The State Of REITs: December 2018 Edition

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Includes: AMH, APTS, BBRE, BRG, CBL, CDR, CLNY, CTT, EWRE, FREL, FRI, FRIFX, ICF, INVH, IYR, KBWY, LAMR, MNR, MRT, NRE, NURE, OUT, PLYM, PPTY, PSR, REZ, ROOF, RORE, RVEN, RWR, SCHH, SRET, SRVR, USRT, VNQ, WHLR, WPG, XLRE
by: Simon Bowler
Summary

The REIT sector moved back into positive territory year to date, bouncing back after a rough September and October.

There has been a strong, positive correlation between market cap and total return thus far in 2018.

Student Housing led all REIT property types in November, while Single Family Housing and Malls underperformed.

NorthStar Realty Europe outperformed all other REITs in November, while Reven Housing REIT produced the worst return.

Even after a strong November, the REIT sector currently trades at an 8.5% median discount to consensus NAV.

REIT Performance

After a painful September (-2.54% total return) and October (-3.91%), the REIT sector began to recover with a solid November (2.73% total return). For the 2nd month in a row, REITs generated a better return than the broader market. REITs outperformed the S&P 500 (1.79%), DJIA (1.68%) and NASDAQ (0.34%). Based on the tremendous outperformance of large-cap REITs in November relative to their smaller peers, the market-cap weighted Vanguard Real Estate ETF (VNQ) had a significantly higher total return (4.67%) than the average REIT (2.73%). The REIT selloff of September and October was fueled largely by fear that the Fed will not slow their pace of quarterly rate hikes. However, Powell's shift to a notably more dovish tone in November reduced investor fear of the risk of 3 or more 2019 rate hikes. This helped to guide the 10-year treasury to finish November at a lower yield than it began the month. Additionally, REIT earnings largely came in at or above analyst expectations, demonstrating continued fundamental strength. Which REITs are currently best positioned to outperform through the remainder of the year and as 2019 begins? 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 of 2nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article

REIT market cap and total return were strongly positively correlated in November as large-cap REITs outperformed micro-cap REITs by nearly 10%. Large-cap, mid-cap and small-cap REITs all bounced back from negative returns in September and October, but micro-cap REITs struggled for the 3rd straight month after a stellar August (10.15% average return). Large-cap and mid-cap REITs moved back into the black YTD, but small-cap and micro-cap REITs remain in negative territory.

Source: Graph by Simon Bowler of 2nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article

18 out of 20 Property Types Yielded Positive Total Returns in November

90% of REIT property types averaged a positive total return in November, up from only 20% in October. The total return spread between the best and worst performing property types was less than 10% in August and September, but the spread jumped to 18.33% in October and grew to 19.63% in November. This elevated performance variance will likely carry into December as tax loss selling continues and holiday retail sales data begins to come in. Student Housing (+12.18%) and Advertising (+10.35%) outperformed, while Single Family Housing (-7.45%) and Malls (-4.68%) were the only property types to average a negative return in November. Advertising REIT performance varied dramatically with OUTFRONT Media (OUT) generating a 17.27% return whereas the return for Lamar Advertising Company (LAMR) was only 3.44%. Mall returns were weighed down by a dismal -20.91% return for CBL Properties (CBL).

Source: Table by Simon Bowler of 2nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article

75% of REIT securities yielded positive returns in November, up from only 24.4% in October. Thanks to a strong month for Advertising REITs, the number of property types that average a positive YTD total return rose from 11 to 12. Timber REITs continue to underperform (0.67% for Timber vs. 2.73% for REITs) and remain the worst performing property type of 2018 (-17.32%). Student Housing and Infrastructure remain the best performing property types thus far in 2018 with 16.75% and 13.73% average total returns, respectively.

Source: Table by Simon Bowler of 2nd Market Capital, 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 15.6x at the end of October to 16.3x at the end of November. Malls were already priced at a lower multiple than any other property type, but fell even further to a mere 8.9x (down from 9.3x at the end of October). Mall REITs CBL Properties and Washington Prime Group (WPG) are now trading at strikingly low multiples of only 1.5x and 4.1x, respectively. Single Family Housing (27.5x) and Industrial (22.8x) now trade at the highest multiples. Advertising (13.5x) saw average multiple expansion of 100 bps, surpassing the falling multiple of Timber (12.4x), which saw multiple contraction of 160 bps. However, it should be noted that CatchMark Timber Trust (CTT) is the only Timber REIT included in this metric, given the lack of analyst FFO estimates for the other 3 Timber REITs due to the fact the FFO is not the primary valuation metric for Timber. It is more common for Timber REITs to be valued based on NAV or even adjusted EBITDA multiples.

