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Long/short equity, value, hedge fund analyst, REITs
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The historically low interest rates of late have been heavenly for REITs providing two direct benefits:

1) Lower interest rates translate to better financing options, directly increasing the profitability of the business model for most REITs.

2) Low bond yields send yield seekers into the REIT market, which has previously been overlooked.

Consequently, REITs are swelling with greater internal revenues and a plethora of fresh investors. Today (7/20/12), the MSCI US REIT Index (RMZ) hit 902.81, a gain of 12.41% since the start of the year. As the REIT market continues to rise, it becomes increasingly difficult to find stocks that are still value buys. Yet in the face of such market prosperity, some securities have been left in the dust. Here are a few that still have potential for capital appreciation and certainly warrant a closer look.

Company (ticker)

Price at start of 2012

Recent price

% gain (loss) since start of year*

Performance relative to index*

MSCI US REIT Index (RMZ)

803.16

902.81

12.41%

100%

Inland Real Estate Corporation (IRC)

$7.76

$8.30

3.05%

24.5%

Gladstone Commercial Corporation (GOOD)

$17.71

$17.21

(2.82%)

(22.7%)

Associated Estates Realty Corporation (AEC)

$16.21

$14.61

(9.87%)

(79.5%)

Agree Realty Corporation (ADC)

$25.02

$23.29

(3.12%)

(25.1%)

*Price only

With such poor market performance this year, we are given some very desirable entrance points into an otherwise fully valued market. In-depth analysis of each company would be prudent before initiating investment, but following is my perspective.

Inland Real Estate

Inland Real Estate spawned from its parent company Inland Real Estate Group in 1994 and deals primarily with retail centers, community centers, and power centers. At the 2012 REITWeek conference, Mark Zalatoris, the CEO of Inland Real Estate, detailed his strategy on acquisitions: "Retail real estate that meets consumer demand for value and necessity." This perspective allows the company to acquire a broad range of property types focusing on attaining well-leased properties in good locations. Through the sheer variety of its acquisitions, it has some built-in diversification.

Financials: In the most recent quarter, Inland Real Estate has experienced an increase in both occupancy and rental rates for a bolstered FFO of $0.20/share which easily covers dividends. The company already has a decently cheap debt with opportunity to further improve it as a high interest rate (10%) loan comes due early in 2013. Given its low price/est. FFO of only 10.1 (less than 66% of sector avg.), this stock would seem like a definite buy, but its shockingly low book value ($3.67/share) concerns me. As an older company, this may simply be due to depreciation of its assets, but it could be indicative of impending CapEx to get properties revamped as leases come due. In my opinion, a good entrance point into Inland Real Estate would be around the $8.00 range.

Gladstone Commercial

Gladstone Commercial is a diversified REIT best known for its unique acquisition strategy in which it independently rates prospective tenants allowing them to safely take on unrated tenants that other companies are forced to pass up. Consequently, Gladstone has an enhanced pipeline of high cap-rate properties to choose from. As the Q2 2012 earnings reports come in, pay close attention to FFO changes resultant from its new properties as this will be a strong indicator of its future performance.

Considering its 8.5% dividend yield, it is rather surprising to see it underperform the market since the start of the year by 1,523 basis points. Speculatively, the reason its price is so low is because people view David Gladstone as somewhat of a loose cannon. While this may be true for his personal life, (I have no opinion either way) his business practices are very conservative and intelligent. With a price/est. FFO of 11.0 and a well-orchestrated triple net lease model, Gladstone is a champion of its sector in value and stability. I had recommended purchase of Gladstone back when it was at $16.95, but even at its current price, it remains an excellent buy.

Associated Estates Realty

The multi-family housing sector has seen a good deal of prosperity in recent times, and among all the well-performing stocks, only two remain cheap: Associated Estates Realty and Preferred Apartment Communities (APTS). I know very little about Preferred Apartment, so I will only be discussing Associated Estates.

Associated Estates has multi-family properties throughout the U.S., but has been focusing its acquisitions in key areas such as Raleigh and Dallas, which have excellent projected growth. Financially, it looks strong with improved FFO and solid dividend coverage. A weighted average cost of fixed rate debt around 5.5% affords capture of a nice spread. Much of the discount in its market price is due to its recent stock offering, which was well below its normalized price. Shareholders at the time suffered from a dropped price and the resulting sentiments may be partially responsible for its continued discounting. In the end, if rational behavior prevails, we can catch nice capital gains as Associated Estates returns to its normalized price from performance over 2,200 basis points below market since the start of the year.

Agree Realty

Agree Realty is a retail REIT whose tenants are primarily parent corporations as opposed to individual franchisees. Under most circumstances, this prevents loss of tenants due to a single franchisee failing, but in the case of Borders Books, the entire corporation went down so Agree Realty was left with many vacancies. By now, this is relatively old news, but the stellar response of Agree Realty in handling this mess has prompted Compass Point to issue a buy rating on Agree Realty and declare its target price at $28.00.

Since then, the company's market price has largely recovered to the point where much of the discount is gone. Based on Compass Point's target price, there is still room for capital appreciation, but personally I would wait for a dip in its price to use as an entry point.

In the recovery environment of the past few years, we could pick just about any stock and get nice returns, but as the market asymptotes with full valuation, it becomes increasingly important to discern the best values. In the mean time, we can benefit from stocks that have underperformed the market despite internal success.

Additional Disclosure: 2nd Market Capital and its affiliated accounts are long GOOD, AEC, and ADC.

Disclaimer: This article is for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer.

Source: Remaining Opportunities In REITs