The State Of REITs: January 2019 Edition

|
Includes: BBRE, CBL, EWRE, FREL, FRI, ICF, IFEU, IYR, KBWY, NURE, PEI, PPTY, PSR, REK, REZ, ROOF, RORE, RWR, SCHH, SRET, SRVR, USRT, VNQ, WHLR, WPG, WREI, XLRE
by: Simon Bowler
Summary

There was a strong, positive correlation between market cap and total return in 2018.

Student Housing led all REIT property types in 2018, while Timber and Malls saw the largest average declines.

Reven Housing REIT was the only REIT with a double-digit positive return in December, Wheeler REIT was yet again the worst-performing REIT.

After a particularly painful December, the REIT sector finished the year trading at a staggeringly large 17.7% median discount to consensus NAV.

REITs are well-positioned for very strong returns in 2019.

REIT Performance

After outperforming the broader market in October and November, REITs fell short of extending that streak to three months. In December, REITs (-9.31%) performed worse than the S&P 500 (-9.18%) and DJIA (-8.66%), but slightly outperformed the NASDAQ (-9.48%). Based on the outperformance of large-cap REITs in December relative to their smaller peers, the market-cap weighted Vanguard Real Estate ETF (VNQ) had a less dismal return (-7.96%) than the average REIT (-9.31%).

The December selloff was particularly rough for securities that had already fallen farthest from their 52-week highs, as tax loss selling led investors to aggressively sell off the securities from which they could harvest the largest losses to offset taxable gains from earlier in the year. Which REITs and sectors are currently best positioned to outperform as we head into 2019? 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 remained positively correlated in December as large cap REITs again outperformed their smaller peers. Micro-cap REITs have underperformed for the fourth straight month after a stellar August (10.15% average return). The aggressive selloff in December pushed large-cap and mid-cap REITs into negative territory YTD and sent small-cap and micro-cap REITs further into the red, with REITs of all market caps averaging a negative return in 2018. The average REIT (-7.85%) underperformed the S&P 500 (-6.24%), DJIA (-5.63%) and NASDAQ (-3.88%). Large-cap REITs outperformed micro-cap REITs by more than 1000 basis points in 2018. Due to the large disparity in performance between large-cap REITs and smaller-cap REITs in 2018, the market cap weighted Vanguard Real Estate ETF (-6.02%) beat the average REIT total return by 183 basis points.

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

20 out of 20 Property Types Yielded Negative Total Returns in December

All REIT property types averaged a negative total return in December, after only 10% were negative in November. The total return spread between the best- and worst-performing property types remained high for the third straight month at a spread of 18% in December. This elevated performance variance will likely carry into January as value investors jump back into the market and buy up securities that were excessively beaten down during tax loss selling season. Single Family Housing (-0.30%) and Manufactured Housing (-4.20%) outperformed, while Malls (-18.32%) and Corrections (-16.04%) struggled. Mall returns were weighed down by a trio of 20%+ declines for CBL Properties (CBL) (-23.75%), Washington Prime Group (WPG) (-22.24%) and Pennsylvania Real Estate Investment Trust (PEI) (-27.47%).

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

Only 5.2% of REIT securities yielded positive returns in December, down from 75% in November. The number of property types that averaged a positive total return in 2018 fell to 8 from 12 during December. Hotels, Advertising, Casino and Corrections were in the black going into December, but finished 2018 in the red. Timber REITs continued to underperform (-13.95% for Timber vs. -9.31% for REITs in December) and finished the year as the worst-performing property type of 2018 (-27.14%). Student Housing and Infrastructure were the best-performing property types in 2018, with 13.64% and 4.47% 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 decrease from 16.3x at the end of November to 15.3x at the end of December. Malls were already priced at a much lower multiple than any other property type, but fell even further to 7.6x (down from 8.9x at the end of November). 3 of the 5 REITs trading at the lowest FFO multiples are Mall REITs (CBL Properties (CBL) at 1.1x, Washington Prime Group (WPG) at 3.3x and Pennsylvania Real Estate Investment Trust (PEI) at 3.4x). Single Family Housing (26.2x) and Triple Net (22.5x) now trade at the highest multiples. The average multiples of Hotels and Corrections REITs fell to high single digits, ending the year at 8.3x and 8.9x 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

Performance of Individual Securities

Reven Housing REIT was the best-performing REIT of December with a total return of 11.1%. This appears to largely be a bounce back from November when Reven was the worst-performing REIT with a -24.4% total return. Due primarily to low trading volume, Reven has swung back and forth wildly throughout the year. Wheeler REIT (WHLR) was by far the worst-performing REIT of December with a dismal -68.1% total return. This is a continuation of the steady freefall that Wheeler has had throughout 2018, although the severity of December’s decline can be primarily be attributed to the December 20th suspension of the preferred dividends and to tax loss selling. Prior to the preferred dividend suspension, Wheeler’s horrific year included the issuance of $25 par value Series D preferred shares at only $16.50/share, the firing of Jon Wheeler (president, CEO and chairman), the bankruptcy of Southeastern Grocers (whose subsidiaries accounted for about 14% of Wheeler’s annual base rent), a proxy fight with activist investor Stillwell Group and the elimination of the common dividend. WHLR had a 2018 total return of -91.07%, far below that of any other REIT.

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 the highest dividend yield (as of 12/31/2018) to the 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

Valuation

REITs ended 2018 at a median discount to NAV of 17.7%, far lower than the 3.4% median discount to NAV at the end of 2017. Timber saw the sharpest decline, beginning the year at a 3% discount and ending the year at a 35.9% discount. Healthcare, however, saw its median premium to NAV rise from 4.4% to 4.9% during 2019. In order to best illustrate the changes in the relationship between pricing and net asset values over the course of 2018, I have included the premium/discount to NAV by property type as of December 31, 2017, and December 31, 2018. It is important to note that this change in premium/discount to NAV reflects both changes in consensus NAV and changes in price.

NAV Data as of December 31, 2017

NAV Data as of December 31, 2018

Takeaway

The REIT sector ended 2018 with a median discount to NAV of 17.7%. Given that this is the median, half of REITs trade at even larger discounts than that. In much the same way that a shopper can buy an item that is on sale this week for a lower price than the exact same item cost last week, investors can now buy REIT shares at a large discount to the price that those exact same shares were available before the recent selloff pushed them down to their current “on sale” prices. Many of these REITs that saw such dramatic share price declines in December have not actually experienced a comparable decline in the value of their assets. As a result, investors can now acquire shares of many REITs at prices far below what those shares are worth. This offers investors substantial upside if REITs revert even halfway back toward the 3.4% discount to NAV at which they began the year.

The bigger opportunity, however, may be in M&A. Most REIT investors are not deciding between buying discounted shares of an Industrial REIT or directly buying an industrial property at full price. Private equity companies and large REITs, however, will be evaluating this decision. They will be presented with the opportunity to either buy a property portfolio in the private market at full price or buy a deeply discounted REIT to acquire a comparable property portfolio at a much more attractive price. This creates a great arbitrage opportunity benefitting both parties as the acquirer can buy the REIT to get these properties at a price far lower than could be attained in the private market, while the shareholders of the acquired REIT will see the share price rise rapidly toward the per share acquisition price. The larger the discount to NAV, the larger the opportunity for both parties to transact profitably at a price somewhere between NAV and current pricing.

Given how many REITs are entering 2019 at highly discounted pricing, this could be a big year for REIT M&A. Although the REIT sector as a whole is well-positioned to have a strong 2019, investors should carefully examine the data to determine which REITs are best-positioned to outperform, paying particular attention to those that have the greatest likelihood of being acquired. By carefully analyzing REIT data and industry trends, active investors have the opportunity to outperform ETFs.

Disclosure: I am/we are long CBL, PEI, WPG. 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, and PEI. I am personally long CBL and WPG. 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.