Small can be beautiful
Founded in 1982, One Liberty Properties (OLP) is a diversified REIT with an active net lease strategy. The company originally concentrated on retail, but began changing course in 2012. The past years, the vast majority of the underwriting has been dedicated to industrial buildings. OLP thinks that long term, industrial is a good place to play because industrial properties aren’t as capital-intense as retail and offices. Most industrial properties are 90 to 95 percent warehouse, so almost all of the space is open and easily reusable. That means you only have to refresh 5 to 10 percent for a new tenant, whereas in office or retail, you usually have to refurbish every square inch. Moreover, the market for industrial tenants is fairly brisk, allowing for annual rent increases. Retail rents, by comparison, typically increase every five years.
One of One Liberty Properties’ strengths is the high insider ownership. 21.5 percent of the REIT’s outstanding shares are insider-owned. The flip side of this coin is of course that the company is very conscious of share dilution. OLP hasn’t been in the market for new shares since 2.7 million shares were sold in 2011. This hampers growth and as a result, One Liberty Properties is one of the smallest listed REITs. A challenge for smaller REITs is the competition for industrial acquisitions. A smaller company trying to go after larger portfolios or well-marketed transactions may find it tricky. It may not be able to pull together capital as quickly as larger companies. On the other hand, however, smaller REITs can be more nimble than larger ones and transact smaller deals that are highly effective. One Liberty Properties looks for non-investment-grade industrial facilities, in B-ish markets.
Non-investment-grade, B-markets,… One Liberty Properties doesn’t look to be top quality at first sight.
But OLP certainly has some strong points. The first is the high occupancy: 99.2%!
Exhibit 1: Occupancy rates
Source: Company presentation
The nature of One Liberty Properties’ portfolio makes it resistant to e-commerce in general and Amazon (NASDAQ:AMZN) in particular because of the consumer's preference to purchase food and other staple goods and services in person in supermarkets rather than online.
OLP’s portfolio consists mostly of internet-resistant tenants like supermarket, restaurants, health & fitness and theatres. We see only office supply (3.1% of the portfolio) as high risk and furniture (8.8% of the portfolio) as a potential risk.
Exhibit 2: Portfolio overview
The high occupancy doesn’t necessarily mean there are no tenant-issues.
In December 2018, the tenant at the assisted living facility in Round Rock, Texas, filed for Chapter 11 bankruptcy protection. This property accounted for $353,000 or less than 1.0% of 2018 rental income and $2.2 million or 3.2% of 2017 rental income. The Vue, a multi-family complex, experienced a significant decrease in its operating cash flow in 2018 due to a decrease in the property's occupancy rate. The occupancy rate, which at December 31, 2018, was 72.1%, declined during 2018 due to a casualty loss, the impact of which was compounded by competition from recently constructed residential buildings.
In October 2018, Kmart filed for Chapter 11 bankruptcy protection. OLP’s Kmart property located in Clemmons, North Carolina, accounted for $601,000 or 0.9%, and $699,000 or 1.0% of rental income for 2017 and 2018, respectively.
The weighted average remaining term of OLP’s leases is 7.7 years.
Exhibit 3: Lease expiration overview
In 2022, more than 20% of OLP’s leases expire!
The weighted average remaining term of OLP’s mortgage debt is 8.7 years and the weighted average interest rate thereon is 4.26%. Nearly all debt is fixed rate debt.
Exhibit 4: Debt maturity profile
When we compare One Liberty Properties with comparable REITs or the average REIT sector it becomes clear OLP indeed isn’t a top quality REIT. We follow NAREIT’s sector classification (which places One Liberty Properties in the Diversified sector). One Liberty Properties sees itself as a Triple Net Lease player.
Exhibit 5: Key ratios
The team of Simply Safe Dividends calculates its so-called Dividend Safety Score. Its system takes into account more than a dozen fundamental metrics that influence a company's ability to continue paying dividends.
It divides companies into 5 categories, from very safe over safe, borderline safe, and unsafe to very unsafe.
Exhibit 6: Dividend Safety Score
Source: Simply Safe Dividends
When we apply this methodology to REITs we can draw two conclusions.
- The average REIT Dividend Safety Score is (only) borderline safe.
- There is a clear link between the size of a REIT’s market capitalization and its Dividend Safety Score.
The smaller the market cap of a REIT, the bigger the risk of a dividend cut is.
Exhibit 7: Market cap vs. Dividend safety
When there is a clear link between the size of a REIT and on the one hand the valuation and on the other hand the risk of a dividend cut, one would expect also a clear link between the dividend safety score and the valuation of REITs. And this is clearly the case.
Exhibit 8: Dividend safety & Valuation
One Liberty Properties’ dividend safety score is “Unsafe” which implies there is a heightened risk of a dividend cut. OLP is a small-cap REIT and the average dividend safety score for small-cap REITs is also “Unsafe.”
In the past, One Liberty Properties once lowered its dividend during the Great Financial Crisis.
Exhibit 9: Dividend history chart
To be fair, a few quarters earlier OLP paid a big dividend in 2007 when One Liberty Properties bid for industrial acquisitions and repeatedly fell short. CEO Callan: “In the middle of a pie-eating contest, we went on a diet and did not buy any properties. It turned out to be a great call.”
One Liberty Properties’ valuation is a bit cheaper than the average REIT in the Diversified sector.
The average Diversified dividend safety score is “Unsafe.” As a consequence, One Liberty Properties deserves to trade at the same valuation as the Diversified sector given its unsafe status.
Exhibit 10: Valuation
When we compare One Liberty Properties’ valuation with the average unsafe REIT, OLP is again cheaper than its colleagues.
Exhibit 11: Valuation
One Liberty Properties is much cheaper than the average REIT in the Triple Net sector. The average Triple Net dividend safety score is borderline safe! One Liberty Properties deserves to trade at a discount to the Triple Net sector, although the current discount seems to be a bit exaggerated.
Exhibit 12: Valuation
When we regress all the REITs' dividend yield on their dividend safety score, we can compute a “model dividend yield.” This gives us an indication at what dividend yield a REIT should trade given its dividend safety score. We can then compare the actual dividend yield with the model dividend yield to see which REITs are trading too cheap. The target dividend yield for One Liberty Properties is 5.5%, again an indication that OLP is (slightly) undervalued.
Exhibit 13 gives a visual representation for all the REITs with an “Unsafe” dividend safety score. The REITs trading too cheap are the ones on the right.
Exhibit 13: Model dividend yield
The yellow dot represents One Liberty Properties.
Three drivers of expected return
Returns can be decomposed into a set of building blocks:
1. Income Return
2. Earnings Growth
3. Multiple Expansion
When we look at One Liberty Properties, the income return (or dividend yield) is high, earnings growth will be rather low and the expectations for multiple expansion (or change in valuation) are rather limited.
We like undervalued REITs that exhibit at the same time strong momentum. OLP is clearly trending up and while most REITs are overbought after the recent rally this is not the case for OLP.
Exhibit 14: Price chart
One Liberty Properties isn’t a big top-quality REIT. But small can be beautiful. We think that One Liberty Properties is undervalued and deserves to trade at a dividend yield of around 5.5%. We would buy this REIT when the yield reaches 7%. This implies a price below $25.7.
If the price moves consequently up to $32.7 we will reach our 5.5% dividend yield target.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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: This article provides opinions and information, but does not contain a recommendation or personal investment advice to any specific person for any particular purpose. The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor.