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The State Of REITs: September 2019 Edition

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Includes: AHT, BBRE, CDR, CHCT, CONE, COR, CPLG, EQIX, EWRE, FPI, FREL, FRI, HOMZ, ICF, IIPR, INDS, IRM, IYR, KBWY, MAC, NETL, NURE, PEI, PPTY, REK, REZ, ROOF, RORE, RTL, RWR, SCHH, SRET, SRVR, USRT, VNQ, VRAI, XLRE
by: Simon Bowler
Summary

The average REIT has had a positive total return in 7 of the first 8 months of 2019, including a return of +0.62% in August.

Large-cap REITs had an excellent month, outperforming small-cap REITs by 589 basis points.

The majority of REIT securities (54.2%) had positive total returns in August.

Data Center and Self Storage REITs led all property types in August, while Malls and Shopping Centers saw the biggest share price declines.

92% of large-cap REITs trade at a Price/FFO premium to the average small-cap REIT.

REIT Performance

August was a rough month for much of the stock market, but the REIT sector continued its strong 2019 performance with yet another positive monthly return (+0.62%). This brings the average equity REIT to an impressive return of 21.64% over the first eight months of 2019. The REIT sector outperformed the NASDAQ (-2.60%), S&P 500 (-1.81%), and Dow Jones Industrial Average (-1.72%) in August. The market cap weighted Vanguard Real Estate ETF (VNQ) achieved a much stronger total return than the average REIT in August (+3.75% vs. +0.62%), expanding its year-to-date lead over the first 8 months of the year (+25.73% vs. +21.64%). The spread between the FFO multiples of large-cap REITs (22.1x) and small-cap REITs (13.2x) significantly widened in August as multiples rose an average of 1.1 turns for large caps and only 0.3 turns for small caps. 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

In August, REIT performance and market cap had a strong positive correlation. Large-cap REITs (+4.51%) had an impressive August return, while small caps and micro caps performed quite poorly. This disparity of August performance was enough for large-cap REITs (+29.13%) to overtake micro-cap REITs (+28.87%) as the top performers year to date. Mid-cap REITs performed fairly well in August (+1.43%), but remain behind their peers year to date (+18.74%).

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

10 out of 20 Property Types Yielded Positive Total Returns in August

50% of REIT property types averaged a positive total return in August, with a 19.35% total return spread between the best and worst-performing property types. Data Centers (+12.09%) and Self Storage (+6.47%) had the best average returns. Data Center's strong return was largely driven by the 27.98% return of CyrusOne (CONE). On August 16th, Bloomberg revealed that CyrusOne was considering a sale after receiving takeout interest. Although the exact price at which CONE would potentially be acquired and whether or not CONE would accept the offer has not yet been released, the interest was enough to drive up the share prices of all Data Center REITs. Malls (-7.26%) and Shopping Centers (-4.64%) had the worst average performances in August, continuing to face the strong headwind of an enduring media narrative of the "retail apocalypse". There are indications, however, that sentiment may be shifting as numerous brick and mortar retailers (many of whom are tenants of these retail REITs) have seen very strong recent share price performance.

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

All REIT property types except for Malls (-14.43%) and Corrections (-3.58%) remain in the black after the first 8 months of 2019. Industrial (+40.7%) and Advertising (34.90%) have achieved better total returns than all other property types year to date. 85% of REIT property types average double-digit positive returns thus far this year.

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 again during August (from 15.6x up to 16x). After the first 8 months of 2019, REITs now trade 2.9 turns above the 13.1x average FFO multiple at which they began the year. During August, the average FFO multiples rose for half of the property types, fell for 45%, and held steady for 5%. Single-Family Housing began the month trading at the highest average multiple and saw further multiple expansion throughout August (from 25.1x to 28.3x). Mall REITs suffered further multiple contractions (from 7.8x to 7.2x), falling to an even lower multiple than Corrections (7.4x), which endured its third consecutive month of multiple contractions.

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

CyrusOne had the best total return of any equity REIT in August (27.98%), driven by the aforementioned potential sale of the company. When a REIT is acquired for a price materially higher than it is currently trading (or even when there is merely speculation of a potential acquisition), it can sometimes lead to an upward re-pricing of other REITs of the same property type. The potential takeout news stimulated investor demand for many of CyrusOne's Data Center peers such as Equinix (EQIX) (+11.29%), CoreSite Realty (COR) (+10.85%), and Iron Mountain (IRM) (+8.3%).

