The State Of REITs: January 2020 Edition

Summary

• The average REIT had a positive monthly total return in 10 of the 12 months of 2019, including a +0.29% return in December.
• Micro cap REITs (+39.7%) significantly outperformed their larger peers in 2019.
• The vast majority of REIT securities (92.31%) achieved positive total returns in 2019.
• Land and Single Family Housing REITs led all property types in 2019, while Malls and Corrections badly underperformed.
• As we enter 2020, 88% of large cap REITs trade at a Price/FFO premium to the average small cap REIT.

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REIT Performance

December was a very good month for the broader stock market, but less so for the REIT sector, which saw only a modest gain (+0.29%). The average equity REIT achieved an excellent total return of 28.84% in 2019, experiencing gains in 10 of the 12 months. For the 2^nd month in a row, the REIT sector lagged the NASDAQ (+3.54%), S&P 500 (+2.86%) and Dow Jones Industrial Average (+1.74%). In 2019, the total return of REITs (+28.84%) fell short of the NASDAQ (+35.22%), performed in line with the S&P 500 (+28.88%) and outperformed the Dow (+22.34%). The market cap weighted Vanguard Real Estate ETF (VNQ) underperformed the average REIT yet again in December (-0.30% vs. +0.29%), finishing the year 132 basis points shy of the average REIT (+27.52% vs. +28.84%). The spread between the 2020 FFO multiples of large cap REITs (20.4x) and small cap REITs (15.4x) narrowed in December as multiples held steady for large cap REITs, but rose 1 turn 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 2^nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article.

Small cap REITs (-0.65%) underperformed in December, but still managed to achieve a strong 29.96% total return in 2019. Mid cap REITs were the top performers in December (1.05% vs. +0.29%), but finished the year behind their peers (+25.64% vs. 28.84%). Micro cap REITs continued to outperform their larger peers in December (+1% vs. +0.29%), finishing 2019 with a stellar 39.70% and outpacing large caps by 10.87%.

Source: Graph by Simon Bowler of 2^nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article.

12 out of 20 Property Types Yielded Positive Total Returns in December

60% of REIT property types averaged a positive total return in December, with a wide 24.96% total return spread between the best and worst performing property types. Corrections (+17.28%) and Infrastructure (+8.74%) had the best average returns. Corrections’ strong performance in December marks a sharp reversal from the share price declines over recent months that had been driven by the heated rhetoric against private prisons of nearly all of the Democratic candidates that are running for president in 2020. Both prison REITs, GEO Group (GEO) and CoreCivic (CXW), are still priced at low multiples that are completely unjustified by their stellar operating fundamentals. However, the genuine risk posed by the potential of a new president that may seek to end federal contracts with private prisons is weighing heavily on the valuations of both REITs.

Malls were the worst performing property type in December (-7.68%) and for full-year 2019 (-12.46%). This underperformance was driven by declining FFO/share and concerns that the “retail apocalypse” will result in continuously high tenant store closures going forward. All of the Mall REITs are undergoing significant redevelopments across their portfolios to replace vacant big box stores with better, more experiential and less over-leveraged tenants. During this transition, the operating metrics of many of the Mall REITs have meaningfully declined, although some of the REIT CEOs are already forecasting that they will stabilize and resume growth in either 2020 or 2021.

Source: Table by Simon Bowler of 2^nd 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 (-12.46%) and Corrections (-1.15%) finished the year in the black. Land (+63.3%) and Single Family Housing (47.32%) provided investors with higher total returns than all other property type. 90% of REIT property types averaged double-digit positive returns in 2019.

Source: Table by Simon Bowler of 2^nd 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 (2020) increase during December (from 16.3x up to 16.6x). During December, the average FFO multiples rose for 50% of property types, fell for 45% and held steady for 5%. Manufactured Housing saw substantial multiple compression during December (from 28.2x to 26.7x), but remains at a higher average multiple than any other property type. After a very strong December rally in Corrections REITs, Malls now trade a lower FFO multiple (6.8x) than any other property type, followed by Corrections (7.1x) and Hotels (9.2x). All other property types closed out the year with a double-digit average FFO multiple.

