Perseverance Pays With REITs: 'Don't Give Up The Ship'

Includes: CIO, HT, SKT
by: Brad Thomas

I was down in Nassau last week for business, which is when I happened to walk by the supremely stunning Top Five.

Sometimes, it truly is the slow and steady that win the race.

The picks that I am providing today are contrarian in nature, and I have been called a dummy more than once for maintaining strong buys on them.

Over the weekend, I published a piece about Top Five, an absolutely exquisite yacht that costs $180,000 per week.

And, as I only learned after writing that first article, that’s just during the winter. When it’s high season, Top Five is $200,000 per week.

Oh, and keep in mind that neither price tag includes expenses.

Those figures right there should give you an idea of what kind of boat you’re looking at. But here’s a few more details nonetheless, courtesy of YachtCharterFleet:

Top Five’s interior layout sleeps up to 12 guests in six rooms, including a master suite. She is also capable of carrying up to 8 crew onboard to ensure a relaxed luxury yacht experience. Timeless styling, beautiful furnishings and sumptuous seating featured throughout to create an elegant and comfortable atmosphere.

Top Five’s impressive leisure and entertainment facilities make her the ideal charter yacht for socializing and entertaining with family and friends.

Any description that uses the word “sumptuous” is bound to be stunning. Then again, it better be for what they’re charging for it.

Of course, $200,000 per week or even $180,000 per week is a little more expensive than the kinds of opportunities I normally recommend. So what gives with this fixation on big boats right now?

Good question, and I won’t fault you for asking it. But there actually is a decent investment-related explanation.

I was down in Nassau last week for business, which is when I happened to walk by the supremely stunning Top Five. Let me tell you something… Once you see a sight like that, you have to find some way to write about it.

It’s just that attention-grabbing. And I only got to view the outside.

With that said, there were a few other sights I saw that got me thinking.

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Photo by Brad Thomas

Still Seaworthy

Fortunately for you, this second sight I’m writing about today isn’t nearly so expensive – even if it was another yacht.

A significantly smaller ship than Top Five, I’m betting that Perseverance 3 (pictured above) probably doesn’t feature the same stuff. Something tells me it can’t contain a hot tub the size of a tiny cabin… enough room to very comfortably sleep 12… a Titanic-style staircase as well as an elevator… and enough drinks and dining space to put a decently sized bar to supreme shame.

But that doesn’t matter much to me when Perseverance has the kind of character that a $300 million-dollar yacht couldn’t possibly fathom.

For the record, I’m merely guessing about how much Top Five sold for from the start. According to the 2015 Forbes article “How Much Does a Superyacht Really Cost”: “The world’s largest private vessel, Khalifa bin Zayed Al Nahyan’s Azzam, reaches an astounding 180 meters (590 feet) and cost $600 million to build.” So I estimated based on that scale.

One way or the other, you’d better believe it’s expensive.

Here’s the thing though. Top Five is advertised as having not just a modern but “an ultra-modern stabilization system to reduce roll motion effect and ensure the ultimate comfort throughout your charter vacation.”

Perseverance, however, doesn’t have the space or the money to guarantee such smooth sailing. It survives based on being a well-built craft with someone smart at her helm.

Or so I’d imagine.

In which case, she reminds me a whole lot of certain real estate investment trusts out there.

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Slow but Steady Survives the Storms

I know the REITs I’m going to cover below aren’t the flashy ones that get all the attention. They don’t have analysts drooling over them or fawning at their feet, hanging on their CEOs’ every word.

If anything, they’re rather beaten down. Either that or completely ignored, set aside by the financial media and therefore unappreciated by many mainstream investors.

Yet that doesn’t affect their sturdy structures or the quality models they continue to steer by. They’re in it for the long haul, as evidenced by all the storms they’ve successfully navigated so far.

These REITs are solid investments. And I, for one, think they’re worth holding onto – no matter how many bigger boats are cruising the market waters right now.

Sometimes, it truly is the slow and steady that win the race.

With all that said – with complete confidence, mind you – these investments aren’t for the faint of heart. Remember what I quoted before about Top Five’s “ultra-modern stabilization” systems? Well, the REITs I’m going to detail don’t have those.

Therefore, at times, it’s going to take a tremendous amount of courage and discipline to hang onto these shares.

If you’re up for a little less luxury and better-priced property-based profits though, you’re not going to get better than these.

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Riding the Waves

When it comes to investing, sometimes the journey can become difficult and that means that you must learn to not adhere to a herd mentality. Warren Buffett believes: "You need to divorce your mind from the crowd.”

