3 High-Yield/High-Quality REITs To Buy After Solid Earnings Reports

Summary

• Property REITs have pulled back due to investor fears about interest rate hikes by the U.S. Fed.
• This is despite the fact that most REITs are reporting stellar earnings and hiking their dividends.
• The sector is trading now at its lowest valuation in years, creating a great entry point.
• The weakness in REITs is unlikely to last, as history shows that this sector outperforms during periods of rising rates, especially when rate increases are the result of a booming economy.
• 3 quality High-Yield REITs to consider after stellar earnings reports.

This research report was jointly produced with High Dividend Opportunities co-author Jussi Askola.

It seems that many retail investors are scared that higher interest rates will impact REITs, but this is a misconception. As we have noted in several previous articles, real estate is integrated into just about every aspect of the US economy; so when GDP is growing, it positively impacts the bottom line of Property REITs.

Let us have a look at what actually happened the last time the Fed raised rates. Starting in June of 2004 and ending in August 2006, short-term rates were hiked 17 times from a starting point of 1% to a peak of 5.25%. Over this 2.3-year period, GDP grew steadily and property values increased. More importantly is that REIT investors were rewarded with more than a 59% return over this time frame, beating the S&P 500 index which rose only 22% during the same period.

Below is a chart that depicts the price movement of the Property REIT ETF VNQ versus the S&P 500 ETF (SPY) during the 2.3 year-period.

What we would like to say is that as far as REITs are concerned, the proof is in the pudding. All we have to do is look at the most recent earnings reports of the majority of REITs which show that profits and FFO are soaring (and in many cases to new record-highs), dividends keep increasing, and the guidance for the year 2018 are solid. A stronger economy, tax reforms, and infrastructure spending should help boost real estate prices and increase rental income for the sector. This sector is very well positioned for growth as the U.S. economy keeps expanding.

Today, we highlight 3 high-yield Property REITs to consider buying, following great earnings reports.

STORE Capital (STOR) Earnings Report: What Consistency Looks Like

Nothing is more important than consistency to conservative dividend growth investors (or DGI). If you are a DGI investor, you may want to consider an investment in the shares of STORE Capital, a net lease REIT which we hold in our "High-Quality REIT Portfolio".

The company just reported its fourth quarter and 2017 results, and one key term remains king here: consistency, consistency, consistency.

Year after year, the company has increased dividends and cash flow. 2017 was no exception, and 2018 is expected to remain just another year of this continued consistency.

We are pleased with STOR's fourth quarter results and here are some of the key highlights:

• STOR, once again, raised its dividend in 2017. This time by 6.9% in the third quarter of 2017.
• The company invested $1.37 billion in 316 properties at a weighted average initial cap rate of 7.8% which remains way in excess of its cost of capital - allowing it to keep growing FFO per share.
• STOR undertook several value creative initiatives related to its capital structure. It improved its capital structure by repaying higher interest-bearing debt with cheaper capital sources. As an example, it prepaid $198.6 million of 5.77% STORE "Master Funding" debt in August 2017 and raised $135 million of A+ rated net-lease mortgage notes with a 4.32% coupon rate. The company also closed a $100 million two-year unsecured bank term loan, which has an effective interest rate of only 2.57% in March 2017.
• As a result of its continued capital structure improvements, STORE received a credit rating upgrade to BBB, stable outlook, from both S&P Global Ratings and Fitch Ratings and received an initial rating of Baa2, stable outlook, from Moody's Investors Service. These are big catalysts for a growing net lease REIT which relies heavily on capital markets for continued growth.
• Finally, the company received the blessing of Warren Buffett in June 2017, when Berkshire Hathaway (BRK.A) (BRK.B) bought 18.62 million shares - or 9.8% stake in STOR - at $20.25/share.

The CEO made the following comment:

Our 2017 investments and property sales reflect our ability to consistently invest in and divest of assets in ways that are accretive to our shareholders… Additionally, we grew AFFO by 25% for the year and raised our dividend by 7%, providing our shareholders with a well-protected dividend and ownership in a dynamic company that is well-positioned for long-term internal and external growth."

In addition to the 2017 success, management guided for more accreditive growth in 2018 with up to ~6% in AFFO growth. If we take into account that STOR currently yields 5.4%, the growth of 6% is substantial and would bring the total return to double digit territory - assuming the FFO multiple remains intact. At this growth pace, we expect more dividend increases to come, and eventually more upside to materialize as the market warms up to the REIT sector.

Bottom Line: Warren Buffett's investment in STOR is no coincidence. This is a Property REIT that is characterized by high returns on equity relative to risk, simplicity, and predictability. We expect the company to keep outpacing its peers over the long run and generate total returns far in excess of the market average.

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Realty Income's (O) Earnings Report: 5 + 5 = 10

Simple math tells us that a 5% dividend yield combined with a 5% growth rate should result in a 10% total return assuming that the valuation multiple of the given company remains intact.