Source: Table by Simon Bowler of 2^nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article.

Performance of Individual Securities

On December 30^th, Health Care REIT Senior Housing Properties announced that it would change its name to Diversified Healthcare Trust, effective January 1^st, 2020. The ticker symbol also changed from SNH to DHC at market open on January 2^nd. DHC also made announcements regarding numerous property transactions and capital markets activities on December 30^th as well.

DHC announced the acquisition of a 169-unit active adult rental property in Plano, TX, for $50.3M and the completion of $207.8M of property sales in the 4^th quarter. DHC also attained a new $250M senior unsecured term loan with a very near-term maturity date of June 12^th, 2020 with the option to extend it by an additional 6 months. The interest rate of this new unsecured facility is LIBOR + 125 basis points. The proceeds from this new term loan as well as proceeds from recent property dispositions, borrowings from its revolving credit facility and cash on hand were used to fully pre-pay the $350M senior unsecured term loan that was scheduled to mature on January 15^th, 2020. DHC also completed the restructuring of its business arrangements with its largest tenant, Five Star Senior Living (FVE), on January 1^st. This severely dilutive restructuring was discussed in greater detail in the December edition of The State of REITs.

Uniti Group (UNIT) outperformed all other REITs in December (+25.53%), but remained the worst performing REIT of 2019 with a -44.94% total return. The share price rebound in December can largely be attributed to the fact that Uniti was added to the S&P SmallCap 600 Index on December 18^th. Although Uniti’s largest tenant, Windstream Holdings (OTCPK:WINMQ), remains in Chapter 11 bankruptcy, Uniti has thus far continued to be paid rent by Windstream in full and on time. Share price volatility may dramatically increase over upcoming weeks and months as major decisions (assumption or rejection of the master lease, rulings regarding Windstream’s efforts for lease recharacterization, etc.) will be made by Windstream, Uniti and bankruptcy Judge Drain. These decisions will have tremendous impact on the future of the relationship between the two companies and thus the appropriate valuation for Uniti Group.

CBL & Associates Properties (CBL) had the lowest total return (-27.08%) in December due primarily to the suspension of the preferred dividends on December 2nd. There was speculation on the 2^nd quarter earnings call that CBL may need to reinstate the common dividend due to positive taxable income in order to continue to comply with REIT classification rules. CBL added during the 3^rd quarter earnings call that CBL expects to pay “the minimum required common dividend, if any, to distribute taxable income”. CBL then announced on December 2nd that not only would the common dividend not be reinstated but that the preferred dividends would be suspended as well for an estimated 4 quarters. This decimated the share price of the preferred shares and sent the common sharply lower as well. The price of CBL’s unsecured bonds, however, did not move as meaningfully on the news given that this decision did not negatively impact CBL’s fundamental value and in fact improved the ability of CBL to complete redevelopments more quickly due to a greater amount of available cash over upcoming quarters. CBL continues to rapidly pay down debt and work to stabilize and transform their portfolio. Although the preferred dividends that were suspended are cumulative (and thus will need to be paid out in full once dividend payments are resumed), CBL may have an improved balance sheet and growing FFO/share by the time they need to make these catch-up payments.

49.72% of REITs had a positive return in December, with 92.31% in the black over full-year 2019. In 2018, the average REIT had a dismal -7.85% return, whereas in 2019 the average REIT had an impressive total return of +28.84%.

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 12/31/2019) 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 2^nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article.

Valuation

NAV Data as of December 31^st, 2019

The REIT sector median discount to Net Asset Value widened for the 2^nd straight month in December from 2.5% to 2.8%. However, the 2.8% median REIT NAV discount at the end of 2019 is much narrower than the 17.7% discount at which REITs began the year.

The median NAV premium of Health Care REITs narrowed again in December from 21.8% to 17.1%, but Health Care remains the REIT property type afforded the largest premium by the market. Other Retail (for example: free-standing net lease retail) also saw its median premium narrow from 21.2% down to 17%. Community Healthcare Trust (CHCT) continues to trade at the largest premium to Net Asset Value, despite declining during December from a premium of 101.2% to 77.6% due to both an upward revision to NAV and a decrease in share price.