The picks that I am providing today are contrarian in nature, and I have been called a dummy more than once for maintaining strong buy calls on all three of these stocks. As Buffett said:

To be a successful investor you must divorce yourself from the fears and greed of the people around you, although it is almost impossible.

Perseverance by definition means “don’t give up the ship” or “to always keep fighting”. According to The Free Dictionary:

At the Battle of Lake Erie (September 10, 1813) when Commodore Perry adopted it as his battle cry (“don’t give up the ship”), it was he who popularized the words and made them memorable. The expression has extended beyond its naval origins and application and is now currently used to give encouragement to people in all walks of life.

Our first “perseverance pick” is City Office (CIO), a small cap office REIT that we upgraded to a Strong Buy just over a year ago (has returned around 4% since that time). Year to date shares have performed in-line with the equity REIT sector (CIO has returned +19% YTD), and we are standing behind this pick because we believe there’s an opportunity to generate impressive returns (+25% annual returns).

There are two things holding back CIO today and we believe that eventually the market will recognize the company for its true value. The first overhang is market positioning.

CIO owns a portfolio of 27 properties located in “18-hour cities” with strong economic fundamentals, primarily in the Southern and Western U.S. By definition an “18-hour city” is a second-tier city with higher-than-average urban population growth and featuring a lower cost of living and lower cost of doing business than first-tier cities.”

These 18-hour cities are practical investment substitutes to the "big six" markets of Boston, Chicago, Los Angeles, New York, San Francisco and Washington, D.C. — “most of which are often dubbed 24-hour cities”.

Similar to STAG Industrial (STAG), an industrial REIT that focuses on secondary markets, CIO operates a similar business model that deploys capital in smaller markets to achieve higher returns (CIO’s average cap rate is around 7.1% in the 18-hour markets).

For example, in February CIO purchased Canyon Park, a three-building campus in the Eastside/Bothell submarket of Seattle for $63 million at a 7.1% cap rate. Seattle is officially a new market for the company and the acquisition enhances the company’s existing set of attractive markets.

The second overhang for CIO is leverage, a tad high today (net debt-to-enterprise value of 54%) but the company is hoping to reduce leverage, so it fully covers the dividend. In Q1-19 FFO per share was $.29 and AFFO was $.21 per share (payout ratio was 113%).

The company reiterated 2019 core FFO per share of $1.15-$1.20, same-store cash NOI growth of 2.0%-4.0%, and year-end occupancy rate at 91.0%-94.0%. This means that it should achieve ~8% FFO/AFFO growth in 2019 and analyst forecasts suggest another 6% growth in 2020. Given these clear catalysts, we are maintaining our Strong Buy recommendation as viewed below:

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Source: FAST Graphs

Our next perseverance pick is Hersha Hospitality (HT), another Strong Buy pick that we called out last October 2018. At the time we explained that “our fundamental research suggests that the company could generate another 20-25% over the next 18-24 months.”

Since that time (October) HT shares have returned only 5.3% (and only 4.4% YTD). One of the things that we like about this particular lodging REIT is that it focuses on markets (48 hotels) concentrated around the most populated technology and innovation districts, including the fast-growing Seaport in Boston, Playa Vista and Santa Monica in Los Angeles, Silicon Valley and South Lake Union in Seattle.

Essentially this means the company has a bi-coastal focus in which it invests in a unique combination of category-killing branded hotels and independent lifestyle hotels. As the company’s president and COO, Neil Shah, explained on the most recent earnings call:

This strategy coupled with our operational alignment is unique to Hersha and we believe it offers us the capability to outperform and maintain market leading margins in this current low single digit RevPAR environment.

HT has also maintained a disciplined capital market strategy with optimal financial flexibility ($33.5 million in cash and ample capacity under the $250 million line of credit). The dividend payout ratio is expected to be below 50% (the target range) and is one of the lowest in the lodging REIT sector.

In Q1-19 HT generated AFFO of $6.3 million (up 133% from Q1-18), the equivalent of $0.15 per share, a 150% increase from AFFO per diluted common share and OP Units in Q1-18. RevPar (revenue per available room) at the 37 comp. hotels increased 2% and occupancy grew 235 bps to 78.8%. The company maintained 2019 AFFO guidance of $2.22 to $2.35 per share.

HT is a small cap ($700 mill market cap) that is flying under the radar. We like the low payout ratio and high yield of 6.3%. We consider this stock cheap – based on all metrics – and conclusively the P/FFO multiple of 8.0x( 5-year average is 10x) provides investors with a wide margin of safety. We are maintaining a Strong Buy.

