Comparing America's 3 Largest Diversified Real Estate Investment Trusts

Includes: AMT, NLY, VNO
by: Joseph Cafariello


The Diversified REIT industry is expected to outperform the S&P broader market significantly this quarter, underperform moderately in 2015, and outperform marginally beyond.

Mean/high targets for 3 largest U.S. Diversified REITs –- American Tower (AMT), Vornado Realty Trust (VNO) and Annaly Capital Management (NLY) -- range from 2% to 32% above current prices.

Find out which among Am Tower, Vornado and Annaly offers the best stock performance and investment value.

* All data are as of the close of Thursday, October 30, 2014.

* Since REIT performance is better analyzed using Funds From Operations (FFO) instead of forward earnings and earnings per share, this comparison will differ slightly from my norm.

Wouldn't it be great to own a vast number of properties and simply sit back and collect the rent? "Of course," you say. "But I can't afford that."

Oh yes you can, thanks to Real Estate Investment Trusts -- aka REITs. Real estate management companies have done all the legwork and heavy lifting for you. They've researched the real estate market for the best deals, they've borrowed the money required to purchase them, they've rented them out to tenants, they've even packaged their properties into neat and tidy little stocks and listed them on stock exchanges for people like you and me to purchase so we could own our own little piece of the real estate pie.

There are a wide variety of these real estate stocks -- or investment trusts -- to chose from, conveniently sub-divided into seven broad categories: diversified, healthcare facilities, hotel/motel, industrial, office, residential and retail. Over the next few articles I'll be comparing the top three U.S. real estate investment trusts in each category, beginning here with the Diversified REITs.

What segment of the real estate market do Diversified REITs invest in exactly? In the simplest of definitions:

"Diversified real estate investment trusts invest in a wide variety of real estate assets, including leveraged portfolios of real estate financial products, such as mortgage backed securities, agency and non-agency mortgage investments, and other debt, along with physical properties. REITs are required to pay out most of their earnings in dividends, and as a result tend to offer very high dividend yields."

High dividend yields? Now we're talking. In this low-interest rate environment where getting even the smallest of yields is tough, REITs tend to deliver more than the average.

The one thing to keep in mind about the diversified group of REITs is their rather large holdings of real estate debt, as explained above. While they do own actual tangible properties, they also own real estate "paper," that is, a number of mortgages all packaged together into funds or stocks -- aka "mortgage-backed securities." This can be risky, however, if the property owners of those mortgages start to default.

How risky? Enough to cause the real estate market to tank, bankrupt one of the largest banks in America (Lehman Brothers), nearly bankrupt several others, cause the evaporation of liquidity, cause the stock market to lose 50% of its value in a few short months, cause businesses to fail and factories to close, cause the loss of 8.5 million jobs, plunge the United States into the deepest recession since the Great Depression of the 1930s, prompt the U.S. Federal Reserve to mount three Quantitative Easing programs which have so far pumped more than $3.6 trillion into the economy, export America's crisis around the world, cause foreign currencies to collapse, factories to shut down, and millions more jobs to be lost…

Whew! What a disaster. All caused by mortgage-backed securities? Pretty much, yes. Banks were so eager to churn out as many mortgages as possible that they lowered their qualification standards, handing out loans on so much as "stated income" without proof of repayment ability. They then hurriedly packaged all these high-risk mortgages into funds and stocks, dumping these "toxic securities" onto an unsuspecting market both at home and abroad. By the time the mortgages started defaulting, these securities had changed hands through "swaps" so many times that no one knew who owned what anymore, so that banks, investment houses and even governments all came tumbling down together.

And now we're talking about REITs that invest in these types of mortgage-backed securities? Thankfully, no, not "those" types of MBS. The ones that are out today were issued under much more stringent qualifying conditions. There still are risks, of course. But investors shouldn't equate today's MBS with those of the mid-2000s.

What is more, diversified REITs hold hundreds of these MBS, so that even if a few should fail, there would still be plenty of healthy ones remaining. Hence the "diversified" part of the name.

Since that mortgage-backed chaos of 2008-09, REITs and the entire financial sector have been doing very well for themselves despite such ultra-low interest rates. Real estate companies were handed a once-in-a-lifetime opportunity to snap up tens of thousands of foreclosed homes at insane bargain prices, allowing them to add new properties to their portfolios for a song.

What is more, since the average American family found it more difficult to qualify for a mortgage, the demand for rental units soared, allowing REITs to actually increase their rents even during the worst recession in a generation. The end result is soaring REIT prices, as noted in the graph below.

