The State Of REITs: June 2019 Edition

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Includes: AHT, AINC, BBRE, BHR, CBL, EWRE, FREL, FRI, HIFR, ICF, IIPR, IYR, KBWY, MRT, NETL, NURE, O, OHI, PPTY, PSR, REXR, REZ, ROOF, RORE, RWR, RYN, SCHH, SRET, SRVR, STAR, USRT, VNQ, VRAI, WHLR, WY, XLRE
by: Simon Bowler
Summary

The average REIT had a total return of -0.98% in May after producing positive returns in each of the first four months of 2019.

Large-cap REITs significantly outperformed their smaller peers in May.

The percent of REIT securities in the black in 2019 fell from 93.4% to 91.2% during May.

Timber and Hotels were the worst-performing REIT property types in May, while Corrections and Single Family Housing outperformed.

In May, the REIT sector’s median discount to NAV increased from 6% to 6.8%.

REIT Performance

After achieving gains in the first 4 months of 2019, REITs dipped slightly in May (-0.98%). However, the average REIT still maintains an impressive year-to-date return of 17.22%. REITs weathered the May market selloff much better than the broader market did, as the NASDAQ (-7.93%), S&P 500 (-6.58%) and Dow Jones Industrial Average (-6.69%) fell sharply. The market-cap weighted Vanguard Real Estate ETF (VNQ) achieved a better return than the average REIT in May (+0.14% vs. -0.98%) and also pulled slightly ahead year to date (+17.35% vs. +17.22%). This ETF’s stronger performance is driven by the fact that large-cap REITs outperformed in May. The spread between the FFO multiples of large-cap REITs (20.5x) and small-cap REITs (12.5x) widened even further in May. Do larger REITs possess genuine competitive advantages that justify the massive and growing premium to their smaller peers or has the popularity of market-cap weighted ETFs created substantial mispricing within the REIT sector? 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

Large-cap REITs (+1.48%) performed well in May, while their micro-cap, small-cap and mid-cap peers fell into negative territory for the month. Micro-cap REITs had a particularly rough month (-5.32%), but thanks to a stellar first four months of the year, remain far ahead of their larger peers YTD with an impressive return of 26.92%. Mid-cap REITs (+14.74%) now trail the REIT sector as a whole (+17.22%) by nearly 250 basis points after the first 5 months of 2019.

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

11 out of 20 Property Types Yielded Positive Total Returns in May

55% of REIT property types averaged a positive total return in May, with an 18.36% total return spread between the best and worst-performing property types. Corrections (+7.39%) and Single Family Housing (+6.11%) had the strongest average performances. Timber (-10.97%) had the worst average performance, dragged down by Weyerhaeuser (WY) and Rayonier (RYN) with returns of -14.93% and 11.45%, 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 45% of REIT property types averaged a negative return in May, all except for Malls remain in the black YTD. Land (+31.17%) and Industrial (27.86%) remain the best-performing property types year to date. 95% of REIT property types average double-digit positive returns this year. Mall REITs (-6.2%), however, are severely underperforming the REIT sector as a whole (+17.22%), due primarily to a disproportionately large number of recent retailer bankruptcies, most of which occurred 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 15.3x down to 15.2x) during May. REITs still trade well above the 13.1x average multiple at which they began the year. The average FFO multiples rose for 45% of property types and fell for 55%. Manufactured Housing (24.2x) and Single Family Housing (24.2x) have continued to see multiple expansion and now trade at the highest average multiples. Malls (8x) saw further multiple contraction during May and remain 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

During May, two publicly traded REITs ceased trading, both due to M&A. Oncor Electric Delivery Company LLC completed the acquisition of InfraREIT (HIFR) and its subsidiary InfraREIT Partners LP for $1.275B on May 16th. On May 17th, Omega Healthcare Investors (OHI) completed the acquisition of MedEquities Realty Trust (MRT) for a combination of stock and cash, representing a value of approximately $10.85/share of MRT.

Wheeler REIT (WHLR) narrowly remains the best-performing REIT thus far in 2019 (+87.43%), despite being the worst-performing REIT of May (-30.71%). CBL & Associates Properties (CBL) was the 3rd worst-performing REIT in May (-19.38%) and remains the worst-performing REIT of 2019 (-55.54%). The best-performing REIT in May was iStar (STAR), a small-cap diversified REIT, which during the month of May raised its dividend by 11% and announced the authorization of $50M of additional share buybacks.

