The State Of REITs: September 2018 Edition

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Includes: BBRE, CBL, ELS, EWRE, FPI, FREL, FRI, GMRE, HT, ICF, IIPR, INVH, IYR, KBWY, NURE, PPTY, PSR, RESI, REZ, RLJ, ROOF, RORE, RTL, RWR, SCHH, SRET, UHT, UMH, USRT, VNQ, XLRE
by: Simon Bowler
Summary

The REIT sector extended its winning streak to 6 straight months of positive total return after a strong August.

After struggling for the first 7 months of 2018, micro-cap REITs had a stellar 10.15% average total return in August.

Single Family Housing led all property types in August, while Malls lagged.

Innovative Industrial Properties, buoyed by the significant investor enthusiasm for marijuana-related stocks, was the top REIT performer in August with a tremendous 40.21% return.

Even after 6 months of recovery, REITs are still at a 3.6% average discount to consensus NAV.

REIT Performance

After a disappointing July (0.10% average total return), the REIT sector saw stronger gains in August (3.36% total return). This performance was largely in-line with of the broader market, despite new record highs for the S&P 500, NASDAQ and the Russell 2000. REITs outperformed the S&P 500 (3.03%), and DJIA (2.16%), but fell short of NASDAQ (5.71%) for the 2nd straight month. Based on the weaker performance of large-cap REITs in August relative to their smaller peers, the market-cap weighted Vanguard Real Estate ETF (VNQ) had a lower total return (2.58%) than the average REIT (3.36%). After 6 straight positive months, is the rally nearing its end or can the REIT sector continue to extend its winning streak? In this monthly publication, I will provide REIT data on numerous metrics to help readers identify which property types and individual securities currently offer the best opportunities to achieve their investment goals.

Source: Graph by Simon Bowler, Data compiled from SNL.com, See important notes and disclosures at the end of this article

Although micro-cap REITs were mired in negative territory for the first 7 months of 2018, they were the top performers in August with a stellar 10.15% average total return. This double-digit return was more than 3 times the August return of small-cap, mid-cap or large-cap REITs. The massive gains made in August propelled micro-cap REITs ahead of large-cap REITs for the first time in 2018. Small-cap and mid-cap REITs, however, continue to lead the REIT sector YTD.

Source: Graph by Simon Bowler, Data compiled from SNL.com, See important notes and disclosures at the end of this article

16 out of 20 Property Types Yielded Positive Total Returns in August

After a weak July (+0.10% total return) in which more than half of REIT property types averaged a negative return, the REIT recovery gained strength in August (+3.36%) as 80% of property types were in the black. The total return spread between the best and worst performing property types in August was less than 10% for the first time in many months. Single Family Housing (8.8%) and Industrial (7%) led, while Malls (-1%) and Advertising (-0.9%) lagged. Single Family Housing was pulled up by the 26.5% increase in Front Yard Residential (RESI), which announced the acquisition of property manager HavenBrook Partners and the beginning of the internalization of management. Malls were dragged down by CBL Properties (CBL), whose CEO revealed during the 2nd quarter earnings call that the company is considering another dividend cut in the near future. CBL was the worst performing REIT in August with an 18.2% decline.
Source: Table by Simon Bowler, Data compiled from SNL.com, See important notes and disclosures at the end of this article

Thanks to share price appreciation for the majority of REITs, the number of property types that average a positive YTD total return increased from 13 to 16 in August. Single Family Housing, Diversified, Office and Data Centers all moved into the black, but Malls slid back into negative territory. Despite a disappointing return in August (-0.5%), Corrections remains the top performing property type thus far in 2018 with a 17.1% average total return.

Source: Table by Simon Bowler, Data compiled from SNL.com, See important notes and disclosures at the end of this article

The REIT sector as a whole saw the average P/FFO increase from 15.9x at the end of July to 16.7x at the end of August. Malls (10.4x) and Hotels (11x) continue to trade at the lowest average FFO multiples, while Single Family Housing (30.4x) and Industrial (23.3x) are the highest. It is important to recognize that the degree of multiple variance of individual REITs within each property type is not consistent. For example: Single Family Housing 2018 FFO multiples range from 20x for Invitation Homes (INVH) to 49.7x for Front Yard Residential (RESI), whereas Manufactured Housing multiples only range from 21x for UMH Properties (UMH) to 24.9x for Equity Lifestyle Properties (ELS).

