By Robert Gordon
With the economy gradually recovering, some healthcare, apartment, industrial and commercial REITs are in good positions for earnings growth. However, not all REITs are created equal. While much ink has been spilled on the income potential of companies like Annaly (NLY) and Chimera (CIM), I decided to take a look at some lesser known REITs and show why these four stocks are not suitable for investment right now.
These REITs are all highly specialized in different areas of real estate development. While Brandywine and ProLogis specialize in the commercial and industrial side of real estate development, respectively, Avalon Bay and Felcor Lodging engage in multi-family apartment complex and hotel development, respectively. To examine these four stocks, I primarily use the metric "funds from operations" (FFO), or earnings plus depreciation and amortization, as the basis for their ability to pay out dividend. I use FFO in my analysis because I believe it is a better measure than earnings alone while assessing an REIT. Please use my research as a starting point for your own due diligence.
Brandywine Realty Trust (BDN)
Pennsylvania-based Brandywine Realty Trust is a real estate REIT that specializes in development, management and ownership of commercial buildings. It also owns a limited amount of vacant land and mixed use property, in addition to its 306 commercial Class A buildings with some 3.5 million square feet of leasable space. Brandywine has a fund from operations to earnings ratio of 8. It has a market capitalization of $1.5 billion, and pays a quarterly dividend of $0.15 per share, for a yield of 5.5%.
Brandywine reported FFO in 2011 of $1.37 per share, up marginally from the $1.34 posted in 2010. Underlying numbers were trending up as well, as the all important average occupancy rate increased 100 basis points from fourth quarter 2010 to fourth quarter, 2011, ending at 86.5%. Management projects further growth in 2012, up to 89.4% by this year's end. Anaylsts see Brandywine's future cash FFO as pretty much flat for 2012 and 2013. That will preclude dividend growth. There is no shame in a 5.5% yield, but I believe there are better choices in the REIT world.
ProLogis, Inc. (PLD)
ProLogis is a large, international REIT with interests in the development, management, ownership and leasing of industrial properties worldwide. It has a price to FFO of 21.7, and a market capitalization of $15.6 billion. It pays a quarterly dividend of $0.28 per share, for an annual yield of 3.3%.
The world leading ProLogis that we see today is the result of a 2011 merger between ProLogis and AMB Property Corp. The combined company posted fourth quarter adjusted FFO of $0.44 per share, compared with $0.41 in the same quarter of 2010. For the full year, core FFO came in at $1.57 per share, a 24% increase from $1.27 in 2010.
Looking ahead, ProLogis management forecasts 2012 FFO of within 5 cents of $1.65 per share. I can see expansion in ProLogis growth if macro economic growth absorbs overcapacity in the industrial real estate sector. Yet with Europe on the ropes, and the Chinese economy slowing, I question if that growth will happen. ProLogis is selling at too expensive a price relative to its FFO for anemic growth. I would avoid this issue.
Avalon Bay Communities, Inc. (AVB)
Avalon Bay is a REIT specializing in the development and management of high end, multi-family apartment complexes in 10 states and the District of Columbia. It owns about 200 apartment communities, encompassing some 59,000 units. The company also has 13 new developments under construction. Avalon Bay is trading at a price to FFO of 29, and has a market capitalization of $12.8 billion. It recently raised its dividend for the first time since 2008. The new quarterly dividend is $0.97 per share, for an annual yield of 2.9%.
Avalon Bay had a solid 2011. FFO for the year totaled $414 million, or $4.57 per share, a 14% jump from the $338 million, or $4.00 per share, posted in 2010. Secondary numbers were also impressive. Rental revenues per unit increased just over 5% year over year, and operating expenses for the same period increased only 1.4%, enhancing margins.
Due to its expansion plans, Avalon Bay projects 2012 FFO at about 18% above the 2011 totals, or within 15 cents of $5.40 per share. Analysts project further double digit growth, to $6.12 per share, in 2013. Yet, I believe that much of that growth is already reflected in the stock price. And given that the yield is well below average for a REIT, I do not endorse this one.
Felcor Lodging Trust, Inc. (FCH)
Felcor is one of the largest REITs specializing in hotel real estate. Specifically, it owns or manages 76 brand name, upscale properties around the United States. Felcor has a price to FFO of 36. It has a market capitalization of $542 million. The company does not pay a dividend.
Felcor, by any measure, has had a horrid past few years. Its stock was up near $30 in 2007, but when the market for high end resort hotels evaporated, so did Felcor's cash flow. Losses have been consistent, and book value per share has fallen from around $30 per share in the year 2000, to about $0.65 per share today.
To help solve this problem, other than hope for a sharper rebound in the economy than has so far been the case, Felcor has been selling properties. The plan is to sell as many of 40 of its properties, typically the more midscale ones, and use the proceeds to shore up its balance sheet. During 2011, it sold ten properties, so it has as many as 30 that it wishes to sell. Some of the proceeds, it has demonstrated by its recent Knickerbocker Hotel purchase in Manhattan, it plans to reinvest in its core business.
I am a fairly conservative and patient investor, and Felcor is not for me. Yet the case can be made, if the economy stabilizes and Felcor deals with its debt, to see the stock double, or even triple out to mid decade. If you have a strong constitution and some patience, you might find Felcor a risk worth taking.