The State Of REITs: July 2019 Edition

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Includes: AHT, AINC, BBRE, BHR, CDR, CUZ, EWRE, FREL, FRI, ICF, IIPR, IYR, KBWY, NETL, NURE, PPTY, PSR, REZ, RMR, ROOF, RORE, RWR, SCHH, SNH, SNR, SRET, SRVR, TIER, USRT, VNQ, VRAI, WY, XLRE
by: Simon Bowler
Summary

The average REIT has had a positive total return in 5 of the first 6 months of 2019, including a return of +1.61% in June.

Small-cap REITs had a strong June, outperforming large caps by 120 basis points.

Nearly 63% of REITs securities had positive total returns in June.

Timber and Industrial were the best-performing REIT property types in June, while Corrections and Manufactured Housing lagged.

In June, the REIT sector’s median discount to NAV decreased from 6.8% to 6.6%.

REIT Performance

After a poor performance in May, REITs rebounded in June (+1.61%), bringing the average equity REIT to a stellar return of 19.17% over the first half of 2019. REITs saw much smaller gains than the broader market did in June, as the Nasdaq (+7.42%), S&P 500 (+6.89%) and Dow Jones Industrial Average (+7.19%) surged. The market cap-weighted Vanguard Real Estate ETF (VNQ) achieved a slightly lower return than the average REIT in June (+01.56% vs. +1.61%) and had a virtually identical performance to the average REIT over the first half of the year (+19.16% vs. +19.17%). The spread between the FFO multiples of large-cap REITs (20.7x) and small-cap REITs (12.6x) continued to widen further in June. Is this 8.1 turn large-cap premium warranted, or is it merely due to the impact of the $2.77 billion influx of capital in the first half of 2019 into real estate ETFs (nearly all of which are market cap-weighted)? 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.

Small-cap REITs (+2.92%) and large-cap REITs (+1.72%) had a strong June, while micro-cap REITs (-0.74%) were in negative territory for the 2nd month in a row. Over the first half of 2019, however, micro-cap REITs (+25.81%) remain the top performers, outpacing their larger peers. Mid-cap REITs (+15.76%) continue to trail the REIT sector as a whole (+19.17%), lagging 341 basis points behind thus far this year.

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 June

70% of REIT property types averaged a positive total return in June, with a 17.21% total return spread between the best- and worst-performing property types. Timber (+13.51%) and Industrial (+9.42%) had the best average returns. Timber was led by Weyerhaeuser (WY) with an impressive +17.23% return in June. Corrections (-3.7%) had the weakest average performance, dragged down by rising pressure on big banks from political activists to stop lending to companies that operate private prisons or provide services to U.S. Immigration and Customs Enforcement.

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 June, all except for Malls remain in the black thus far in 2019. Industrial (+41.98%) and Land (40.94%) remain the best-performing property types year to date. 95% of REIT property types average double-digit positive returns this year. Mall REITs (-6.81%), however, are badly underperforming the REIT sector as a whole (+19.17%), due largely to a disproportionately large number of recent retailer bankruptcies, most of which occurred in the first quarter of 2019. Although unexpected bankruptcies can and do occur, the 2nd half of 2019 is expected to have far fewer retailer bankruptcies.

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) increase slightly (from 15.2x up to 15.3x) during June. Halfway through 2019, REITs continue to trade well above the 13.1x average FFO multiple at which they began the year. The average FFO multiples rose for 45% of property types, fell for 35% and held steady for 20%. Single Family Housing (25.1x) continues to see multiple expansion and now trades at the highest average multiple. Malls (7.8x) saw even further multiple contraction during June 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

On June 14th, TIER REIT (TIER) ceased trading as the merger with Cousins Properties (CUZ) officially closed. TIER common shareholders received 2.98 shares of CUZ for each share of TIER that they owned. The combined entity continues to trade under the ticker CUZ.

Innovative Industrial Properties (IIPR) was yet again the best-performing REIT during the month of June with a strong 47.78% return. IIPR has far outpaced every other REIT in 2019, and has already achieved an exceptional 175.04% return year to date. IIPR has benefited greatly from disproportionately strong investor interest in any company connected to the rapidly growing marijuana industry. Many companies in the marijuana industry have difficulty attaining financing due to the fact that the drug is still illegal at the federal level (although an increasing number of states have legalized or decriminalized the drug). IIPR buys the real estate of marijuana companies and leases the space back to them, effectively providing a much-needed source financing to some of these companies at terms that are very favorable to IIPR. The combination of the strong property-level returns and the investor appetite for pot stocks have driven IIPR to a 130.3% premium to Net Asset Value.