Source: Table by Simon Bowler, Data compiled from SNL.com, See important notes and disclosures at the end of this article

Performance of Individual Securities

Innovative Industrial Properties (IIPR) led all other REITs in August with an impressive 40.2% total return. IIPR’s business model is to partner with medical-use marijuana growers by acquiring and leasing back their industrial facilities. This serves to provide equity to the growers, who have limited access to capital due to the nature of their industry, and a very high yield revenue stream to IIPR. The share price rose dramatically after IIPR reported strong 2nd quarter earnings that showed a 152% Y/Y increase in revenue and a big improvement in FFO/share (from -$0.07 to $0.26). 7 of the 20 best performers in August were Health Care REITs, led by Universal Health Realty Income Trust (UHT) and Global Medical REIT (GMRE) each with a 13.3% August return.

Source: Table by Simon Bowler, Data compiled from SNL.com, See important notes and disclosures at the end of this article

For the convenience of reading this table in a larger font, the table above is available as a PDF as well.

Source: Table by Simon Bowler, Data compiled from SNL.com, See important notes and disclosures at the end of this article

Dividend Yield

Dividend yield is an important component of a REIT's total return. The particularly high dividend yields of the REIT sector are, for many investors, the primary reason for investment in this sector. As many REITs are currently trading at share prices well below their NAV, yields are currently quite high for many REITs within the sector. Although a particularly high yield for a REIT may sometimes reflect a disproportionately high risk, there exist opportunities in some cases to capitalize on dividend yields that are sufficiently attractive to justify the underlying risks of the investment. I have included below a table ranking equity REITs from highest dividend yield (as of 08/31/2018) to lowest dividend yield.

Source: Table by Simon Bowler, Data compiled from SNL.com, See important notes and disclosures at the end of this article

For the convenience of reading this table in a larger font, the table above is available as a PDF as well.

Source: Table by Simon Bowler, Data compiled from SNL.com, See important notes and disclosures at the end of this article

Although a REIT’s decision regarding whether to pay a quarterly dividend or a monthly dividend does not reflect on the quality of the company’s fundamentals or operations, a monthly dividend allows for a smoother cash flow to the investor. Below is a list of equity REITs that pay monthly dividends ranked from highest yield to lowest yield.

Source: Table by Simon Bowler, Data compiled from SNL.com, See important notes and disclosures at the end of this article

Valuation

REITs ended the month of August trading at a median discount to NAV of 3.6%, which is narrower than the 5.6% discount at the beginning of August. However, it still remains slightly steeper than the 3.4% discount at which REITs began the year. After a strong August, Health Care REITs now represent 6 of the top 8 REITs trading at the largest premiums to NAV. 3 of the 10 largest discounts to NAV belong to Diversified REITs. Health Care has overtaken Self-Storage as the property type that trades at the largest average premium to NAV, while Malls continue to remain at the largest discounts to NAV of all REIT property types.


Source: SNL.com and S&P Global Market Intelligence, See important notes and disclosures at the end of this article

Takeaway

After 6 consecutive months (March-August) of positive returns for the REIT sector, REITs still remain at a larger discount to NAV than they began the year. Investors continue to price the assets of publicly traded REITs lower than the prices at which those assets transact in the private market. For executives of discounted REITs, this provides an opportunity to sell assets at full price and buy back stock at a discount, creating value for shareholders. Examples of some of the REITs that are successfully employing this strategy are Hersha Hospitality Trust (HT), Farmland Partners (FPI) and RLJ Lodging Trust (RLJ). Active investors have the opportunity to target REITs with management teams that are capitalizing on this public vs. private pricing arbitrage. By carefully analyzing REIT data, active investors can identify REITs that are still trading at unjustifiably discounted multiples.

Disclosure: I am/we are long CBL, UMH, GMRE, HT, FPI, RLJ. 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.

Additional disclosure: 2nd Market Capital and its affiliated accounts are long CBL, UMH, GMRE, HT, FPI and RLJ. I am personally long CBL, UMH, GMRE, HT and FPI. This article is provided for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer. Information contained in this article is impersonal and not tailored to the investment needs of any particular person. It does not constitute a recommendation that any particular security or strategy is suitable for a specific person. Investing in publicly held securities is speculative and involves risk, including the possible loss of principal. The reader must determine whether any investment is suitable and accepts responsibility for their investment decisions. Simon Bowler is an investment advisor representative of 2MCAC, a Wisconsin registered investment advisor. Positive comments made by others should not be construed as an endorsement of the writer's abilities as an investment advisor representative. Commentary may contain forward looking statements which are by definition uncertain. Actual results may differ materially from our forecasts or estimations, and 2MCAC and its affiliates cannot be held liable for the use of and reliance upon the opinions, estimates, forecasts and findings in this article. Although the statements of fact and data in this report have been obtained from sources believed to be reliable, 2MCAC does not guarantee their accuracy and assumes no liability or responsibility for any omissions/errors.