Score Big With These 5 Small Cap REITs

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Includes: CIO, CORR, CTT, DEA, LAND
by: Brad Thomas
Summary

By their very nature, small caps are riskier choices to consider.

The very fact that analysts aren’t as involved means they’ve got a good chance of being underrated during pre-earnings season speculation.

When you do your research and stick to smart strategies, small caps can turn out to be your best market friend.

What’s so great about small-cap REITs, those real estate investment trusts (or REITs) with market caps of $1 billion or less?

For starters, they’re not large-cap REITs.

Taken at face value, that last statement might seem obvious to the point of inanity. But look a little further and you’ll find it to be a powerful point, and for more than one reason too.

No portfolio should ever be filled with just one category of investment. It doesn’t matter how well precious metals, or bonds, or biotech, or any other market designation out there has done in the past.

It can have the best 5-year, 10-year or even 20-year performance ever, and you still shouldn’t “stock” up on it too much. Not unless you have a time-traveling machine to jump forward into the next five, 10, or 20 years to make sure that trend won’t change going forward.

Assuming that you don’t have that kind of nifty little device, here’s a fact of life… The more you can diversify, the better your invested money is bound to do over time.

That’s why small-cap REITs being something other than large-cap REITs is a plus. The more categories and subcategories you have your financial hands in, the more protected you’re going to be.

In this regard, it’s all about diversification and portfolio safety, two necessary topics that are, admittedly, rather boring. There’s nothing attention-grabbing about either, so too many people end up ignoring them altogether.

If you’re one of those thrill seekers, here’s a much more interesting reason to like small-cap REITs…

They’re scrappy little fighters that know how to roll with the punches.

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In It to Win It

One way to look at small-cap REITs is that many of them are still up-and-comers. They’ve got higher goals to reach than their larger-cap brethren, and they know they have to work harder to reach them.

That means they’re not set in their ways. They can’t be if they want to grow at more than a large-cap snail’s pace.

Bigger businesses know what works for them and they rely on those formulas, sometimes too much. Weighed down by rules, regulations and bureaucratic red tape, they can end up being too cautious or just too encumbered, unable to return the kind of stock gains that small caps can.

These factors and many more, make small-cap REITs tempting, to say the least.

Now, it’s true that all those potential pluses can be potential negatives. By their very nature, small caps are riskier choices to consider.

  1. Their track records are shorter, which means there’s less information to analyze and fewer tried-and-true conclusions to reach.
  2. They’re not as well-known and therefore not as covered by analysts (or anyone else).
  3. And because of reasons 1 and 2, they’re more likely to be volatile whenever the fear factor kicks into the market.

Don’t let any of that throw you off of the small-cap REIT bandwagon though. The very fact that analysts aren’t as involved means they’ve got a good chance of being underrated during pre-earnings season speculation.

That means they’re more likely to outperform.

Long story short: When you do your research and stick to smart strategies, small caps can turn out to be your best market friend.

5 Small Cap REITs We're Buying

So here’s a starter: a handful of currently notable, small-cap players. Current prices seem favorable for interested investors.

Easterly Government Properties (DEA) is focused on acquisition, development, and management of class A commercial properties leased to U.S. government agencies through the General Services Administration. It’s the only publicly-traded, "pure play" government office REIT - with internalized management (external management costs more and allows the potential for management and other conflicts unfavorable to shareholders).

Easterly sticks to critical missions of the federal government that don't go out of favor - agencies such as the Federal Bureau of Investigation, and Immigration and Customs Enforcement. No state or local government leases. DEA has 64 properties, totaling 5.5 million square feet. Not surprisingly, the portfolio is 100% leased. Weighted average age, 13.5 years.

Q3-18 showed significant growth, with approximately 1.5 million square feet of new rental space, 99% leased with weighted average lease expiration in 2022. The investor risks (a high payout ratio) are adequately rewarded in the form of a 6.1% dividend - one of the highest yields in the office sector. Keep in mind, DEA's tenants are paying their rent, regardless of the government shutdown, and we are maintaining a BUY. Source: FAST Graphs

Gladstone Land (LAND) is a farming sector REIT. The company went public around six years ago and now has 75 farms with 63,000 total acres in 9 states. Gladstone struggled during its first several days of trading, likely due to its 70% tenant concentration with Dole Food Company; however, the company has since diversified its portfolio considerably.