Ashford Hospitality REIT (AHT) was the worst-performing REIT in June with a dismal -32.04% return, due largely to the June 14th decision to cut the quarterly dividend in half (from $0.12/share to $0.06/share). Ashford Hospitality REIT is externally managed by the infamously self-serving team at Ashford Inc. (AINC). Ashford’s management have consistently made self-enriching decisions at the expense of shareholders of the managed REITs, such as the recent decision by AINC (whose chairman and CEO is Monty Bennett) to pay a high price to acquire the hotel management business of Remington Holdings, LP (whose CEO is Monty Bennett). Remington Holdings, LP is owned by Monty Bennett and his father Archie Bennett, Jr. For many years, Monty Bennett has enriched himself with the lavish fees that Remington charged to manage both Ashford Hospitality REIT and Braemar Hotels & Resorts (BHR), both of which also have Monty Bennett as chairman. This toxic, incestuous relationship between all these Monty Bennett companies has destroyed a tremendous amount of value for the shareholders of each of these REITs.

62.78% of REITs had a positive return in June, with 91.76% in the black year to date. Over the first half of 2019, the REIT sector has performed substantially better than it did over the first 6 months of 2018. During the first half of last year, the average REIT had a +1.92% return, whereas this year the average REIT has already seen a total return 10x higher (+19.17%).

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 6/30/2019) 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

NAV Data as of June 28th, 2019

The REIT sector median discount to Net Asset Value narrowed in June from 6.8% to 6.6%.

Health Care now trades at the greatest NAV premium of all REIT property types, overtaking Other Retail. The median Health Care premium from 16.0% to 18.3% during June. Other Retail (this is retail that is neither regional malls nor shopping centers - for example: free-standing Triple Net Retail) saw its average NAV premium decline again in June from 17.7% to 14.3%, and now trades at a smaller premium than Health Care or Self Storage. IIPR had a stellar June and saw its already very high premium to consensus NAV rise from 121% to 130%. What is particularly remarkable is that this premium rose despite a significant increase in consensus NAV from $38.07 to $53.65.

Mall REITs remain at the largest discounts to consensus NAV, but saw the median discount narrow in June from 39.2% to 36.2%. Timber REITs performed very well in June as they recovered from a rough May, leading to a meaningful narrowing of the median Timber REIT NAV discount from 26.7% to 17.4%. Shopping Center REIT Cedar Realty Trust (CDR) now trades at the largest discount (53.8%) to NAV of any REIT, followed closely by the aforementioned AHT, which is now trading 53.1% below consensus NAV.

Takeaway

Month after month, the large-cap REIT premium continues to grow. Investors are now paying on average upwards of 64% more for each dollar of FFO/share to buy large-cap REITs than small-cap REITs (20.7x/12.6x - 1 = 64.3%). This steadily rising market cap-based spread presents a growing arbitrage opportunity. Whether REIT pricing normalizes due to a market correction (in which high multiple large caps that are priced for strong growth have further to fall) or due to an increase in the multiple afforded to small-cap REITs, there is the potential for significant alpha to be achieved through overweighting excessively discounted small-cap and micro-cap REITs. It is important to note, however, that while smaller REITs are collectively more attractively priced than larger REITs, investors should choose investment positions carefully, as not all low multiples are unjustified. In order to target investment into those securities that are genuinely worth substantially more than the current share price reflects, an investor needs to take active positions rather than simply using an ETF.

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.

Over recent years, a larger and larger portion of money in the market has been invested passively. ETFs and other passive investment vehicles have continued to experience growing inflows of investor capital, while active investment has declined in popularity. While the ease and simplicity of investing passively in an ETF rather than spending time carefully analyzing specific securities is certainly appealing, foregoing this analysis takes away an investor’s ability to differentiate between securities that have great upside potential versus those that are likely to perform poorly. Take, for example, two Health Care REITs with a focus on senior housing.

New Senior Investment Group (SNR) and Senior Housing Properties Trust (SNH) both began 2019 as senior housing REITs with beaten-down share prices. However, to those who were actively following each company, it was clear that they were positioned for very different results in 2019. SNH continues to be managed by RMR Group (RMR), which is one of the worst external REIT managers when it comes to achieving good operating performance and generating shareholder returns. SNR, on the other hand, had recently cut the dividend (and already experienced the resulting price drop) and announced in late 2018 an effort to aggressively reform the company in a way that could produce strong shareholder returns.

SNH announced an ugly restructuring of its arrangement with Five Star Senior Living on April 2nd and cut the common dividend by 61.5% on April 18th. SNR, on the other hand, internalized management on January 1st, appointed an independent director as the chairman of the board on January 4th, began providing guidance for the first time on February 22nd and has maintained steady dividend payments during 2019. Halfway through 2019, these strategic differences have resulted in dramatically different results for shareholders. SNH has a dismal -25.97% return, whereas SNR has a stellar 70.85% return. Active investors had the opportunity to choose SNR over SNH, whereas REIT ETF investors passively bought both. In fact, due to the larger market cap of SNH, most market cap-weighted REIT ETFs hold a larger position in SNH than SNR. This higher weight may cause the loss from SNH to largely wipe out the tremendous 2019 return of SNR. Active investors who put the time into researching both companies and correctly identified the superior opportunity, however, got to enjoy the strong SNR total return without the offsetting loss from SNH. By carefully analyzing REIT data and industry trends, active investors have the opportunity to outperform ETFs.

Disclosure: I am/we are long WY & SNR. 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& SNR. 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.