We bring you 2 buy ratings
Today, we will be taking a look at Healthcare Trust of America (HTA) and ARMOUR Residential REIT (ARR). They come with a risk rating of 2.5 for HTA and 5 for ARR on a scale of 1-5. While we mostly cover safer securities, we also look for good trading opportunities. Further, we look for securities for the aggressive buy-and-hold investors and believe HTA is a good choice. Meanwhile, our rating on ARR is only intended for investors who are comfortable trading the shares based on discounts to projected book value.
Who we cater to as investors
We cater to both buy-and-hold investors and traders at The REIT Forum.
However, we believe the REIT sector can be very inefficient, and there are times where it just makes good sense to walk away from a position. We try to buy securities with a sufficient margin of safety so that the fundamentals are unlikely to deteriorate to the level implied by the share price.
- The preferred shares are generally pretty stable in price, but we find our returns are strengthened by being ready to capture gains and walk away if prices soar to unrealistic levels. We believe the preferred stock often makes a more suitable investment for the long-term buy-and-hold investors.
- There are several stocks where it is very difficult to beat the equity market at forecasting future returns. Those stocks generally represent companies that are simpler to analyze and have lower yields. It is the very high yields that drive more retail investors into this sector. It is the presence of trades occurring without adequate research that drives an imbalance in the supply and demand. This is precisely where we want to make our money.
The challenging part is that means we will regularly be going against the flow. We'll be advocating securities that current shareholders hate due to poor price performance and selling securities when many investors think they finally turned a corner for better returns.
We have a full analysis of Healthcare Trust of America for subscribers of The REIT Forum.
MOB (Medical Office Building) REITs, specifically discussing Healthcare Trust of America, Healthcare Realty Trust (HR), and Physicians Realty Trust (DOC) are a bit of a strange hybrid. They could best be described as a cross healthcare REITs and triple net lease REITs.
We find HTA as the most interesting opportunity here. This page from HTA's June Presentation describes it well:
The first point we want to make is that Ventas (VTR), Welltower (WELL), and HCP (HCP) are in the middle. They are hybrid healthcare REITs. When you look at the rally in those names, it should raise some questions about how the MOB REITs were left out.
One of the critical factors here (highlighted on the slide) is that the MOB buildings are not operator-dependent. One of our concerns about healthcare REITs is their reliance on specific tenants, who often have dreadful rent coverage ratios, continuing to perform successfully.
We also find high retention rates and low re-tenanting costs to be a very appealing aspect.
The slide above discusses how HTA compares to the broader healthcare REIT subsector and to office REITs. However, they haven't highlighted how they have some comparable metrics to triple net lease REITs. They certainly aren't a pure play on net leasing, but it is a material aspect of their portfolio:
One reason HTA may not have pushed for this comparison is that triple net lease REITs usually emphasize retail properties. Retail properties tend to trade at higher capitalization rates. All else equal, the lower capitalization rates on HTA's assets should warrant a higher FFO multiple if leverage is comparable. A higher FFO multiple would also suggest a lower dividend yield. If HTA doesn't want to tackle explaining capitalization rates to most investors, then it makes sense for them to avoid highlighting it.
It is also worth noting that the total portfolio occupancy rates for MOB REITs are materially lower than they would be for the triple net lease REITs like Realty Income (O), National Retail Properties (NNN), and Store Capital (STOR). With those REITs, you may regularly expect occupancy above 98% or even above 99%.
For comparison, this slide comes from Realty Income Corporation:
Source: Realty Income
By comparison, that makes the occupancy for triple net lease REITs like HTA look much weaker:
The area where HTA shines in this comparison is their growth rate in same-store NOI:
While same-store NOI growth slowed over the last few quarters and may give analysts some concern, we don't foresee it suddenly falling off.
Investing in mortgage REITs
The mortgage REIT market frequently has periods that should make investors question efficient markets. There are periods where things appear efficient, but there are also some incredible failures, and the duration of those failures can be as short as a couple of hours or as long as a few quarters, perhaps even a few years. In our experience, something between the extremes is far more common.
One of the problems the mortgage REIT sector faces is the presence of investors trading on dividend yield with no idea what levels of dividends are sustainable or not sustainable. If those investors create a large enough group to move the market, they could influence the larger mREITs to trade at larger discounts on the basis of their tools showing inaccurate numbers for dividend yields. Remember that prices are still determined by supply and demand, so it is entirely possible for share prices to deviate from a comparable value in other similar companies. To be more precise, it is not only possible but it is also common, and uncovering those discrepancies is a major part of our work.
We had a buy alert on ARR for subscribers on 5/17/2019.
