The State Of REITs: October 2018 Edition

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Includes: BBRE, CMCT, CTT, EWRE, FREL, FRI, GOV, ICF, IFEU, ILPT, IYR, KBWY, MPW, NURE, PPTY, REZ, RMR, ROOF, RORE, RWR, RYN, SAFE, SCHH, SIR, SRET, SRVR, STAG, USRT, VNQ, XLRE
by: Simon Bowler

Summary

The REIT sector saw its 6-month winning streak of positive total returns snapped with a dismal September.

Micro-cap REITs underperformed their larger peers in September.

Advertising REITs led all property types, while Timber lagged.

Safety, Income and Growth was the best-performing REIT, while Government Properties Income Trust was the biggest loser in September.

Due to the September selloff, REITs are now trading at a 6.0% average discount to consensus NAV.

REIT Performance

After 6 straight positive months (March-August), the REIT sector performed poorly in September (-2.54% total return). This performance was in stark contrast with much of the broader market, which generated positive returns in September. REITs were beaten by the S&P 500 (0.43%) and DJIA (1.90%), as well as falling short of Nasdaq (-0.78%) for the 3rd straight month. Based on the slightly weaker performance of large-cap REITs in August relative to their smaller peers, the market-cap weighted Vanguard Real Estate ETF (NYSEARCA:VNQ) had a slightly lower total return (-2.6%) than the average REIT (-2.54%). Will the rate hike fears that led to the September selloff continue through the rest of the year, or will investors be drawn back into REITs due to the attractive discount to NAV? 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 large-cap REITs outperformed their smaller peers during the first 4 months of 2018, they have consistently underperformed since. As of the end of the 3rd quarter, large-cap REITs have averaged a YTD total return that is less than half of micro-cap, small-cap or mid-cap REITs. Small-cap REITs continue to average the highest total return thus far in 2018.

(Source: Graph by Simon Bowler, data compiled from SNL.com; see important notes and disclosures at the end of this article)

Only 5 out of 20 Property Types Yielded Positive Total Returns in September

After a strong August (+3.36% total return) in which 80% of REIT property types averaged a positive return, the REIT sector struggled in September (-2.54%), as only a quarter of property types were in the black. The total return spread between the best- and worst-performing property types in September was less than 10% for the 2nd month in a row, showing markedly less variance than earlier in the year. Advertising (+2.18%) and Casinos (+0.83%) led, while Timber (-6.13%) and Malls (-5.78%) lagged. Both Advertising REITs were up 2.2%, whereas Timber REITs ranged from -2.2% (Rayonier Inc. (NYSE:RYN)) to -8.9% (CatchMark Timber Trust (NYSE:CTT)).

(Source: Table by Simon Bowler, data compiled from SNL.com; see important notes and disclosures at the end of this article)

Due to share price declines for more than 80% of REITs, the number of property types that average a positive YTD total return fell from 16 to 11 during September. Single Family Housing, Diversified, Office and Data Centers all moved back into negative territory after only 1 month in the black. Timber REITs also dropped into the red, having fallen from the best-performing property type at the end of April (7.18%) to the 16th best at the end of September (-3.95%). Despite a disappointing return in September (-2.6%), Corrections remains the top-performing property type thus far in 2018 with a 14% 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 decrease from 16.7x at the end of August to 16.2x at the end of September. Malls (9.8x) and Hotels (10.8x) continue to trade at the lowest average FFO multiples, while Single Family Housing (26x) and Industrial (23.2x) are the highest. Multifamily and Advertising saw slight multiple expansion by 10 bps each as Multifamily’s multiple (18.4x) rose above that of Self-Storage (18.3x) and Advertising (13.5x) surpassed Health Care (13.1x).

(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

Safety, Income and Growth (NYSE:SAFE) moved into the black YTD and led all other REITs in September with a 14.4% total return. Two of the 5 worst performers in September were Office REITs: Government Properties Income Trust (NYSE:GOV) with a dismal -33.2% return and CIM Commercial Trust Corp. (NASDAQ:CMCT) with -9.5%. GOV’s disastrous share price collapse was the result of a non-arm's-length merger with Select Income REIT (NYSE:SIR), both of which are externally managed by The RMR Group (NASDAQ:RMR). GOV will acquire SIR, and the combined entity will be renamed Office Properties Trust and trade under the ticker OPI. It will continue to be managed by RMR.

The stated reasons for this merger are to form a substantially larger office REIT and to uncomplicate the intertwined ownership structure of 3 RMR managed REITs: GOV, SIR and Industrial Logistics Properties Trust (NASDAQ:ILPT). As per the terms of the merger, GOV will sell all 24.9 million of the common shares of SIR that it owns, and SIR will distribute a special dividend to shareholders of all 45 million of the common shares of ILPT that it currently owns. SIR shareholders will receive 1.04 shares of GOV and 0.502 shares of ILPT for each common share of SIR that is owned. The terms of this merger left GOV shareholders with far less value due to a very unfavorable share exchange rate. The share price of GOV declined 33.27% in the 3 days of trading after the announcement.

(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.

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 09/30/2018) 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.

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 September trading at a median discount to NAV of 6%, which is steeper than the 3.6% discount at the beginning of September and the 3.4% discount at which REITs began the year. The median price/NAV of Hotels and Data Centers moved from a premium to a discount during September. Although Mall REITs (-19.8%) continue to trade at the largest discounts to NAV of all REIT property types, the continuous share price declines of Timber REITs over recent months have led to a sizable average NAV discount for Timber (-18.2%) as well. Three of the 8 largest discounts to NAV now belong to Office REITs. Health Care remains the property type that trades at the largest average premium to NAV.

(Source: SNL.com and S&P Global Market Intelligence; see important notes and disclosures at the end of this article)

Takeaway

At the close of the 3rd quarter, REITs remain at an even larger discount to NAV than they began the year. Although some REITs have recovered and are trading at or above fair value, within each property type there are individual securities that can be found which are a bargain relative to their peers. Active investors have the opportunity to target well-managed, high-quality REITs that are trading at very low multiples relative to their property type. Some good examples would be Medical Properties Trust (NYSE:MPW), which trades at a price/FFO of 10.7x compared to the Health Care average of 13.1x, or STAG Industrial (NYSE:STAG), which trades at 15.4x compared to the Industrial average of 23.2x. Both REITs have strong management teams, stable tenants and attractive dividends (6.7% and 5.2% respectively), but are currently priced well below their peers. Active investors can outperform ETFs by analyzing REIT data and carefully selecting REITs that are currently mispriced by the market.

Disclosure: I am/we are long GOV, MPW, STAG, CTT.

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 GOV, MPW, STAG and CTT. I am personally long GOV, MPW and STAG. 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.