Since the beginning of the year, there has been a significant rally in the equity REIT market. The rally was concentrated in high-yielding REITs and 'blue chip' REITs. Even after last week's sharp decline in valuations, many can argue that some of the stocks are overpriced. I have summarized in the following charts some REITs that are on my watch-list (some of them I own):
Aviv REIT, Inc.
Digital Realty Trust Inc.
DuPont Fabros Technology, Inc.
Health Care REIT, Inc.
Healthcare Realty Trust Incorporated
Medical Properties Trust Inc.
Omega Healthcare Investors Inc.
Realty Income Corp.
Senior Housing Properties Trust
Sources: Yahoo Finance as of 31.05.2013 close; P/FFO from Morningstar
This chart shows interesting REITs worth exploring such as EPR, DLR, and several of my favorites from the medical sector (such as MPW, SNH, and OHI). However, REITs that pay less than a 4% dividend and have high valuations can be perceived as overpriced.
In this article and in coming articles that I plan to write over the next few months, I will review some small (or even very small) cap equity REITs to assess if they are worth the higher risk compared to the large cap or even the medium caps.
In this article, I concentrate on Gladstone Land Corporation (LAND) - a small cap company that went public only in January this year. LAND plans to be taxed as a REIT, but thus far is not. To be eligible for REIT taxation, the company has to do the following:
- Invest at least 75% of its total assets in real estate
- Derive at least 75% of its gross income from rents from real property, interest on mortgages financing real property, or from sales of real estate
- Pay at least 90% of its taxable income in the form of shareholder dividends each year; as a result, REITs may not generally retain their earnings
LAND's strategy is to invest in a portfolio of net leased farmland and properties related to farming operations. As a long-term investment, this strategy makes sense. As long as the population continues to grow, demand for farmland is expected to continue to grow. As long as new techniques are adopted to improve the productivity of the land, the value is expected to grow. These are the reasons I find this type of investment interesting from a long-term view.
Currently, LAND pays a very high dividend of $1.44 per share that trades at $15.29 per share, meaning a 9.4% dividend yield (as of 31.05.2013 close).
To assess the value proposition in owning LAND stocks, I gathered information from the Q1 2013 10-Q report:
Selected Financial data - LAND
2012 full year
Long term liabilities
Income before taxes
Source: Gladstone Land Corporation 10-K and 10-Q returns as of 31.12.2012 and 31.03.2013
Management and Costs
LAND is externally managed by Gladstone Management Corporation. Many investors prefer an internal management team, but some REITs are externally managed and are doing well. I personally do not have a preference, as long as the management agreement is in line with the interest of the shareholders.
As disclosed in the 2012 10-K, the management fee was changed as a result of the IPO. The change will be done in two steps in which a 1% base management fee will be calculated based on the shareholders' equity for 2013 (that amount will exclude the un-invested IPO proceeds), while in 2014, the base fee will be 2% of the shareholders' equity (and the un-invested IPO proceeds will no longer be excluded).
In addition, an 'incentive fee' will be added based on the company's results and calculated as follows:
As long as the FFO proportion of the shareholders' equity is less than 7%, no incentive fee will be charged. If the FFO to the shareholders' equity exceeds 7%, 100% of the excess will be an incentive fee up to 8.75% of the FFO to the shareholders' equity. For the FFO to shareholders' equity that exceeds 8.75%, 20% of the excess will be an incentive fee.
As an example, if the FFO to shareholders' equity is 10%, the incentive fee will be 1.5% (on top of the 2% base management fee). The external management fees are expensive to my mind, and not always aligned to the shareholders' interests.
Expected Financial Performance
In the following table, I summarized the expected Q1 2014 results based on the following assumptions:
- By 2014, all IPO proceeds will be invested in real estate.
- The leverage level will remain at the current level.
- Investments will be done at the existing CAP rates (about 10%)*.
- Leverage will be at the current interest rates as implied by the existing balance sheet.
- Operating expenses will remain flat to Q1 2013 (excluding depreciation and interest expense).
* This assumption relies on historic CAP rates of the company's properties, while the valuations of these properties are much higher now as disclosed in the company's statements.
Selected Financial Data - LAND
Extrapolation for Q1 2014
Long term liabilities
FFO yield over equity
FFO for incentive fee calculation
FFO per share
I love the idea of leasing farmland properties. Will Rogers said, "Buy land. They ain't makin' any more of the stuff." I also love the idea of getting a 9.4% dividend yield for my investment. The question is if this is sustainable. Based on the extrapolation done in this article, I conclude this is still questionable as FFO is lower than the expected dividend. Some of my assumptions were not very conservative, such as the assumption for the CAP rate.
To summarize, I believe that this can be a great investment, but currently, there are too many question marks, so I view an investment in LAND as a gamble.