Only 46.15% of REITs had a positive return in May, with 91.21% in the black year to date. Although May represented the weakest performance for REITs thus far in 2019, the REIT sector has still fared much better in 2019 than over the same period in 2018. During the first five months of 2018, the average REIT had a -1.88% return, whereas this year the average REIT is already up 17.22%.

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 5/31/2019) 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

2019 Dividend Raises

Thus far in 2019, 70 different real estate companies across the US, Canada and Bermuda (most of which are REITs) have raised their dividends. Some are minimal raises used to maintain a dividend growth streak such as the 0.2% raise by Realty Income (O), whereas others are substantial such as the 28.6% increase by IIPR or the 15.6% increase by Rexford Industrial Realty (REXR).

Valuation

The REIT median discount to consensus NAV widened in May from 5.7% to 6.8%.

Other Retail (This is retail that is neither regional malls nor shopping centers. For example: free-standing Triple Net Retail) saw its average premium to NAV decline from 20% to 17.7%, but narrowly remained the REIT property type trading at the largest median premium to NAV. Health Care’s NAV premium rose from 12.7% to 16.0% and Self-Storage’s premium rose sharply from 9.4% to 16.5%. Innovative Industrial Properties (IIPR), an industrial REIT that leases space to marijuana companies at a high rent per square foot, saw its sky-high premium decline from 139.4% above consensus NAV down to a still lofty 121%. It should be noted that this premium narrowed not because of a decline in the numerator (share price), but rather due to an increase in the denominator (consensus NAV).

Mall REITs continue to trade at the largest discounts to consensus NAV, with the median discount widening yet again in May from 34.1% to 39.2%. Timber REITs performed particularly poorly in May and saw the median discount plummet from 17.1% to 26.7%. Two hotel REITs, Ashford Hospitality Trust (AHT) and Braemar Hotels & Resorts (BHR) saw their share prices fall far enough during May to become 2 of the 10 most discounted REITs. Both REITs are externally managed by Ashford Inc. (AINC), which has an ugly history of destroying shareholder value for its managed companies. Over the past 5 years, the SNL U.S. REIT hotel index had a positive total return of 13.21%, whereas BHR (-21.31%) and AHT (-32.22%) both consistently and substantially underperformed their peers. Although both REITs own a number of quality properties, REIT investors appear to have determined that the poor quality of management warrants a particularly hefty discount to net asset value.

NAV Data as of June 3rd, 2019

Takeaway

There has been a substantial increase in investment in market-cap weighted REIT ETFs in recent years. This has played a central role in driving up the share prices and FFO multiples of large-cap REITs. Large-cap REITs began the month of May at an FFO multiple of 20x, whereas small-cap REITs averaged only 12.2x. This 7.8 turn premium increased to 8 turns by the end of May (20.5x for large-caps vs. 12.5x for small-caps). Investors are currently paying on average a whopping 64% more for each dollar of FFO/share to buy large-cap REITs than small-cap REITs (20.5x/12.5x - 1 = 64%).

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

Why would investors flock to an investment vehicle, such as the market-cap weighted REIT ETF, that is structured to overweight the most expensive tier of REITs (large-caps) and underweight those that are more attractively priced (micro-cap and small-cap)? In order to justify such an investment, investors would need to be comfortable with the size of the premium that they are paying for the over-weighted securities. If the premium for large-cap REITs became unjustifiably large, would the trend reverse and investors start to sell out of market-cap weighted REIT ETFs? It appears that this reversal may have already begun. In each of the last two months, market-cap weighted REIT ETFs have seen net outflows. In May, investors pulled out $529.7M from these ETFs.

If these net outflows continue for an extended period of time, particularly if the money is being reinvested into individual securities, the FFO multiple spread between large-cap and small-cap REITs could steadily narrow. In much the same way that significant REIT ETF inflows over recent years have contributed to a dramatic increase in the premium afforded to large-caps, outflows could have exactly the opposite effect. 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.

Disclosure: I am/we are long WY & CBL. 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 WY & CBL. I am personally long WY. 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.