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Finally, we have Tanger Outlets (SKT), a mall REIT that I consider to be the quintessential “perseverance pick”. As many of you know, I have been quite bullish with Tanger and the cheaper shares get, the more I become fixated on the “opportunity”.

When I think about the word “perseverance” and the example cited above – “don’t give up the ship” – I cannot help but to recount the “battleship” attributes behind this best-in-class retail REIT.

First off, Tanger is the only mall REIT that increased its dividend during the last recession (and one of just a dozen or so equity REITs that increased during the same period). Why is that?

It seems that most of the REITs that increased dividends during that period were well-managed and they recognized the concept of discipline. Tanger (like the others that increased) maintained a fortress balance sheet and did not rely too heavily on secured financing.

Another differentiator for Tanger is the disciplined development practices. Many REITs that derive revenue from development projects become fixated on growing assets under management and reliant on organic growth. However, Tanger has not completed a new project in a few years (last one was in Fort Worth, TX) as the company is 100% focused on dividend safety.

There is no argument that Tanger’s growth has slowed, in fact, FFO per share was $2.48 per share in 2018 and the company recently updated 2019 guidance to $2.22 to $2.28 per share (from $2.31 to $2.37 per share) after completing the sale of four non-core properties (for $130.5 million).

Meanwhile Tanger’s same-center NOI guidance for 2019 is -2.00% to -2.75% (maintained the range) and occupancy dropped from 95.9% (Q1-18) to 95.4% (Q1-19). 2018 was the first full-year that Tanger’s SS NOI dropped into the red (-1.30% in 2018) and from 2008 – 2018 Tanger’s SS NOI has grown by an average of 3.5% per year.

And recently Ascena, Tanger’s largest tenant (7% of ABR) said it was “eventually” closing down all of its Dress Barn locations. Tanger has 21 Dress Barn stores in the portfolio (167,186 square feet) and 3 other Dress Barn stores in JV’s (18,370 sq. ft.).

Ascena recently completed the sale of its Maurices women's clothing brand and Ascena is taking another step to optimize its portfolio by focusing on its most profitable brands such as Lane Bryant and Ann Taylor.

However, several other tenants within the Tanger portfolio are seeing improvements notably Hansbrands’ cash flow remains strong (projected $7 billion in revenue), PVH (Tommy Hilfiger, Calvin Klein, etc..) is forecasted to grow earnings by 4% in 2019, Ralph Lauren saw North American sales +3% in the latest quarter, V.F. Corp. (i.e Vans, North Face) saw top-line rise by over 25%, and Nike shares are hitting an all-time high (thanks to Tiger Woods win at The Masters and NA stalwarts, Kevin Durant, Kyrie Irving, and Paul George).

Notably, Tanger has no department stores within the portfolio and this means that the company doesn’t have to fork out millions and millions of dollars like Washington Prime (WPG) or CBL (CBL) to redevelop dark stores.

Even with a “modest” decline in occupancy and NOI, Tanger’s payout ratio is in excellent shape and I see no signs of a dividend cut on the horizon. Fundamentals are not getting worse overall, and new growth prospects are on the horizon (the company is considering a new deal in Nashville, TN).

As you can see below, Tanger’s share price has plummeted, and there are only two ways to spin this one: (1) Mr. Market has over-reacted to the “retail apocalypse noise” and the company will eventually return to a “new norm”, (2) Mr. Market is right and Tanger is worth 50% less than the all-time high of $41.75 (3 years ago – July 2016).

When it comes to trades like Tanger, there are two ways that I continue to sleep well at night…

First, I’m a big believer in fundamental analysis, is this simply means that I spend hours and hours researching each REIT as well as the revenue drivers (tenants) for each company. I also spend considerable time with management (I will be attending REITweek next week in NYC) and I also visit many of the properties.

Second, I maintain adequate and responsible diversification. I’m not Warren Buffett (obviously folks, I write on Seeking Alpha) and this means that I cannot afford to spread my “hard earned” capital across 15 or 20 companies. I have well-defined risk tolerance limitations and my objective is not to impress my friends with high-yielding picks.

In other words, I have no desire to become a “high yield landlord”, I prefer to dedicate my resources to thoughtful fundamental analysis and oftentimes I must have to “ride out the storms” in order to achieve the most favorable results. We maintain a Strong Buy, as viewed below:

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Source: FAST Graphs

In theory, that sounds good, but in reality, it takes extreme discipline. But rest assured, I am the captain of the ship, and I will continue to guide passengers to safety, recognizing that I’m not always right, but the secret to investing can be summed up by Warren Buffett:

To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.

Author's note: Brad Thomas is a Wall Street writer, and that means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, 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 CIO, HT, STAG, SKT. 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.