This is essentially the buy thesis of Realty Income. O is a consistent dividend grower, with over 571 consecutive monthly dividend payments - A real growth machine that appears to be unstoppable.

The company reported its 2017 results, and we are today sharing our initial thoughts on its performance as well as its future prospects.

Investors should note that despite the poor price performance of the stock in 2017, the fundamentals have remained particularly strong. This is the reason why we recently became bullish on this REIT, and the latest result report comes to confirm our thesis: the growth machine is NOT dead.

Realty Income reported 6.3% AFFO per share growth for the year 2017 as compared to the year 2016 - allowing it to raise the dividend by 5.6%. Given that the current dividend yield stands at 5.4%, this is significant growth and even surpassing our "5 +5 = 10" thesis.

5.4% (dividend yield) + 6.3% (growth) = 11.7% expected total return.

And yet, the stock went down by over 20% during the last 12 months due to interest rate fears. This spells potential opportunity to us and taking a longer-term stance, we believe that shareholders will be well compensated here. This is the reason why we recommended the stock to our investors just this month, as the valuations have become attractive. For reference, please refer to our most recent report on Realty Income: Big Dividend, Low Risk, & Steady Growth - Recipe For Outperformance

Other highlights include the following:

• Realty Income achieved a rent recapture rate of 106% on its re-leasing activities - proving that Mr. Market is wrong about this company. Rents are not dropping, retail assets remain highly demanded, especially the net lease properties that Realty Income owns.
• The firm ended the year with a portfolio occupancy of 98.4%, matching its highest year-end occupancy rate in the last 10 years.
• The consistency of the operations, continued strength of the balance sheet, and track record of performance allowed Realty Income to receive a rating upgrade from Moody's raising the credit rating to 'A3' in the fourth quarter - placing Realty Income among only a few REITs with at least one 'A' rating.

2018 Outlook

Management commented the following in relation to the year 2018:

Given our healthy real estate and tenant portfolio, active investment pipeline, and conservative capital structure, we enter 2018 from a position of strength. We expect to acquire $1.0 billion to $1.5 billion in real estate investments based on current market conditions. Additionally, we are introducing 2018 AFFO per share guidance of $3.14 to $3.20, representing annual growth of approximately 3% to 5%."

Bottom Line: No big surprise here… Realty Income is a predictable growth machine with one of the best track records of all dividend growth stocks. 2017 was above average in our view and yet the company suffered losses in its share price. 2018 is expected to be another year of attractive growth with a mid-point guidance of 4%. This may not sound significant, but for a firm paying a 5.4% yield and operating a relatively low-risk business model, we consider this guidance to be favorable. The recent selloff in Realty Income stock has created a great buying opportunity.

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Hersha Hospitality (HT) Earnings Report: Hersha Remains Our Top Hotel Pick

Hersha Hospitality Trust, a REIT we hold in our Conservative Portfolio, posted its results for the fourth quarter and full-year 2017, and we are once again happy to see the management focusing on what it does best:

Create long-lasting value to its shareholders and ignoring short-term market noise.

We have been saying it for a long time: Hersha has one of the best (if not the best) management teams of the hotel industry. They have a long history of outperformance, accreditive share buybacks, superior capital allocation, and last quarter was another confirmation of it.

The key highlights to us as long-term holders of the shares:

• Fourth Quarter 2017 Comparable Portfolio RevPAR growth of 6.0% which is very significant and encouraging to see after the latest difficult quarters caused by natural disasters.
• The portfolio achieved strong EBITDA outperformance driven by newly acquired assets.
• Hersha exceeded the High-End of its 2017 guidance:

Looking ahead, Jay H. Shah, Hersha's Chief Executive Officer commented:

Results over the prior quarter and in early 2018 leave us encouraged for continued growth in corporate travel spending and sustained leisure demand. As we look into 2018, we are encouraged by favorable comps and positive fundamentals from our market-leading clusters on the West Coast, New York, Boston, and South Florida. We've spent the last several years on selective capital recycling opportunities and meaningful ROI-generating capital investments at a number of our hotels, positioning them to leverage domestic and global GDP growth and the reacceleration of lodging fundamentals."

Having taken a deep dive into the portfolio characteristics, we are confident that the individual properties are of high quality and have strong prospects for the long run.

But, most importantly, what we took away from the results report is the following:

In the fourth quarter 2017, the Company repurchased approximately 1.7 million common shares for an aggregate repurchase price of $30.4 million. Since January 1, 2014, the Company has repurchased $232.3 million in common shares, representing 21.8% of the January 1, 2014, float.

In the fourth quarter 2017, Hersha's Board of Trustees approved a new share repurchase program of up to $100 million of the Company's outstanding common shares. The new repurchase program expires on December 31, 2018, unless extended by the Board of Trustees.

These large share buybacks were financed by selling properties, and as such, Hersha is essentially selling assets at it "Net Asset Value" (or NAV) to buy shares that are trading at a discount to NAV. It creates significant value and is accreditive for long-term holders.

