"A man is usually more careful of his money than he is of his principles." - Ralph Waldo Emerson
When it comes to conserving capital, investors observe tax law incentives that lower their aggregate tax liability. At the end of each calendar year, one tax-incentive investors use is often referred to as "tax-loss selling," where stocks with unrealized losses are sold to offset capital gains. As one could imagine, this is especially important in up markets, as larger gains have been attained.
With the S&P 500 up 23.61% YTD, there is a plethora of capital gains to be harvested. The question for tax-savvy investors naturally becomes one of which stocks to dump to offset such gains.
REIT Sector Slammed In 2013
2013 started off as a year of gain, however it quickly turned into one of pain for many classes of yield-based investments, including both the bond market and the real estate investment trust [REIT] sector. When looking at REITs in particular, well-run and historically sound companies have been slammed and are trading well below their 52-week highs. As such, yields have improved and earnings multiples have been reduced.
Finding Value In Lower Pricing
Over the next few weeks, the drop in REITs may be exacerbated due to tax-loss selling, which could create artificially low prices that lead to very attractive trading (or long-term holding) positions. Keep in mind that there are several REITs that may drop, with the iShares U.S. Real Estate ETF (NYSEARCA:IYR) a general proxy for such movement.
Select REITs Drop & Pop List
In screening for contenders, I looked for companies that I wouldn't mind owning as long-term income investments. I focused on industry-leaders with a market capitalization of over $5 billion that have stable and increasing dividends, a yield of over 4% and current valuations that are below the mean YTD trading range.
Below are four select REITs that may drop over the next three weeks and as such, could create an attractive position for both long-term holders and active traders.
1. HCP, Inc. (NYSE:HCP)
HCP is the largest healthcare REIT in the U.S. The company trades at a P/FFO on 2013 estimates of 13.6, which could be viewed as an absolute bargain. The stock has been underwater for most of the year, with investors who bought in between January and July looking at heavy unrealized losses.
HCP could be the biggest bargain of this group as the low P/FFO multiple is accompanied with efficient debt levels and a current yield of 5.15%. Also, the company has raised its dividend in the first quarter of each year since 2004, which would make the 2014 yield 5.4% if they raise it just 2.5 cents to $0.55 per quarter.
Assuming no dividend raise, a 2014 yield of 5.5% (on the current $2.10 dividend) would be attained at an entry price of $38.18. Today the stock trades at $40.79.
2. Realty Income Corp. (NYSE:O)
Realty Income Corporation is to REITs what cult classics are to movie buffs. This retail-oriented landlord has raised dividends every year since their first payout in 1994 and as such, the company has attained quite the following among retail investors. They pay a monthly dividend, which is an added bonus to income investors.
There are two major problems with O however. First, the company is under water on most of the YTD trading range. While September and October investors are up, those who dove in shortly after the new year have unrealized capital losses. Looking at the chart, Realty Income took a huge dive in the end of May.
Secondly, with a P/FFO of 17.3 on 2013 FFO estimates, the stock is expensive. Assuming a 15.5 P/FFO as fair price, the company would be on sale only if it dropped below $37.20. Today it sits higher at $41.45 and as such, the stock could be considered over-valued by 11.4%.
3. Camden Property Trust (NYSE:CPT)
Camden Property Trust is a true leader in multi-family residential real estate. The company focuses on properties in the top-growing municipalities in the U.S. and has recently divested properties on slower-growing areas. Camden started the year off with 65,775 apartment homes throughout 193 properties, with 9 properties under development that would add an additional 2,845 homes to their portfolio.
CPT did lower its dividend in 2009, however the company has raised its dividend each year starting in 2011. Look for a 2014 dividend increase in Q1, as that was the quarter they raised it over the last three years. Their 3-year compound annual dividend growth rate is 11.87%, which is very attractive for the REIT sector.
4. Digital Realty Trust (NYSE:DLR)
Digital Realty Trust is the weakest performer YTD as well as on a 2013 trading-range basis. DLR sits near its 52-week low, as investors punished the company for disappointing Q3 2013 results. Digital Realty Trust is a leader in renting digital office space, with locations around the world. DLR also has a long history of dividend increases, raising it each year since 2004.
The company does have its enemies, however. Jonathan Jacobson, of hedge-fund Highfields Capital, announced a short-position on the company this May at the Ira Sohn Conference. This may or may not increase short positions or fend off long-term investors. Regardless, DLR investors are in a world of hurt.
Comparing The Drop & Pop List
Of these four companies, each has a market capitalization above $5 billion. As such, they are larger companies that have established both credibility and higher levels of liquidity versus their smaller REIT peers. The largest company is HCP, at $18.6 billion and the mean value (^MED) of the REIT drop and pop list is $9.6 billion.
Of these REITs, the P/FFO on 2013 FFO guidance average is reasonable at 14.1. The least expensive in terms of FFO is DLR, which trades at just 10.4 times projected 2013 FFO. The most expensive is O, which historically trades closer to 15.5 times FFO, however at this time trades relatively high at 17.3.
The forward yields on this list is 5.27% on average. As these REITs generally raise their dividends each year, the 2014 yields could be projected higher. The highest yield, DLR, is 6.52% while the lowest yield, CPT, is 4.15%. Generally speaking, the multifamily REIT names trade at yields much lower than their healthcare and retail peers.
The YTD performance of our list is a collective -10.98%. While O is actually up YTD, it is down heavily from the 52-week high and was trading at higher valuations most of the year. DLR, which disappointed investors with the 2013 Q3 earnings release, is down 26.67% from the start of the year.
With the exception of CPT, each REIT here is over 20% below its respective 2013 peak price. The biggest loser was DLR at 35.3%, while CPT did the least damage, with a drop of just under 20%.
The mentioned REITs may drop over the next few weeks due to tax-loss selling, which could create artificially low prices that lead to more attractive pricing. As seen in the YTD charts, each company traded higher than current pricing for much of the 2013 year, thus creating unrealized losses for many shareholders.
In comparing our REIT drop & pop contenders, each company is trading well below its peak.
The four companies here, HCP, O, CPT and DLR are mentioned because they are market leaders with an established and growing dividend, yield over 4% and are trading at levels that are well below their 52-week highs as well as most of the 2013 trading range.
By purchasing securities at levels that are artificially depressed due to a tax-incentive that lowers demand, both long-term income investors and traders may find value in several names.
To learn more about tax-loss selling in the REIT space, as well as another reason I believe the REITs will sell-off this month, please read The U.S. REIT Market: IYR Ripe For A Pullback, published October 21, 2013. Since the close of trading on October 21, the IYR is down 1.57% while the S&P 500 is up 1.05%.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.