Where the broader market S&P 500 index [black] has gained 195% and the SPDR Financial Sector ETF (NYSE: XLF) [blue] has gained 275% since the recovery began in early March of '09, two of the three largest U.S. Diversified REITs -- American Tower Corporation (NYSE: AMT) [beige] and Vornado Realty Trust (NYSE: VNO) [purple] - have beaten the broader market and kept pace with XLF, which they are components of, posting gains of 260% and 265% respectively.

But not all REITs are created equal, as noted by the performance of the third largest diversified member -- Annaly Capital Management, Inc. (NYSE: NLY) [orange], which has posted a loss over the period of 14%. However, in this case we must note Annaly's enormous dividend currently yielding 10.7% per year, which over the past 5.5 years since the recovery would have produced a net gain of about 40% or so.


As the U.S. soon enters a period of rising interest rates, perhaps in late 2015 or early 2016, borrowing capital will gradually become more expensive, cutting into REITs' profits and taking a little bit of the power out of the industry. While we can, therefore, expect REITs' profits to gradually slow as interest rates are raised, Tower, Vornado and Annaly shares are still projected to rise from 2% to 11% over the next 12 months as per analysts' mean expectations.

But there is more than just analyst price targets to consider when sizing up a company as a potential investment. How do the three compare against one another in other metrics, and which makes the best investment?

Let's answer that by comparing their company fundamentals using the following format: a) financial comparisons, b) analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best-performing company will be shaded green, while the worst-performing will be shaded yellow, which will later be tallied for the final ranking.

This comparison may help investors plan ahead of Vornado's Q3 report due November 3rd, and Annaly's Q3 report due November 5th.

A) Financial Comparisons

• Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.

• Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.

In the most recently reported quarter, Am Tower provided the greatest revenue and FFO growth by a substantial degree. Meanwhile, both Vornado and Annaly reported shrinkage in both metrics, with Annaly's being the worst.

• Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials, and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes and depreciation.

Of our three contestants, Annaly operated with the best profit and operating margins by a significant degree, while Vornado had the worst.

• Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control, and from the equity invested into the company by shareholders.

In both returns on assets and equity, Am Tower's management team outperformed the others by a significant amount, while Vornado and Annaly split the last spots between them.

• Funds From Operations: Used to define cash flow from REITs, and serves as a better gauge of growth than earnings per share. Since the number of shares outstanding varies from company to company, I prefer to convert FFO into a percentage of the current stock price to better determine which stock provides the best value for the amount invested.

Of the three companies here compared, Annaly provides common stock holders with the greatest FFO per diluted share gain as a percentage of its current share price by a large degree, while Vornado provided the least FFODS percentage.

• Share Price Value: Even if a company outperforms its peers on all the above metrics, however, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to company book value comes under scrutiny, where lower ratios indicate the stock is currently trading at a discount, and might thus be a bargain.

Among our three combatants, Annaly has the cheapest stock price relative to company book value, while Am Tower's stock is the most overpriced.

B) Analyst Recommendations

Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts are projecting in the way of stock price targets and buy/sell recommendations.

• Price Targets: Like cash flow figures above, a company's stock price targets should be converted into a percentage of its current price to properly compare multiple companies.

For their high, mean and low price targets over the coming 12 months, analysts believe Annaly has the greatest upside potential and greatest downside risk, while Vornado has the least upside potential and Am Tower has the least downside risk.

• Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up are analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked since they are determined after determining the winners of the strong buy and buy categories, and would only be negating those winners of their duly earned titles.

Of our three contenders, Am Tower is best recommended with 7 strong buys and 12 buys representing a combined 95% of its analysts, followed by Vornado with 2 strong buy and 4 buy recommendations representing 50% of its analysts, and lastly by Annaly with 1 strong buy and 2 buy ratings representing 15.79% of its analysts.

C) Rankings

Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.

In the table below you will find all of the data considered above plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.

The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits while last place finishes count as demerits.

And the winner is… American Tower by a towering lead, outperforming in 10 metrics while underperforming in 6 for a net score of +4, followed by both Vornado and Annaly in a tie for second place with net scores of -3 each.

Where the Diversified REIT industry is expected to outperform the S&P broader market significantly this quarter, underperform moderately in 2015, and outperform marginally beyond, the three largest U.S. companies in the space are expected to continue their split performances, with American Tower towering high above Vornado and Annaly, while Annaly sinks further underground.

When taking all company fundamentals into account, American Tower stands first among its peers given its best debt ratio over market cap, best trailing revenue and FFO growth, best returns on assets and equity, best mean and low price targets, and best analyst recommendations -- handily winning the Diversified REITs competition.