CorePoint Lodging (CPLG), a hotel REIT spun off from La Quinta in May 2018, was the worst-performing REIT in August (-22.42%). A disappointing second quarter earnings report and an ugly reduction to guidance sent investors fleeing. Although August was a fairly bad month for Hotel REITs (-4.12%) across the board, CPLG's sharp price decline was due to ongoing struggles with operations and failures of the company's management team.

54.19% of REITs had a positive return in August, with 87.36% in the black year to date. During the first eight months of last year, the average REIT had only a +5.09% return, whereas this year, the average REIT has already seen a total return more than 4x higher (+21.64%).

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 8/31/2019) 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

Valuation

NAV Data as of August 31, 2019

The REIT sector median discount to Net Asset Value widened in August from 6.4% to 7.2%.

The median NAV premium of Health Care REITs rose sharply from 18.8% to 26%. Self Storage REITs also saw a material increase from a median of 18.8% to 24.4%. Casino REITs and Data Center REITs traded at a discount to NAV at the end of July but now trade at a premium at end of August. Innovative Industrial Properties' (IIPR) share price again suffered a significant decline in August (from $105.67 to $89.16) and no longer trades at the largest NAV premium of any REIT. Community Healthcare Trust (CHCT) now trades at a larger NAV premium than any other REIT (87.1%).

Mall REITs saw their already brutal 40.8% median discount to consensus NAV widen further in August to 44%. After suffering a large share price decline in August, Cedar Realty Trust (CDR) overtook Ashford Hospitality Trust (AHT) as the most discounted REIT. Mall REITs Macerich (MAC) and Pennsylvania REIT (PEI) trade at sizeable 47% and 44% discounts to NAV respectively but have much stronger potential than their other deeply discounted peers to close that valuation gap in the near term. This is due primarily to numerous significant redevelopments coming online over upcoming months, most notably Fashion District Philadelphia, the long-awaited 50/50 joint venture of MAC and PEI that opens on September 19th. PEI has estimated that their 50% ownership in Fashion District will increase NOI by $11-15M in 2020. As other redevelopments finish for both REITs over upcoming quarters, there is tremendous potential for growth in 2020.

Takeaway

For many months in a row, the large-cap REIT premium (relative to small-cap REITs) grew larger and larger, reaching a recent peak of 64.3% at the end of June, before falling back slightly to 62.8% in July. Money flooded into REIT large caps again in August, however, pushing the premium to new heights. Investors are now paying on average more than 67% more for each dollar of FFO/share to buy large-cap REITs than small-cap REITs (22.1x/13.2x - 1 = 67.4%).

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 average small-cap REIT trades at a multiple of 13.2x FFO, whereas 92% of large-cap REITs trade at multiples higher than 13.2x. Although it could be argued that large-cap REITs often have certain advantages (such as economies of scale), it seems implausible that more than 9 out of 10 large-cap REITs warrant such a premium over their smaller peers. This can more likely be explained by rampant mispricing driven by increasingly heavy investment into market cap weighted ETFs. This is good news for investors, as mispricing creates opportunity for active investors.

Buying back common shares can be highly accretive to FFO/share and NAV/share for REITs trading at sizeable discounts to NAV. With cap rates remaining low across most asset classes, many discounted REITs are able to achieve a higher return from buying back their own stock than using that money for an acquisition or new development. Some REITs, most notably Farmland Partners (FPI), are selling off assets at a premium valuation in the private market and buying back stock at a discount in the public market. This public-private arbitrage is available for a significant number of REITs but only a handful of management teams are aggressively taking advantage of this opportunity. Investors would be wise to pay attention to which REITs are utilizing this arbitrage.

By carefully analyzing REIT data and industry trends, active investors have the opportunity to outperform ETFs.

Disclosure: I am/we are long CONE, IRM, CDR, MAC & PEI. 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 CONE, IRM, CDR, MAC, and PEI. I am personally long IRM, MAC, and PEI. 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.