Seeking Alpha

REITs In Retirement - September 2019 Update

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Includes: CUBE, DEA, DOC, IRM, KIM, MPW, O, SKT, SPG, VTR, WPC
by: Steve Shea
Steve Shea
Dividend investing, gold & precious metals, long-term horizon
Summary

REITs have enjoyed a great third quarter, thanks in part to lower interest rates.

Mall REITs are undervalued in the current market.

Medical REITs are discussed.

My portfolio is compared to Vanguard's VNQ fund.

Introduction

Three months ago, I published my actual portfolio of REITs. I record changes daily and this update gives me an opportunity to evaluate the performance of my investments. Here is the third quarter update:

There was an extraordinary tailwind for REITs that occurred this quarter. The interest rate for the 10-year treasury declined from 2.03% to 1.68% during the quarter. To put this in perspective, a bond purchased on July 1st for $10,000 would have paid a yearly interest rate of $203. On Sept 30th, it would have cost $12,083 to purchase a 10-year treasury yielding the same $203 in annual interest. The 10-year treasury purchased 3 short months ago would have increased in value by over 20%.

Source: YCharts 10-Year Treasury Rate

This helps REITs in 2 ways:

  1. The 10-year treasury is a competitor to REITs, since both are high yield and low-risk (depending on the REIT) investments. A Treasury is the lowest possible risk, so it can demand a lower interest rate than alternative investments. When treasury yields decline (such as this quarter) REITs become more attractive to yield-seeking investors (me included). REITs are bid up, causing the yields to decline in line with the treasury.
  2. The second advantage for REITs is that the cost of long-term financing is reduced. If a REIT refinances a portion of its debt at a time like this, they can use this money to pay off more expensive debt. Of course, they can also use the funds to buy back stock, or reinvest in new or existing assets. For a well-managed REIT, any of these choices can be beneficial. Going from memory, Simon Property Group (SPG), Ventas (VTR), and W.P. Carey (WPC) have refinanced debt this quarter.

The next chart shows my portfolio as of Sept 30th. I have sorted the list from smallest to largest holding. Last quarter, there were two losing positions: Iron Mountain (IRM) and Tanger (SKT). At this point, SKT is my only losing position.

I added a new REIT this quarter: Medical Properties Trust (MPW). I also added to my positions in Physicians Realty Trust (DOC), Iron Mountain, Kimco (KIM), SKT, and Simon Property Group). I briefly owned Macerich (MAC), but it gained 13% in the 2 weeks I owned it, so I sold all the shares. I normally hold my positions for a long time, but I couldn’t resist taking that profit. All these shares are held in Roth IRAs or regular IRAs, so there is no immediate tax consequence for quick gains (and unfortunately) quick losses.

I added two columns to the end of the chart showing how many shares I have purchased with dividend reinvestment plans (DRIP). Notice that over half the appreciation (55%) comes from dividends. Less than half was the result of stock price increases.

All told, I added $73,000 to my REIT portfolio. I would agree that this is exceptionally high especially in one quarter, but I sold my rental home and decided to use some of the proceeds to reinvest in real estate. I am much better diversified with these REITs than my individual rental home, and I like the management teams of these REITs. If there is interest, I will write a detailed article showing the costs and profits of my rental, compared to a similar REIT investment.

Source: Charts and graphs by Steve Shea, data compiled from TD Ameritrade

Mall REITs

I am overweight mall and shopping center REITs. I try to invest in best of breed REITs. I consider SPG the best of the mall REITs. Taubman (TCO) and Macerich have similar properties and are extremely undervalued, in my opinion. However, I have a great deal of admiration for Simon's CEO, David Simon. I don’t know his exit strategy, but as long as he is in charge of the company, I am confident of the direction of SPG. I have first-hand knowledge of the Northgate Mall in Seattle, and think SPG’s investment in this property will yield tremendous returns in the coming years. They have many other remodel plans and have the cash flow to execute those plans without diluting the shares.

In a prior article, I mentioned my love/hate relationship with Tanger. This is my second largest holding, so the love side of the equation is winning at the current time. The popular opinion is that outlet malls are declining in popularity. SPG owns some quality outlet malls, but SKT only owns outlet malls. SKT has used effective marketing to bolster their mall traffic, and can quickly adapt their space for new retailers. They have over a 95% occupancy rate, a strong balance sheet, and good dividend coverage.

Even if the outlet mall traffic declines, they can preserve and even grow the dividend, which currently sits at over 9%. Normally, I consider a 9% dividend a red flag, but in this case, I think it is a bargain. Short interest is at 47% of float, which is excessively high. This means that almost half the SKT stock is supplied by short sellers. By way of comparison, SPG has 3% short interest, and KIM has 4%. The problem with short interest at this 47% level is that it causes extreme price fluctuations.

The short sellers must maintain their margin requirements, plus come up with over a 2% dividend payment every quarter. Looking at the chart of SKT over the past 3 years, the shorts have done quite well. However, the price to FFO guidance for 2019 is 6.8. SPG's price to FFO is 12.3. I think SPG has better properties than SKT, and SPG is A rated by Standard & Poor’s (compared to SKT’s BBB rating). A BBB rating is high compared to most other REITs. Basically, you are getting shares of SKT for half the price of SPG. Warren Buffett says it is better to buy a good company at a great price, than a great company at a good price.