Source: The REIT Forum
It is rare for The REIT Forum to be more bullish on the common shares of a residential mortgage REIT than the preferred shares. We have regularly encouraged investors to focus on safety first and the yield level second. Our strategy has thoroughly outperformed the sector over the last 3 and ½ years.
It is also rare for us to be bullish on ARR.
In our ratings for ARR, we have often been fiercely bearish. We were also correct. Following the most recent declines in the share price, we find ARR is trading at a very reasonable valuation. It carries a double-digit discount to our projected current book value. That means a price to book ratio below .90, based on our current mid-May estimates for ARR's book value.
The recent scare around tariffs has increased volatility in interest rates and widened spreads for mortgage-backed securities. The result is some modest pressure on book value per share, but a better environment for reinvesting proceeds.
ARR's portfolio includes agency MBS and non-agency securities.
We are comfortable with the current spread available on agency securities, which are the lion's share of ARR's portfolio. While spreads on non-agency securities are thinner than we would like, we do not expect dramatic damage to the US housing market. The underlying bonds should continue to perform.
Some investors may be concerned about ARR holding significant positions in CRTs (credit risk transfers).
These CRTs are another way for mortgage REITs to earn income. They are taking on credit risk tied to new mortgage loan originations. The important factor for ARR's CRTs is that the mortgages are not that new. ARR purchased these CRTs several quarters ago. As management discussed in their recent earnings calls, the environment for CRTs was much more attractive in prior quarters, and the credit underwriting left them with less risk than the CRT securities being produced today.
While we find ARR's share price attractive, we still see it as a trading opportunity. We are not interested in a long-term investment. We are simply interested in seeing the price to book value ratio improve.
Any position should be evaluated based on total returns. We would be looking at the combination of dividends earned plus the change in the share price. Using these same metrics, we frequently cited ARR as a poor investment when the share price was substantially higher. The dramatic decline in the share price vastly outpaced the loss of book value. Consequently, ARR is now a bargain as it sits very close to 52-week lows.
ARMOUR Residential - Dividend risk
As a residential mortgage REIT, there is significant dividend risk for ARR on the first quarter earnings releases, AGNC Investment Corp. (AGNC) and Annaly Capital Management (NLY) announced upcoming dividend cuts. Certainly, there is risk for ARR as well, but that risk permeates the entire mortgage REIT sector. With ARR, there is a sufficient discount to book value already built into the shares.
If ARR trims their dividend, we would expect the downside to be limited. If ARR maintains their dividend, we believe the price to book value ratio could pop higher.
It is rare for us to suggest common shares of a mortgage REIT while disliking the preferred shares. However, we find the preferred shares of ARMOUR Residential REIT to be overly expensive.
While the preferred shares offer significantly less dividend risk, we would rather pick preferred shares with a lower risk for that part of the portfolio. The preferred shares have very little potential for price upside and carry a significant risk if the market declines. We could see a decline for the preferred shares that would be roughly close to the decline for common shares in a market panic.
We don't consider either event likely, but only the common shares have the price upside to offset the downside risk.
If ARR's preferred shares were to rally significantly, we believe management would look to call the shares and issue new preferred shares at a lower rate. That should make it quite difficult for much price increase on the preferred shares.
If the investor is simply looking for a stable source of income, then they should consider AGNCN, which is one of AGNC's preferred shares. AGNCN carries a lower dividend yield but has significant call protection and has an FTF feature after the call protection ends. We see AGNCN as a substantially lower risk alternative.
Source: The REIT Forum
The $100k chart for ARR
When we published our buy alert for ARR, we needed to use the closing values as of 5/16/2019 for our $100k chart. We noted that ARR was selling off quite hard that day, so the value was becoming more compelling. We updated the chart to utilize the ending prices from 5/17/2019 ($18.16 for ARR):
If this chart is confusing, please see: Guide to the $100k charts.
Note: We purchased shares at $18.18, which is $.02 higher than the closing price.
Since book value performance should've been relatively comparable during this period, the dramatic underperformance of ARR should reflect a dramatically wider discount to book value.
We find HTA is an interesting opportunity here. One of the critical factors here is that the MOB buildings are not operator dependent. One of our concerns about healthcare REITs is their reliance on specific tenants, who often have dreadful rent coverage ratios, continuing to perform successfully. We also find high retention rates and low re-tenanting costs to be a very appealing aspect.
It is rare for The REIT Forum to be more bullish on the common shares of a residential mortgage REIT than the preferred shares. We are comfortable with the current spread available on agency securities which are the lion's share of ARR's portfolio. If the investor is simply looking for a stable source of income, then they should consider AGNCN.
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Disclosure: I am/we are long ARR, HTA, AGNCN, NLY-F. 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.