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The State Of REITs: May 2019 Edition

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Includes: BBRE, CBL, EWRE, FREL, FRI, ICF, IFEU, IIPR, IYR, KBWY, MAC, NETL, NURE, PEI, PPTY, PSR, REZ, ROOF, RORE, RVEN, RWR, SCHH, SRET, SRVR, TCO, USRT, VNQ, VRAI, WHLR, WPG, XLRE
by: Simon Bowler
Summary

REITs generated an average return of 0.51% in April and have seen gains in all 4 months of 2019.

Micro-cap REITs continued to significantly outperform in April.

93.4% of REIT securities are in the black thus far in 2019.

Single Family Housing and Corrections were the worst performing REIT property types in March, but in a reversal were the top performers in April.

In April, the REIT sector’s median discount to NAV narrowed slightly from 6% to 5.7%.

REIT Performance

REITs have achieved gains in all four months of 2019, with a stellar 18.67% return year to date. REITs (+0.51%) underperformed the broader market in April, falling short of the NASDAQ (+4.74%), S&P 500 (3.93%) and Dow Jones Industrial Average (+2.56%). The market cap-weighted Vanguard Real Estate ETF (VNQ) did not perform as well as the average REIT in April (-0.16% vs. +0.51%) and also lags year to date (+17.18% vs. +18.67%). This ETF’s weaker performance is driven by the fact that large-cap REITs have somewhat underperformed over the first four months of the year. The spread between the FFO multiples of large-cap REITs (20x) and small-cap REITs (12.2x) continues to widen. Is this sizeable premium that the market is currently providing to the big REITs justified or is there an attractive opportunity for value investors to capitalize on a temporary and unjustified valuation gap narrow in upcoming months? 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

Micro-cap REITs (+6.44%) achieved a return more than 12x that of the average REIT (+0.51%) in April. Mid-Cap REITs had the worst April (-0.79%) and now trail both their larger and smaller peers after the first four months of 2019. The 2019 outperformance of micro-cap REITs is primarily due to the fact that many of these micro-caps had been greatly oversold due to tax loss selling in November and December and prices have sharply rebounded, moving closer to fair value during the first 4 months of 2019. Even after the strong 2019 rally, however, the average micro-cap REIT still trades at a sizeable price/FFO discount to the average large-cap REIT (14.3x vs. 20x).

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

14 out of 20 Property Types Yielded Positive Total Returns in April

70% of REIT property types averaged a positive total return in April, with an 18.34% total return spread between the best- and worst-performing property types. Single Family Housing (+7.4%) had the strongest average performance, led by the 17.03% return of Reven Housing REIT (RVEN). Malls (-10.94%) had the worst average performance, dragged down by the dismal -33.11% and -21.1% returns of CBL & Associates Properties (CBL) and Washington Prime Group (WPG), 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

Although 30% of REIT property types averaged a negative return in April, all except for Malls remain in positive territory YTD. Land REITs (+30.9%) overtook Industrial REITs (29.84%) as the best-performing property type year to date. Mall REITs (-0.54%) are greatly underperforming the REIT sector as a whole (+18.67%), due primarily to a disproportionately large number of retailer bankruptcies in the first quarter of 2019.

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) decrease slightly (from 15.4x down to 15.3x) after increasing in each of the prior months. REITs still trade well above the 13.1x average multiple at which they began the year. The average FFO multiples rose for 60% of property types and fell for 40%. Manufactured Housing (23.2x) saw further multiple expansion and continues to trade at the highest average multiple. Malls (8.7x) saw further multiple contraction in April, overtaking Correction (9.1x) as the property type trading at the lowest average multiple.

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) was already the best performing REIT of 2019 at the end of March, but added to these big gains with another very strong month (+48.77%). Over the first four months of 2019, WHLR has achieved a remarkable 170.48% total return. WHLR has risen to $2.41 at the end of April, up from $0.89 at the beginning of the year. Even after this significant price appreciation, however, Wheeler’s share price remains far lower than the $6.30 price at which it traded in early September.

CBL was the worst-performing REIT in April (-33.11%) and is now the worst-performing REIT thus far in 2019 (-44.85%). This comes after a rough 2018 in which CBL had a -60% total return, primarily driven by negative same-store NOI growth and a significant cut to the common dividend. The poor performance in 2019 has resulted from similar problems, as CBL continues to achieve negative same-store NOI growth and announced a suspension of the common dividend for the next 2 quarters as part of the terms in the settlement of a lawsuit brought by former tenants.

Although the past few years have been painful for CBL and its shareholders, CBL is now finally beginning to reap the benefits of the significant redevelopment that it has undertaken over recent years. Occupancy has begun to stabilize and even rose slightly in the first quarter. With several major redevelopments set to be completed throughout 2019, there is an opportunity to meaningfully improve occupancy and rental income. Additionally, debt maturities have been pushed back to 2023, which may give the mall REIT sufficient time to successfully transform the portfolio and return to positive same- store NOI growth. However, if CBL continues to endure elevated levels of tenant bankruptcies over upcoming years, there is the potential for the share price to see new lows.

56.6% of REITs had a positive return in April, with 93.4% in the black year to date. The REIT sector has fared much better in the first third of 2019 than in the same period in 2018. During the first four months of 2018, the average REIT had a -7.14% return, whereas this year the average REIT is already up 18.67%.

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 4/30/2019) 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

Valuation

The REIT median discount to consensus NAV decreased slightly in April, narrowing from 6% to 5.7%. Other Retail (This is retail that is neither regional malls nor shopping centers. For example, free-standing Triple Net Retail) remained the REIT property type trading at the largest median premium to NAV (20%). Innovative Industrial Properties (IIPR), an industrial REIT that leases space to marijuana companies at a high rent per square foot, continues to trade at the largest premium at 139.4% above consensus NAV.

Mall REITs continue to trade at the largest discounts to consensus NAV, with the median discount widening from 31.9% to 34.1% during April. Four mall REITs currently trade at prices more than 30% below their respective consensus NAVs: CBL trades at an 82.4% discount, Pennsylvania REIT (PEI) at a 48.6% discount, Taubman Centers (TCO) at a 38.9% discount and Macerich (MAC) at a 34.1% discount.

NAV Data as of April 30, 2019

Takeaway

Due in part to the significant increase in investment in market cap-weighted REIT ETFs in recent years, the average large-cap REIT has grown increasingly expensive relative to smaller REITs. Large-cap REITs began the month of April at an FFO multiple of 20.1x, whereas small-cap REITs averaged only 12.5x. This 7.6 turn premium increased to 7.8 turns (20x for large caps vs. 12.2x for small caps) by month’s end. Investors are currently paying on average about 64% more for each dollar of FFO/share to buy large-cap REITs than small-cap REITs (20x/12.2x - 1 = 63.9%). Although there are reasonable arguments that can be made for why large-cap REITs should be afforded a modest premium over their small-cap peers, the current massive spread is neither warranted nor sustainable.

There is a tremendous opportunity for active investors (value investors in particular) to capitalize on this mispricing and generate significant alpha by taking long positions in small-cap securities with unwarranted discounts and/or shorting overly inflated large-cap REITs. By carefully analyzing REIT data and industry trends, active investors have the opportunity to outperform ETFs.

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

Disclosure: I am/we are long CBL, WPG, PEI & MAC. 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, PEI & MAC. 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.