The final Mall REIT I own is Kimco. I added over 400 shares of this company in the past quarter. Kimco owns outdoor malls in populated areas. The Standard & Poor’s rating is BBB+ which shows management's attention to the balance sheet. Kimco’s exposure to the online shopping threat is low compared to SPG and SKT. Kimco’s tenants are on the right side of the scale below:

Source: Kimco Quarterly Presentation

Kimco invests in major metropolitan markets as shown below:

Source: Kimco Quarterly Presentation

I think each of these companies will profit from retail sales in the future. Online sales may increase faster than brick and mortar sales. But consider this: Amazon’s (NASDAQ:AMZN) Price to Earnings ratio is over 73, meaning that it will take 73 years of earnings to capture the selling price of Amazon stock. SKT's Price to FFO is 6.8, meaning it will take under 7 years for FFO to capture the SKT stock price. Amazon’s growth prospects are much greater than the three mall REITs I have presented here, but I will be collecting dividend checks greater than 5% annually, while Amazon stockholders wait (and hope) for their company to execute its business plan.

Net Lease

I haven’t changed my net lease REIT position since last quarter. W.P. Carey is my largest holding in this category and this is a high-quality REIT with 35% European exposure. I also like Realty Income (O) and have been waiting for a pullback in price to buy more. I’m still waiting. Finally, Easterly Government Properties (DEA) has been a solid performer this quarter. I would like to increase the relative size of this category, but I think there is deeper value in the mall stocks. Time will tell.

Medical REITs

In the medical category, I have initiated a position in Medical Properties Trust. Also, I have added 400 shares of Physicians Realty Trust.

Ventas has been my best performer overall but I haven’t added to my position (other than dividend reinvestment) since my original 100 shares acquired in March 2018. I like the management team and the results, but don’t like the exposure to skilled nursing. You can see that VTR’s exposure to skilled nursing has decreased from 17% of revenues to 1% in 4 years. Senior housing has increased in that same period. The baby boomer retirement wave is in full force, so this is probably a good investment. VTR is rated BBB+ by Standard and Poor’s.

Source: Ventas Investor presentation

Here is Ventas' long-term strategy which shows a growth in FFO and dividends for the next 3 years. If they execute this plan, I can see VTR providing a total return of 15-20% year over year through 2023.

Source: Ventas Investor presentation

My newest REIT, Medical Properties Trust is in the medical industry. I like medical REIT’s and was looking for another quality stock in this field. The Price to FFO ratio of 12.5 (2019 guidance) made this a candidate for a new position. Their credit rating is BBB-, and MPW is well positioned in their debt management as shown below.

Source: Medical Properties Trust, supplemental information

MPW has assets and revenue outside the USA, which provides international diversification which I seek. I don’t like to purchase foreign stocks, but do like American companies with foreign revenue. The international exposure is only 15% currently, but I will see if that grows in the future.

Source: Medical Properties Trust, supplemental information

Storage REITs

My last REIT category is storage. I initiated a position in CubeSmart (CUBE) exactly 1 year ago. It has grown 24% (dividends reinvested) in that year. It has been a stable stock, but yields only 3.67% currently. My only REIT with a lower return is Realty Income with a 3.55% yield. Of the two stocks, I think O offers a safer beta, but I have no intention of selling CUBE at this time.

Bringing up the rear (and my last stock to report) is Iron Mountain. IRM has appreciated 5.3% in the time I’ve owned it (approximately 1 year). This stock plods along just enough for me to keep it. In my last report, this stock showed a slight loss overall. The dividend is currently 7.55%, so this investment is a cash cow. I don’t expect much if any growth. However, the customer base is extensive, and the product is sticky. Some Seeking Alpha authors have expressed concerns about IRM. In a falling interest rate environment, I am not concerned about IRM’s ability to service its debt. If the stock falls 20% in the next year, while I’ve collected my 7.55% dividend, I might have a different opinion. However, I think the prospects are good that IRM will sell within 5% plus or minus of where it is today. Stay tuned.

Source: Charts and graphs by Steve Shea, data compiled from TD Ameritrade

I have exactly half of my REIT investments in mall REITs. Long term, I would like to diversify further. Currently, I think there is deep value in the mall REITs I have chosen. Because of this exposure, there are large swings in the value of this portfolio compared to VNQ because of this mix of stocks:

Source: Charts and graphs by Steve Shea, data compiled from TD Ameritrade

This is a graph of VNQ compared with my REIT portfolio. VNQ is in Red, mine in Blue. There is a definite correlation, but my REITs are more volatile than VNQ probably because VNQ is more diverse. If I see that VNQ outperforms my investments on a regular basis, I might throw in the towel and invest in VNQ instead. I think investing in high quality REITs will yield better results than an indexed fund. On August 27th, I wasn’t as optimistic, but over the past quarter and year, my results have been good enough to continue the do-it-yourself approach.

Here is another graph showing my returns this quarter compared to the Dow Jones average:

Source: Charts and graphs by Steve Shea, data compiled from TD Ameritrade

The Dow has gained 0.74% this quarter, while my REITs have gained 8.68% the same period. This isn’t really a fair comparison because REITs are more sensitive to interest rates than the Dow 30. That won’t stop me from posting this graph.

Finally, doing the research for this article forces me to take an honest look at each stock in my portfolio. If I can’t make a case that any REIT in this portfolio is worthwhile, I will close that position. I only follow a few stocks and prefer to research them closely. As always, these are my thoughts and opinions and are not to be confused as investment advice.

When I published this portfolio last quarter, I enjoyed the insightful comments. Any new comments are encouraged and appreciated.

Disclosure: I am/we are long ALL STOCKS DISCUSSED IN THIS ARTICLE. 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.