Source: Table by Simon Bowler of 2nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article

Performance of Individual Securities

NorthStar Realty Europe (NRE) was the best performing REIT of November with a total return of 23%. This was primarily the result of investor excitement regarding the evaluation of a potential sale of the company and the announcement of the termination of the asset management contract with an affiliate of Colony Capital (CLNY), which otherwise would have remained the external manager of NRE until January 1st, 2023. NRE had been trading at a substantial discount to NAV, primarily because of this unfavorable contract with the Colony affiliate. NRE will pay a $70 million termination payment upon the date of termination, which will occur upon the earlier of the completion of internalization of management or the sale of the company. Reven Housing REIT (RVEN) was the worst performing REIT of November with a -24.4% total return. This highly volatile stock had fallen by as much as 44.32% YTD by the end of April and had nearly fully recovered until plummeting again in late November. Due in large part to low trading volumes, this micro-cap has experienced substantially greater volatility than its mid-cap peers Invitation Homes (INVH) and American Homes 4 Rent (AMH).

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 11/30/2018) to lowest dividend yield.

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 of 2nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article

Earnings Beats and Misses by Property Type

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

As shown in the table above, Timber REITs accounted for the two biggest earnings beats and two of the biggest misses. This is due primarily to the fact that Timber earnings are highly inconsistent on a quarterly basis and thus notoriously difficult for analysts to forecast. Although quarterly earnings should of course be primarily analyzed on an individual company basis, it can be valuable to also examine them in aggregate across property types. When doing so for Q3 earnings (evaluated based on whether Q3 FFO/share came in above or below the analyst consensus), it is clear that Self-Storage had a particularly strong quarter with all 5 REITs outperforming expectations. Industrial and Data Center REITs also performed well, with 80% of the REITs in each property type reporting FFO/share beats. Specialty REITs (Land, Infrastructure, Timber, Corrections, Casinos and Advertising), however, underperformed expectations with fewer beats (7) than misses (8).

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

Valuation

REITs ended November at a median discount to NAV of 8.5%, rising from the 11.4% discount at the beginning of the month. Residential (composed of multifamily, single family, student housing and manufactured housing) saw the median discount to NAV narrow to 6.4% from 11.4% during November. At an 11.6% premium, Health Care continues to trade at the highest price/NAV of all REIT property types. Although the REIT sector as a whole experienced improved pricing, Mall REITs saw their already tremendous discount to NAV grow from 28.3% to 29.3%. This discount is particularly extreme for CBL Properties, which is now priced at only 31.7% of consensus net asset value.

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

Takeaway

Although the median discount to NAV of the REIT sector narrowed from 11.4% to 8.5% during November, many REITs can still be attained for a price well below the value of their underlying assets. Many of the securities that had performed well going into November also performed well during the month. Likewise, many of the securities that had performed poorly earlier in the year also performed poorly in November. Although, in some cases, this was the result of good companies continuing to be rewarded by the market, in other cases, it was likely the result of tax loss selling. The most efficient way to wash large taxable gains is by selling the securities that have the greatest unrealized loss. This, of course, pushes certain securities substantially lower than they would otherwise trade (were it not for tax loss selling in November and December), creating an opportunity to buy at excessively discounted prices.

This tax loss selling effect impacted pricing across many REIT property types. For example, the 2 Industrial REITs that had seen the largest 2018 price declines over the first 10 months of 2018, Plymouth Industrial REIT (PLYM) and Monmouth Real Estate Investment (MNR), were the only two Industrial REITs that declined in price during November. The Timber REIT that had fallen the furthest pre-November, CatchMark Timber Trust (CTT), was the only Timber REIT that declined in November. The two Shopping Center REITs that had fallen the furthest, Wheeler Real Estate Investment Trust (WHLR) and Cedar Realty Trust (CDR), also fell the furthest in November, while 14 of the other 15 Shopping Center REITs saw gains. The 2 worst performing Multifamily REITs going into November, Preferred Apartment Communities (APTS) and Bluerock Residential Growth (BRG) were also the 2 worst performing multifamily REITs in November. The same also occurred in Health Care, Land, Malls and Manufactured Housing.

Some of these securities that were beaten down by tax loss selling have tremendous near-term upside potential, as many value investors may be inclined to scoop them up at bargain pricing around the beginning of 2019. MedEquities Realty Trust (MRT) is an example of a security that declined to a certain degree for fundamental reasons (the replacement of a troubled tenant with a stronger tenant at a lower rent as well as a brief suspension of the dividend until January 2019), but then sold off aggressively and continuously throughout November despite no additional negative news. Numerous other REIT securities have similarly declined to a degree that is not justified by company or industry fundamentals. By carefully analyzing REIT data and industry trends, active investors have the opportunity to outperform ETFs.

Disclosure: I am/we are long CBL, WPG, PLYM, APTS, CTT & MRT. 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, WPG, PLYM, APTS, CTT and MRT. I am personally long CBL, WPG, PLYM and MRT. 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.