This week I'm attending the annual REITWorld conference (sponsored by NARIET) and while at the conference I have gained valuable insight into real estate strategies and trends for many of the leading publicly-traded commercial real estate REITs, REIT analysts and investment bankers.
As I learned at a retail sector spotlight session yesterday, many of the leading retail REITs are positioning portfolios for the space demands for the retail sector. As explained by David Henry, President and CEO at Kimco Realty Corporation (KIM), the tenants are weighted much like a “barbell” in that the necessity-branded retailers and discounters are pulling the space demand for one side while the “high-end” retailers are pulling the weight on the other side. And the shrinking retail "middle market" demand is the rest of that sector. As explained by Henry, “these consumers are still trying to figure out that 'middle market' space.” Conversely, many of the retail REITs are continuing to focus on the necessity-driven sector by providing retail space to discounters such as Target (TGT), Wal-Mart (WMT) and Kohl’s (KSS). In addition, many of the necessity-driven retail REITs are also focusing on the grocery sector and investing capital and resources in densely populated trade areas.
In a recent issue of the Wall Street Journal, Joseph Dobrian wrote an excellent article titled, REITs Are Offering Liquidity, Security Plus Diversity, and in that article he wrote, “Today, REITs own somewhere between 10% and 15% of U.S. commercial property. Through REITs and other publicly traded vehicles, some $4 billion of commercial real estate is bought and sold via the New York Stock Exchange every day. Ten of the 20 largest real estate companies in the world are U.S.-based REITs.”
As explained by Milton Cooper (in the WSJ article), Chairman of Kimco, “Obviously the REIT vehicle has been successful. The industry’s total public capitalization was $9 billion in 1991. Today it’s well over $300 billion. There has been no scandals, no Enron situations, and only a couple of bankruptcies, which were resolved pretty well.”
Also, in another article, Panel of Experts Views REIT Stocks As a Key Part of an Investment Portfolio, authored by Joseph Dobrian in The Wall Street Journal, Milton Cooper stated, “With a growth stock, there’s practically no dividend. REIT stocks are a hybrid; they give you growth and income. A REIT stock might perform somewhat like a bond, but it gives you so many advantages over a bond. For instance, if you buy a 10-year bond, your yield might be 3%. Your yield on a property leased to Wal-Mart (WMT) might be 5%. With a bond you get yield and security. But with your REIT stock, based on property ownership, you get yield, plus it’s likely that the value of the property will increase."
Most of the 123 equity REITS (with around $403.43 billion in market capitalization as of 10-31-11) are in attendance and the annual REITWorld conference and I decided to focus today’s article on several smaller-cap REITs that are growing in scale but flying under the radar of the larger gorilla REITs. These smaller sample of equity REITs are growing at considerable scale in an effort to meet a critical year-end target of over $1 billion in assets under management. In doing such, these REITs provide valuable upside growth and strong dividend fundamentals. In addition, these smaller cap REIT managers are actively involved acquisitions, development, re-development, and asset management – all critical elements to the growth and income investment fundamentals.
Retail Opportunity Investments Corp.
Retail Opportunity Investments Corp. (ROIC) was formed as a special purpose acquisition corporation (SPAC) in 2007 and the shopping center REIT was later converted to a REIT in 2009. With a "blank check" capitalization of around $400 million, the strategically-focused retail REIT has grown its asset base to around $650 million today. With a significant number of acquisitions closed ($140 million in the last quarter), ROIC is flying its (under the radar) strategy in West Coast markets such as Seattle (20%), Portland (21%), Southern California (27%) and Northern California (32%). In addition, the up and coming REIT has focused its differentiated acquisition strategy on the "value-add" investments where success is heavily weighted on creating value by redevelopment and lease-up. And Stuart Tanz, CEO at ROIC, and his team have assembled a significant team with quantifiable experience in recycling and fixing broken assets. And like any investment operation, rewards are recognized for risk. Conversely, Tanz and his team have built an exceptional and sound platform on mitigating the redevelopment and lease up risk and creating premium investor value.
ROIC has deployed most of its cash and the company has reached its targeted leverage ration of around 40%. The value-add REIT is hoping to reach $1 billion in assets under management early next year as that metric will open up the door for ROIC to reach a broader institutional investor base. In order to hit that threshold, ROIC will need to raise additional equity, dispose of assets, and/or increase leverage. The company has a warrant feature with around 50 million (ROICW) outstanding through October 2014. In the foreseeable future, I do not see ROIC disposing of assets and based upon Tanz's conservative track record (of around 35% leverage at Pan Pacific), I do not see support for leverage above 45%. In addition, ROIC has recently raised its dividend (4.3%) and is likely to pay out close to 100% of AFFO in coming years. Based upon ROIC's track record performance and most recent dividend increase, the platform seems to be catching a strong tailwind as it flies its sound operating model under the radar. ROIC is trading at $ 11.50 and the 52-week ranges are between $9.52 and $11.75.