Diversified REITs and Residential REITs began December trading at a median premium to consensus NAV, but both closed out the year at a small discount. Despite a downward revision to consensus NAV, Mall REIT Taubman Centers (TCO) ended the year at the greatest discount to NAV (-54.9%) due to a large share price decline from the already deeply discounted price at which it began the month. Malls are the only property type to end 2020 at a lower price/NAV than they began the year, seeing their discount to NAV widen from 38.2% at the end of 2018 to 40% at the end of 2019. This is particularly dismal given that mall REIT NAVs have been revised downward throughout the year.

REIT Premium/Discount to NAV by Property Type

This month I am introducing a new downloadable data table, which ranks REITs within each property type from the largest discount to the largest premium to NAV. The consensus NAV used for this table is the average of analyst NAV estimates for each REIT. Both the NAV and the share price will change over time, so I will continue to include this table in upcoming issues of The State of REITs with updated consensus NAV estimates for each REIT for which such an estimate is available.

For the convenience of reading this table in a larger font, the table above is available as a PDF as well.

Takeaway

Although there will be opportunities in all property types, the two that warrant the greatest scrutiny in 2020 are likely Corrections and Malls. The 2020 election year will almost certainly be a matchup between two candidates with polar opposite policies regarding the use of private prisons. President Trump’s administration has been staunchly supportive of the use of privately owned facilities for the Bureau of Prisons, US Marshalls and especially Immigrations and Customs Enforcement (ICE). Considering that every single Democratic candidate with a plausible chance of winning the nomination has endorsed the idea of eliminating the use of for-profit facilities at the federal level (and some candidates have even pushed for banning individual states from being allowed to sign new contracts with for-profit operators), it is clear that no property type has more at stake in the election than Corrections REITs do. The share prices of both prison REITs are likely to be more impacted by political news and polling than by operating results throughout 2020.

As malls around the country are aggressively redeveloping to re-tenant large footprints that have been vacated by struggling big box retailers, revenues are temporarily down (as no rent is being paid is being paid for the under-construction portions of the properties until new tenants move in after construction is completed) and redevelopment expenses are way up. 2020 is a crucial year for mall REITs as this may mark the turning point in which redevelopments coming online will outpace store closures. Mall REITs are still priced for a continuation of the “retail apocalypse”. If the bears are right and some of the Mall REITs are unable to turn things around, malls may yet again underperform in 2020. However, if 2020 sees far fewer store closures and leasing picks up as redevelopments come online, Mall REITs could massively outperform all other property types. As most of these Mall REITs have heavy short interest, a genuine improvement in their balance sheets and operating fundamentals could result in a significant short squeeze.

It is also worth noting that the large cap REIT premium (relative to small cap REITs) grew larger and larger over the first 10 months of 2019, but declined in November and again in December. Even after the multiple gap narrowed over the last 2 months, however, investors are still paying on average more than 32% more for each dollar of 2020 FFO/share to buy large cap REITs than small cap REITs (20.4x/15.4x - 1 = 32.5%). As can be seen in the table below, there is presently a very strong, positive correlation between market cap and FFO multiple.

The table below shows the average premium/discount of REITs of each market cap bucket. This data, much like the data for price/FFO, shows a strong, positive correlation between market cap and NAV premium. Small cap and mid cap REITs are on average currently trading very near to their respective NAVs. Micro cap REITs, however, trade at a discount of 20% while large cap REITs average a 6% premium.

Micro cap REITs significantly outperformed their larger peers in 2019 with a remarkable 39.7% return. Given that many of these micro cap REITs still trade far below their respective NAVs, their incredible 2019 run has the potential to extend into 2020. By carefully analyzing REIT data and industry trends, active investors have the opportunity to outperform ETFs.

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Analyst’s Disclosure: I am/we are long CBL, CXW, GEO, UNIT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

2nd Market Capital and its affiliated accounts are long CBL, CXW, GEO and UNIT. I am personally long CBL, CXW, GEO and UNIT. 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.