3 High-Quality REITs To Buy: The Cream Rises To The Top
Summary
- Over the years, I’ve written numerous articles on Seeking Alpha to steer readers away from sucker-yield stocks.
- In this article, I plan to provide a few of our “sweet REIT” picks: Companies with the widest economic moats to fend off competition.
- Though intelligent REIT investors know they can’t just purchase shares of “important companies” with wide moats, they need to also acknowledge margin of safety.
- This idea was discussed in more depth with members of my private investing community, iREIT on Alpha. Get started today »
In March, we intend to focus almost exclusively on the topic of quality – one of the most important ingredients for investor success. Oftentimes, we see readers becoming mesmerized with yield instead, which only leads to ruin.
Don’t misunderstand us. High-yielding stocks can make for fantastic buying opportunities. But that factor should be a perk, not the main focus.
One of the ways we measure quality is by examining a company’s balance sheet. We’ve found that REITs that maintain discipline – in terms of their capital markets strategies – generally provide higher predictability in terms of their earnings and dividend growth.
Over the years, I’ve written numerous articles on Seeking Alpha, hoping to steer readers away from sucker-yield stocks. There’s always that temptation to own shares in something that yields 10% or higher, I know. But that also indicates an increased cost of capital and safety issues.
Why play around with that kind of dynamite when there are long-term prospects out there that offer much better returns?
The Defensive Investor
As Benjamin Graham explained (emphasis added), “The defensive investor must confine himself to the shares of important companies with a long record of profitable operations and in strong financial condition.”
Those bolded words are highly correlated and essential to unlocking value.
As Graham also pointed out, “Consistency and durability are attributes for competitive advantage.” Or, as Heather Brilliant and Elizabeth Collins put it in Why Moats Matter, look for companies that can “fend off competition and earn high returns on capital for many years into the future.”
This is a strategy Warren Buffett would approve of. In 1999, he told Fortune:
“The key to investing is… determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them ate the ones that deliver rewards to investors.”
However, intelligent REIT investors know you can’t just purchase shares of big companies with wide moats. There’s also margin of safety to consider, which Joel Greenblatt summed up this way in a 2011 Barron’s interview:
“... it’s about figuring out what something is worth and then paying a lot less for it.”
That’s why we utilize our iREIT Lab to screen prospective REIT picks. It allows us to sort for the highest-quality names, assigning scores based on “defensive” attributes such as:
- Geographic and operator diversification
- Industry/category
- Strength of balance sheet
- Earnings growth
- Dividend growth
- Dividend safety
- Management.
After evaluating each REIT on a quarterly basis, we assign it a R.I.N.O. (REIT Indicator Numerically Optimized) score, then screen based on valuation metrics such as:
- Price to funds from operations (P/FFO)
- Dividend yield
- NAV
The results can be downright quality kings.
Simon Says “Buy!”
Our first high-quality pick is Simon Property Group (SPG). It’s a massive retail landlord that owns 233 retail real estate properties including malls, Premium Outlets and The Mills.
All told, it’s got 191 million square feet worth of space across North America, Europe and Asia.
We favor Simon over many other mall REITs due to its tremendous scale advantage – which generates more than $60 billion in annual retail sales. It also has a 22.2% ownership interest in Klépierre, a public real estate company with shopping centers in 15 European countries.
Simon’s scale advantage has been meaningful even while department stores and retail chains downsize. Their closed locations have actually provided it with optimized diversification opportunities to weather the storm.
Other peers like CBL Properties (CBL) and Washington Prime (WPG) have had to cut their dividends. Their earnings power have simply eroded too much over time.
Yet here’s a snapshot of Simon’s five-year price history compared with many of its direct peers:
Source: Yahoo Finance
Now, as the chart illustrates, Simon isn’t immune to market volatility. But it’s still performing admirably, thanks in large part to its cost of capital.
Last quarter, it completed three-tranche senior notes of $3.5 billion with an average weighted coupon of 2.61%. Simon also retired $2.6 billion of senior debt with a combined weighted average coupon rate of 3.76%.
The new notes offering had a weighted average coupon rate approximately 115 basis points lower than those retired. And after repaying the senior notes, Simon had more than $7.1 billion of liquidity consisting of cash on hand – including its share of joint venture cash and available capacity under its revolving credit facilities.
The company ended the quarter with strong credit profile metrics, such as:
- Net debt to NOI of 5.1x
- Fixed charge coverage of 5.4x.
Mergers and More
More recently, Simon decided to flex its financial muscle to acquire Taubman Centers (TCO) for $3.6 billion in cash, or $52.50 per share. Essentially, it purchased an 80% stake in Taubman Realty Group Limited Partnership.