Externally-managed Gladstone Land typically doesn’t farm any of the land, but rather leases the properties to unrelated third-party farmers. Currently, over 85% of total revenues come from farms growing the types of foods you’d find in the produce and nut sections at your local grocery store (i.e., healthy food). Gladstone Land’s annual dividend yields 4.57%... paid out monthly.

Gladstone is attractive to us because of the company's focus on specialty crops (i.e. blueberries, almonds, etc...) and we believe that the company will be able to improve its payout ratio in 2019 and 2020. Management has been especially transparent and this is one of the reasons we are maintaining a BUY on this small-cap REIT. Source: FAST Graphs

The only publicly-traded “pure play” on timber is CatchMark Timber Trust Inc. (CTT) in an enviable position of holding a real timberland heritage while trading at a dirt-cheap valuation against its acreage. Q3-18 earnings showed timber and lumber prices are not necessarily correlated. Prices in the company’s markets remain healthy, even after seeing lumber pricing fall quarter to quarter.

CatchMark’s share price was beaten down from June highs due to an unfair association with lumber. Remember, CTT sells timber (not lumber), and doesn’t engage in higher risk activities like lumber manufacturing or land development. Of the major timberland REITs, CTT is the only one expected to grow EBITDA year-over-year into 2019. Investment in timber has a place in any portfolio, especially when market sentiment is weakest. The net asset value story is here, plus the income story with a 6.38% dividend yield, run by a management team with excellent experience.

We are maintaining a STRONG BUY, recognizing that the shares are more volatile in nature. We expect to see continued price appreciation, and potentially 35% annualized total returns. This is no SWAN so proceed with caution. Source: FAST Graphs

Kansas City-based CorEnergy Infrastructure Trust (CORR) was the first Infrastructure REIT… primarily acquiring and financing mid- and downstream real estate assets within the U.S. energy infrastructure sector, while entering into long-term triple net participating leases with energy companies.

The company has strong growth potential for these “dedicated infrastructure” assets - mostly pipelines and storage assets. Especially attractive is a proven revenue stream, reliable even in periods of distress – CORR came out of the energy crisis with its strategy validated. They’re battle-tested and better prepared to scale into a safer investment platform.

With few peers, the externally-managed company can build a foothold as a premier partner of choice in energy infrastructure sale/leaseback transactions. Instead of competing for deals in the open market, CORR can source off-market deals, essentially as the "go to" landlord of choice.

Owning mission-critical assets, lease payments are “operating” expenses, not “financing” expenses - and operating leases have priority in payment and bankruptcy. CORR‘s revenue stream is resilient and protected even during any encountered bankruptcy. The stable dividend of 8.66% enjoys a comfortable level of coverage. We are maintaining a STRONG BUY. Source: FAST Graphs

City Office REIT Inc. (CIO) offers an attractive combination of current yield, long-term growth potential, and one of the lowest valuations in its industry. Focusing on secondary, fast-growing markets (medium-sized cities), CIO is seeing strong occupancy and continued annual rental increases.

This small-cap REIT owns 62 office buildings in seven cities (four in fast-growing major metro areas). Their goal is to buy new properties for cap rates (cash yield) of 7% to 8%. By the end of Q1-19, CIO expects to put $170 million into acquiring new properties, and beyond that, has a potential $330 million acquisition pipeline that could keep their property base growing strongly for several more years.

While the AFFO payout is 122% (in part, to attract investor interest), City Office expects to fully cover its 8.48% yielding dividend with cash flow this year, and begin growing the dividend in line with AFFO/share growth in 2021. As the fastest growing office REIT in America, City Office collects 35% of rent from government agencies, or investment grade companies or subsidiaries. Risk-tolerant investors are potentially looking at 16% to 18% long-term annualized returns over coming decades.

City Office is internally-managed and we consider this small-cap REIT to be a true outlier capable of generating 30% annualized returns. We maintain a STRONG BUY. Source: FAST Graphs

Author's note: Brad Thomas is a Wall Street writer and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos and be assured that he will do his best to correct any errors if they are overlooked.

Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking.


Disclosure: I am/we are long DEA, CIO, CORR, CTT, LAND. 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.