Bottom Line: Hersha remains our top pick in the hotel sector along with Sotherly Hotels (SOHO). We see near-term upside in both on top of strong potential for long-term market outperformance. The dividend yield is high in both cases, and therefore, not much appreciation is needed to achieve very satisfying results. The management of Hersha is the real deal here. They are very well aligned with shareholders and continue to do what is best for long-term value maximization rather than short-term result boosting. We remain bullish and HT is a Strong Buy.

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Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I am/we are long STOR, O, SKT, SOHO, HT. 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.

Comments

[omega2345]

With trade tariffs we could have slower economic growth plus higher inflation = more rapidly increasing interest rates. Not good for stocks or REITS

[thorgood4]

funny no mention of CLDT.

[Rida Morwa]

Hi Thorgood, CLDT earnings were among the weakest in the Hotel REIT sector, although we have a lot of respect to their management team. I pretty confident they can turn things around.

All the best,

[User 47987527]

I love it when the market overreacts on O and STOR.

Simply buy more when their price breaks below the 200MA and correlate with your favorite indicator (Stochastic, MACD, RSI ...etc..) to catch the new upswing.

It's like shooting fish in a barrel.

[dginsberg2222]

the sleeper in the group is AHOTF. All the boxes check.

[socalquest]

Just buy a FUND and let it do its magic!

[jarco]

I’m not a big fan of mutual funds but in this sector the management fees are probably worth it. Would you mind sharing your favorites?

[socalquest]

I like CEF RQI

[CincinnatiRick]

You are singing the praises of HT and SOHO...but what about AHP?

[Rida Morwa]

Hi Rick, AHP had also a solid earnings report. We will be providing an update to our members very soon.

All the best, Rida

[pelican]

Is HT growing its AFFO year-over-year (2017-8)? If so, by how much?

[Jussi Askola, CFA]

HT is still doing big changes to its portfolio causing short term dilution. No not much growth as of right now, but this will change soon. RevPAR growth is very encouraging and buy backs are massive. Best, Jussi

[papaone]

JA, what really is accomplished by selling assets to fund buy backs?

[pluton7]

Hi Rida,
Because you prominently mentioned it, would you also consider SOHO a STRONG BUY?
Thanks for your help and advice.

[Rida Morwa]

Hi Gerard,

In today’s market environment, we are bullish on hotel investments because historically they have greatly benefited from accelerating GDP growth. With the recent tax cuts and improving economy, we expect business people to engage in more trips and individuals to have more savings for leisure travel.

One of the main beneficiary of this trend will be hotel owners, and we have been advising our investors to overweight the Hotel REIT sector for the potential rewards.

Today, as we look at the recent results of most hotel REITs, we are glad to see our assessment is being reflected in fundamentals. Despite the latest REIT market sell-off, it is fair to note that many of our hotel REIT investments have kept posting solid results. This applies to both HT and SOHO which are strong buys at the current price.

All the best, Rida

[pluton7]

Thanks for your well-reasoned response, Rida.

[rdbach]

SOHO just bought a hotel in recession proof Arlington, VA, adjacent to a metro station. Good move I think. Also, the dividend was recently increased. Long SOHO, HT and PK.

[Javelina]

HT is a good one, but I prefer APLE.

[Rida Morwa]

Hi Javelina, HT has one of the best management team in the entire hotel industry, and this is what counts the most in our opinion. The company has a high insider ownership, and management seems to always be doing its best to increase shareholder value.

Having a management that is aligned with shareholders is key for the success of any company, and even more so in the Property REIT space.

All the best, Rida

[Sajit Kapurvalapil]

Hersha is ridiculously cheap on all metrics: P/AFFO, P/Book, AFFO payout ratio.

Additionally, there's been significant insider buying recently, and a share buyback program that is retiring over 10% of outstanding shares. Buybacks below book-value are the best kind, they are almost guaranteed of being accretive...

The downside is -- hospitality industry is high beta, and will take a hit if economy sours. I am long both common and preferreds.

[papaone]

Rida, is it accurate information that HT management is selling assets--maybe at a capital gain, to use the funds for very large buy-backs? If so, it makes me concerned, not a normal strategy.

[walter scott]

Very interesting. Thanks. But what about the Amazon hysteria? It's not all about interest rates.

May increase my position in O, and maybe take a bit of STOR, SKT, SOHO, and HT on board. However, I wonder how much cash should be on the sidelines should a big market pull-back create a huge opportunity.

[Rida Morwa]

Hi Walter, what is interesting to note is that the Property REIT has performed well recently when the general markets have pulled back, and have acted as a defensive sector. Most investors who are overweight REITs should have noticed this.

This makes me believe that the downside risk is very limited and the upside potential is enormous given the low valuations in the sector.

[Rida Morwa]

Finally, Property REITs are not just retail REITs, they include office space, storage, hotels, industrials, etc, which are not in competition with Amazon.

All the best, Rida

[socalquest]

People are working from home more so nowadays. I myself prefer shopping online via AMZN since it saves me time driving to the store! These are real headwinds for REITs, not just the rise in rates.