The State Of REITs: February 2019 Edition

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Includes: BBRE, BRX, CTO, EPR, EWRE, FREL, FRI, HT, ICF, IYR, KBWY, LAND, MRT, NURE, O, OHI, PPTY, PSR, REK, REZ, RLJ, RMR, ROOF, RORE, SCHH, SRET, SRVR, STAG, USRT, VNQ, WHLR, WREI, XLRE
by: Simon Bowler
Summary

REITs soared 14.28% in the first month of 2019, rebounding from a rough 2018.

There was a strong, negative correlation between market cap and total return.

A whopping 97.8% of REIT securities yielded positive returns in January, up from only 5.2% in December.

Shopping Centers led all REIT property types in January, while Land and Self-Storage lagged.

REITs are well-positioned for continued strong performance throughout 2019.

REIT Performance

This was the best January for the S&P 500 in 32 years and the best month for small caps since 2011. However, even the strong performance of the S&P (+8.02%) fell well short of the REIT sector’s tremendous January return (+14.28%). REITs also substantially outperformed the NASDAQ (+9.99%) and the Dow Jones Industrial Average (+7.63%).

Although most REITs had a strong start to the year, those whose prices had been most negatively impacted by tax loss selling in December generally outperformed in January. Tax loss selling had 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. In many cases, this caused REITs that were already trading at discounted prices to become greatly oversold by the end of the year. Throughout January, value investors aggressively bought up these overly discounted securities, which rapidly drove share prices higher. After January’s huge rally, which REITs and property types are best positioned to outperform? 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 positively correlated in 2018, but this sharply reversed in January as large cap REITs fell short of their smaller peers. After underperforming for 4 straight months, micro-cap REITs (+22.75%) produced an average January return more than double that of large cap REITs (+11.08%). This micro-cap surge was driven by a rapid share price recovery from being disproportionately oversold during tax-loss selling season. Micro-cap REITs outperformed large cap REITs by more than 1100 basis points in January. Due to the large disparity in performance between large cap REITs and smaller cap REITs in January, the market cap weighted Vanguard Real Estate ETF (VNQ) (11.85%) underperformed the average REIT total return by 243 basis points.

20 out of 20 Property Types Yielded Positive Total Returns in January

All REIT property types averaged a positive total return in January, a strong reversal from December when all REIT property types were negative. The total return spread between the best and worst performing property types narrowed to 12.32% after 3 straight months of much larger spreads. Shopping Centers (+19.48%) had the best average performance, with 18 out of 19 REITs achieving double-digit returns. Self-Storage (+7.16%) had the weakest start to the year, as all 7 Self-Storage REITs underperformed the average REIT.

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 (2019) increase from 13.1x at the beginning of the year to 14.7x at the end of January. Despite strong share price performances in January, Malls (9x), Hotels (9x) and Corrections (9.6x) continue to trade at single digit multiples (up from 8.1x, 7.9x and 8.5x respectively). Manufactured Housing (21.5x) and Industrial (20.8x) REITs currently trade at the highest average FFO 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

Wheeler REIT (WHLR), a highly leveraged shopping center REIT, substantially outperformed all other REITs in January with a tremendous 90.8% return. This comes after Wheeler was far and away the worst performing REIT in 2018 with a devastating -91.07% total return. Despite the share price nearly doubling in January 2019, WHLR has generated a dismal -82.97% since the beginning of 2018, -85.84% since the beginning of 2017, -85.68% since the beginning of 2016 and -92.23% since the beginning of 2015.

MedEquities Realty Trust (MRT), a diversified health care REIT, also strongly outperformed with a stellar 69.15% January return. This gain is the result of the announcement on January 2nd that Omega Healthcare Investors (OHI) would be acquiring MRT in a cash and stock purchase. MRT shareholders of record (as of the trading day immediately before the closing date of the transaction) will receive $2.00 in cash and 0.235 OHI shares for each MRT share owned as well as a $0.21/share cash dividend. The acquisition is expected to close during the 2nd quarter of 2019.

Although the rest of the REIT sector did not perform quite as well as WHLR and MRT, nearly every single REIT participated in the January rally. 97.8% of REITs had a positive return in January, with only 4 REITs in negative territory.

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 01/31/2019) 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

In January, 6 REITs increased their dividends (as well as Consolidated-Tomoka Land (CTO), which is considering a conversion to REIT status). 4 of the 6 increases came from REITs that pay a monthly dividend: STAG Industrial (STAG), Gladstone Land (LAND), Realty Income (O) and EPR Properties (EPR).

Valuation

REITs began 2019 at a median discount to NAV of 17.7%, but after an impressive rally closed the month of January at a 7.2% discount. Even after the median discount narrowed by 10.5% in January, many REITs remain very attractively priced. Health Care remains the property type trading at the largest premium to NAV, rising to a premium of 16.7% from 4.9% at the beginning of the month. Among the 8 REITs trading at the largest premium to NAV, 5 are Health Care REITs. Industrial, Casino and Other Retail REITs finished December at a median discount to NAV, but finished January at a premium. Malls remain the most discounted property type at a median 32.5% below consensus NAV. It is important to note that changes in premium/discount to NAV reflect both changes in consensus NAV and changes in price.

NAV Data as of January 31st, 2019

Takeaway

After a particularly brutal selloff in December, the REIT sector rebounded sharply in January. Many of the stocks that saw their share prices beaten down the most severely in December were those that fell victim to tax loss selling. Throughout the month of January, value investors swooped in and aggressively bought up these oversold securities at heavily discounted prices, rapidly pushing share prices upward. Due to the fact that tax loss selling had a disproportionately negative effect on micro-cap REITs in December, their rebound was disproportionately larger. Micro-cap REITs (+22.75%) generated an average January return more than double that of the average large cap REIT (+11.08%).

After the strong January recovery, is the REIT sector still attractively priced? If so, where do the opportunities remain? Publicly traded REITs still trade at a 7.2% median discount to NAV, suggesting that REIT prices have not yet caught up with private sector real estate pricing. It appears that some of the lowest hanging fruit was picked in January, but that many great opportunities still remain. There are well-managed REITs that are taking advantage of the opportunity to sell non-core assets at attractive cap rates in order to buy back stock at deeply discounted prices, pay down debt or both. Some of these shareholder-friendly REITs are still trading at single-digit FFO multiples, such as Hersha Hospitality Trust (HT) at 8.0x, RLJ Lodging Trust (RLJ) at 8.1x or Brixmor Property Group (BRX) at 8.9x.

Although tenant bankruptcies will continue to take a toll on retail REIT landlords in 2019, the impact will likely be smaller than it was in 2017 or 2018. Given the enduring strength of the American economy and increasingly strong wage growth, consumers will continue to have strong disposable income to spend in malls and shopping centers. Additionally, the rapid growth of buy online and pick up in store will help to increase both the number of customers and sales per square foot. With substantial downside risk already priced into many of the Mall and Shopping Center REITs, there is the potential for substantial upside if the “retail apocalypse” narrative fails to come true. By carefully analyzing REIT data and industry trends, active investors have the opportunity to outperform ETFs.

Disclosure: I am/we are long STAG, LAND, HT, BRX, RLJ, OHI. 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 STAG, LAND, HT, BRX and RLJ. I am personally long STAG and BRX. 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.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.