 4.2x. Additionally, they highlighted that they raised roughly $7 billion in debt financing at an average interest rate of 4.9% with an average term of 8 years.
In terms of the increased vacancy, PLD believes this will stabilize in 2024 as they expect new supply will decline as development starts continue to fall in 2023 and that 2024 deliveries will fall short of demand which should reduce vacancy over the next year.
During the Q&A , Hamid Moghadam, the CEO of PLD commented that they are pushing rents pretty hard and are targeting occupancies a little lower than 98%. He went on to say that they track the leases lost due to price and adjust accordingly to figure out the tradeoff between rental rates and occupancy levels.
Several questions revolved around Southern California and the uptick in vacancies. PLD’s acknowledged that vacancy has grown and attributed it partially to the port operations that have not yet returned to normal, as well as some customers that are diversifying their operations to other markets in the Southwest.
Due to these factors, PLD reduced their forecast for rent growth in Southern California in 2023, but went on to say that vacancy still remains low in the region and with supply constraints and the large consumption base they believe strongly in the Southern California market.
Since 2013, PLD has delivered an average AFFO growth rate of 12.15% and an average dividend growth rate of 11.13%. They pay a 2.83% dividend yield that is well covered with an AFFO payout ratio of 68.27% and trade at a P/AFFO of 26.66x, which compares favorably to their normal AFFO multiple of 27.95x.
We rate PLD a Buy.
Rexford Industrial Realty, Inc. ( REXR )
Rexford invests in industrial properties that are located in the coveted region of Southern California (“SoCal”). While all of their industrial properties are located in this region, SoCal has roughly 21 million residents and over 600,000 businesses, making it the largest market in the U.S. and the fourth largest global market.
In addition to its enormous economy, SoCal has high-barrier to entry with a low supply of developable land due to natural barriers such as mountains and oceans as well as restrictive zoning regulations.
REXR owns or has an ownership interest in 365 industrial properties which encompass approximately 44.2 million square feet and has an average same property occupancy rate of 98%.
While REXR is geographically concentrated, they have a diverse tenant base with approximately 1,600 tenants, and no tenant accounting for more than 2.2% of their ABR.
Rexford Industrial released their 2 nd quarter results on July 19 and reported net income of $0.26 per share compared to $0.22 per share in the same period a year ago.
Core FFO of $108.4 million was a 32.8% increase over the prior year’s quarter, and on a per share basis Core FFO of $0.54 represented a 10.2% increase over the same period in the previous year.
Additionally, same property net operating income increased 8.0% and same property cash net operating income increased 10.0%.
REXR had a 98% average same property occupancy rate which was supported by 450,000 SF of positive net absorption as well as 2.1 million SF of leasing activity with leasing spreads of 75% on a cash basis.
Their management team went on to say that they are seeing their infill markets occupancy and rents normalizing compared to the exceptional levels seen during the pandemic. They expect to see some volatility in market rent growth over the short term, but said that over the long term they expect superior rent growth due to the favorable fundamentals of the SoCal market.
Rexford’s management team highlighted that the infill SoCal industrial market has the lowest threat from new supply of an major U.S. market which is due to “an essentially incurable supply demand imbalance.”
Additionally, REXR pointed out that their same property occupancy for the 2 nd quarter was up 10 basis points from the prior quarter which is in contrast to the overall infill market which saw a 40-basis point decline in occupancy according to the Global Commercial Real Estate Services (“CBRE”).
During the call, REXR commented on the strength of their balance sheet with a 16% net leverage to total enterprise value ratio, a net debt to EBITDA of 3.7x, and total available liquidity of $1.9 billion.
Additionally, they provided updates on their debt metrics that included an average interest rate of 3.6% and an average term to maturity of 5.1 years. They also disclosed that they have no floating rate debt exposure and no significant debt maturities until 2026.
REXR increased 2023 guidance for both net income and core FFO with net income guidance increased from $1.01 - $1.05 to $1.03 - $1.06 per share, and core FFO guidance increased from $2.11 - $2.15 to $2.13 - $2.16 per share. Guidance for same property NOI growth and average full year occupancy remained unchanged.
Rexford Industrial has delivered an average AFFO growth rate of 13.55% and a compound dividend growth rate of 22.03% since 2014. They pay a 2.82% dividend yield that is well covered with an AFFO payout ratio of 80.25% and currently trade at a P/AFFO of 31.99x which is a discount to their normal AFFO multiple of 35.54x.
We rate Rexford Industrial a Strong Buy.
In Closing…
Growth REITs are those viewed by investors as having the ability to increase FFO much faster than other REITs.
This growth potential may be because a specific sector is enjoying the boom phase of its property cycle when rental rates and occupancies are rising rapidly, or because their management’s strategy is to implement a very aggressive acquisition of development program.
In this “tech trifecta” article I just identified, these are some of the more promising names within the growth category that should continue to generate above average growth in AFFO per share.
Within our customized REIT ETF Index known as the iREIT®-MarketVector ™ Quality REIT Index , we maintain diversification across all property sectors which includes exposure to cell towers, data centers, and warehouses. In addition, our selectivity for the Index is correlated to quality and value.
Quality is our emphasis, and as most know, a REIT that yields 10% almost always means that investors perceive very low growth, or even worse, a potential dividend cut.
Many investors are seeking dividend yields higher than their local bank CD:
They’re ignoring the fact that these lower yielding REITs have superior pricing power - they can grow annual dividends by 5% or higher.
By owning “tech-trifecta” REITs along with other higher yielding REITs (including preferreds), the intelligent REIT investor is able to take advantage of the growth prospects that are fueled by the infinite technological demand that powers EVs, cell phones, computers, stock exchanges, social media, and practically every second of our life on this planet…
That's why I'm overweight Tech-Trifecta!
For further details see:
Why I'm Overweight Tech-Trifecta