Another exceptional small cap REIT flying under the radar of the big boys is Excel Trust (EXL). This San Diego based REIT is also a fairly new (IPO was April 2010) addition to the NAREIT index. However, like ROIC, the management has extensive experience (decades of experience) in the sector. Perhaps the biggest differentiator with Excel (as compared with other shopping center REITs) is the geographic selectivity of the assets. As I wrote in a previous Seeking Alpha article (here) on Excel Trust, "the REIT's growth model is to locate in hubs that form a lower circle around the United States. By connecting dots in San Diego, SF Bay, Phoenix, Dallas, Atlanta and Washington D.C., the “smile states” model forms a demographic footprint representing a broad base of retail tenants with above average sales per square foot."
And since inception, Excel Trust has done an excellent job with sourcing and acquiring credit-driven (70% anchored) shopping centers. One notably recent transaction was the acquisition of The Promenade in Scottsdale, Arizona. This 433,538 square foot center was acquired on July 11, 2011, at a price of around $110 million. At around 97.1% occupancy, the high-quality tenant mix includes many national retailers such as Nordstrom Rack (JWN), Trader Joe's, OfficeMax (OMX), PetSmart (PETM), Old Navy, Michael's (MIK), Stein Mart, Cost Plus World Market and Pier One Imports (PIR), as well as Lowe's (LOW) (non-owned) and The Great Indoors (non-owned).
Based upon Excel's most recent results, the retail REIT had assets of around $674 million with a portfolio occupancy of around 95.1%. And like ROIC, Excel is also aiming to reach $1 billion in assets as that will also propel the low flying platform into an enriched investor pool. Excel capitalized its platform with around $194.6 million with several subsequent follow-on offerings. In addition, Excel amended its credit facility (with joint arrangers Wells Fargo and Key Bank) earlier this year to increase its capacity from $125 million to $200 million with an accordion feature that allows an increase of up to $400 million (while also removing the interest rate floor, effectively lowering its interest rate by 200 bps).
Because of its integrated model and healthy balance sheet, Excel acquires both single tenant and shopping center assets in many primary and secondary markets with an emphasis on high credit quality and high exposure sites. And because Excel deploys a strategic acquisition (and development) model, the going in cap rates are better than average. Conversely, an investor benefits for getting exposure to a broad base of high quality tenants and he or she is rewarded for a better than average 6% dividend. As Excel continues to grow its asset base, the company will gain more efficiencies in its asset management and capital markets initiatives and that should result in significant growth. The REIT is trading around $11.63 (up 7.5% due to Excel's entry into MSCI US REIT Index) and the 52-week ranges are between $8.88 and $13.21.
As explained by Joseph Dobrian in The Wall Street Journal article, REITs 20-Year Track Record Shows It Beat Private Equity Funds On a Regular Basis: "Recently published studies by several research, investment and real estate services firms have revealed that real estate investment trusts (REITs) have outperformed all types of private real estate funds in the 20 years of the modern REIT era. Studies by Morningstar, Cohen & Steers, Kingsley Associates and others suggest that REITs experience stronger 'bull markets' than the private funds generally favored by large institutional investors; they recover more quickly from downturns; their fees and other expenses to investors are lower."
In addition, Dobrian adds, "Over the 20-year period that the Morningstar study examined, the average annual return on equity REITs was 9.3%. By comparison, opportunistic funds - the riskiest type of real estate funds - produced 6.1%. Value-added funds, which are slightly risky, returned 3.7%, while core funds, which invest in the safest properties, gave an average annual return of 4.4%."
While at REITWorld this morning, I ran into Dr. Brad Case, Ph.D., CAIA and Senior Vice President at NAREIT (and also a fellow Seeking Alpha writer) and he summed up the state of the REIT market as follows: "I think investors are responding to three types of opportunities in REITs right now. The first is income: dividend yields are low by historic standards, but at about 4 1/2% they're much higher than most other assets. The second is growth opportunity, because REITs have better access to capital and can acquire high quality properties at good prices. And the third is the diversification opportunity with REITs providing good returns that are different from the returns on non-REIT stocks or bonds."
Retail Opportunity Investments Corp. and Excel Trust are two growing retail equity REITs that are soaring high. Both REIT platforms provide investor-aligned operating fundamentals and risk-adjusted acquisition strategies. Consequently, both of these sound equity REITs provide retail investors with three differentiated well-balanced fundamentals of income (dividend), growth, and value.