If anyone can do that, it’s Simon. As viewed below, its shares have returned an average of 11.9% annually since December 1999:
Source: FAST Graphs
Last quarter, it reported FFO of $1.045 billion, or $2.96 per share. And comparable FFO was $3.29 per share, an increase of 2.8% year over year.
The company's comp net operating income (NOI) grew by 1.7% year over year. And retail sales per square foot for the malls and premium outlets was $693 per foot, a 4.8% increase.
While 2019 can be summed up as "better than expected," 2020 will be seemingly conservative. Simon guided FFO per share of $12.25-$12.40.
The company indicated expectations for 1% same-store NOI growth, attributed to:
- Extended downtime for developments
- Lower overage rents (related to international tourism)
- Drag from 2019 bankruptcies.
However, CEO David Simon offered words of encouragement on the earnings call, saying that store closures "will be dramatically less than last year."
As viewed below, Simon generated FFO per share growth of 14% in 2015, 6% in 2016, 7% in 2017, 8% in 2018, and -1% in 2019. Analysts forecast 3% in 2020 and 4% in both 2021 and 2022.
Source: FAST Graphs
One Nasty (but Not Unbeatable) Bug
In the midst of all this, the coronavirus epidemic that started in China in late 2019 continues to spread. As I recently explained on Forbes.com:
“The latest figures as of February 28 show more than 83,000 reported cases of the coronavirus in at least 53 countries, with more than 2,800 deaths globally. The death toll has surpassed the 2002 SARS epidemic.”
I also explained that “retail, hotels, and restaurants assets are bearing the brunt of the impact. But other asset classes are suffering tertiary effects.”
And I summed up by saying that:
“Considering what has happened already in Asia, real estate investors, owners, and operators in other parts of the world can begin for the possibility of difficult conditions, particularly in the retail and hospitality spaces.”
While the possibility of a “black swan” event – like the coronavirus getting much worse – could impact retail landlords in the U.S., we believe the odds are much more in favor of making money off of Simon.
Shares closed last week at $123.08, the lowest price seen since 2012. And the dividend yield is now 6.8%.
Simon appears to be of one of the few A-rated companies that offers a yield of over 6.5%. We believe investors will eventually be rewarded for their patience in owning shares.
It’s one of the highest-quality and most defensive REITs in our coverage spectrum, with a R.I.N.O. score of 4.32.
Source: FAST Graphs
The Somewhat Volatile Ventas
Our second high-quality pick is Ventas Inc. (VTR), a diversified healthcare REIT. It owns a diverse portfolio of 1,200 properties, including
- Senior Housing Operating (32%)
- Office (27%)
- Triple-Net (36%)
The rest of its investments are through loans.
Ventas has around 25% exposure in U.S. senior housing operating properties (SHOPs) and about 7% exposure in non-U.S. SHOPs. This means that a good chunk of its income is concentrated in the most volatile healthcare property subsector around.
The remaining 75% of VTR’s NOI is healthy. And it arguably provides more defensive revenue to support the company’s earnings and dividend growth profile.
However, the continued drag on the U.S. SHOP portfolio has softened investor sentiment. So has the Q4-19 same-sale NOI results of -7.5%.
Guidance also was weaker than expected for 2020, with normalized FFO per share being predicted at $3.56-$3.69. The midpoint is $3.63, which is below the consensus of $3.71 and implies a 5.8% decline year over year.
This guidance does not include the impact of 2020 investments.
Here’s a snapshot of the company’s five-year price performance vs. a few peers:
Source: Yahoo Finance
To combat negative SHOP growth specifically, Ventas recently said it was hiring Justin Hutchins. A veteran REIT exec formerly with National Health Investors (NHI), Hutchins will be starting April 1. At that time, he’ll oversee the senior housing business in North America, which amounts to 700 properties and 60,000 residents.
Obviously, one new employee – no matter how highly placed or recommended – won’t turn the tide all by himself. But he might be a key component to helping things improve nonetheless.
More Reasons to Perk Up
Ventas also introduced a new business line: The Ventas Life Sciences & Healthcare Real Estate Fund, which invests in life sciences properties, medical office buildings (MOB), and SHOP real estate. It should launch later in Q1 2020, with around $700 million in assets under management and third-party equity capital of about $650 million.
Collectively, we believe Ventas has the resources to restore its performance record shown below. It generated annual total returns averaging 17.4% between December 1999 and now.
Source: FAST Graphs
Similar to Simon, Ventas also enjoys an impressive cost of capital advantage. At the end of the year, it had average debt duration of around eight years on its senior notes. And its average cost of debt was approximately 3.5%.
Its unsecured debt rating is BBB+ and debt maturities through 2021 are minimal.
Ventas also is an experienced recycler. So it’s marketing more than $600 million in non-strategic senior housing assets and proceeds for sale. Those will be reprocessed into its growing R&I pipeline with leading research universities – in which Ventas has invested in heavily.
Meanwhile, it generated FFO growth of 19% in 2013, 8% in 2014, 10% in 2016, and 15 in 2017. Though, in 2019, that number did fall to -5% and analysts estimate the same for 2020.
Source: FAST Graphs
However, as explained in a recent article:
“We maintain a Buy here, recognizing that it could take two, three, or even four quarters to see our faith pay off. SHOP occupancy should ramp up in Q3-20, but there's the possibility of the stock taking off before then. Given the latest initiatives outlined by management, we’re optimistic that the company can successfully navigate its risks and generate attractive returns. Given its soundly-valued shares, we consider this healthcare REIT to be a long-term buying opportunity.”
Source: FAST Graphs
Flight to Quality
Our final “flight to quality pick” is Digital Realty (DLR), a leading data center REIT. With 210 data centers in 14 countries on five continents, it recently entered Chile and South Korea with agreements to expand in Europe and explore India going forward.
Last week, Digital shareholders approved all proposals related to its pending merger with InterXion (INXN). And the company itself should accept those validly tendered shares from the tender offer as early as March 9.
I explained in an earlier article that:
“This highly strategic and complementary $8.4 billion transaction will create a leading global provider of cloud and carrier-neutral data center solutions, complete with an enhanced presence in high-growth major European metro areas.”
Interxion's connectivity capabilities are a primary source of competitive advantage. They offer highly connected locations for content providers, and the cloud platform providers seeking to provide services to them.
Overall, the businesses are complementary and should provide their mother corporation with significant scale advantages.
On the latest (Q4-19) earnings call, management said that:
“Core FFO per share was down 3.6% year over year… and we are not providing formal guidance for 2020 at this time given the number of moving parts related to our pending strategic combination with Interxion, as well as the acquisition of our partners interest in the Westin Building.”
But, given Digital’s expected dilutive impacts, we have modeled 2020 FFO per share at $6.92.
A Lot Going for It
Here’s a snapshot of Digital’s five-year price performance compared to its peers:
Source: Yahoo Finance
Similar to Simon and Ventas, Digital also has an attractive cost of capital advantage. Its weighted average debt maturities over six years (including the January bond issuance) was 2.9%.
And a little less than half its debt is non-U.S. dollar denominated. This acts as a natural forex hedge for investments outside the U.S.
More than 90% of its debt is fixed-rate to guard against a rising-rate environment. And 99% of its debt is unsecured, providing the greatest flexibility for capital recycling.
Digital’s balance sheet also is investment-grade rated (BBB by S&P). Plus, it has a clear run rate with no near-term debt maturities. Better yet, because of its impressive capital markets discipline, it has been able to generate impressive growth.
As viewed below, Digital has generated average annual total returns of 18.4% since 2004.
Source: FAST Graphs
One of the reasons I’ve been busy accumulating Digital is because of its impressive growth profile. FFO per share grew by 9% in 2016, 7% in 2017, and 7% in 2018.
To be clear, it only came in 1% ahead in 2019, and analysts forecast -3% for 2020, though we’ve modeled -1%. However, they’re more encouraged for the future, with FFO forecasted to grow by 7% in 2021 and 7% in 2022.
Source: FAST Graphs
Shares pulled back by around 12% last week on coronavirus fears. And we currently have a $122 Fair Value Target on them. This means we’re now recommending Digital as a Buy.
The company has proven it can continue to consolidate its best-in-class platform with a solid management team that focuses on the two most important levers in the REIT space: Scale and cost of capital.
Source: FAST Graphs
In Closing...
I cannot overemphasize the importance of staying away from dangerous stocks. Over the last decade writing on Seeking Alpha – and over the last three decades as a real estate investor – I’ve learned many valuable lessons.
But perhaps the most important one can be summed up by Frank J. Williams:
"There is only one narrow trail leading to permanent success in the stock market. Unless traders are prepared to climb that steep path with cautious steps, it would be better for them to stay out of Wall Street and to keep their money in the savings bank."
In other words, please, please, please avoid chasing yield. Many investors have been burned by investing hard-earned capital into unsafe securities. And while I’ll continue to preach sound logic on Seeking Alpha, always remember that "quick profits are just froth."
As Williams also explained:
"People suffered the agony of financial loss. And many had to start life over again because they would not take the trouble to learn the rules of the game they were playing."
Don’t be that player. Learn how to get out ahead in the long run.
Author's note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.
REIT Bracketology: Back by Popular Demand
2020 marks our 3rd year of REIT bracketology in which we will break down all REIT property sectors in order to determine the best companies to own. Our highly skilled analysts will provide play-by-play coaching so you will not foul out and you can obtain the most predictable results. 
Act Now so you can get your front row seat before tipoff! We want to make sure your winning team makes it to the Final Four and hopefully puts you in the winner’s bracket.
This article was written by
Brad Thomas has over 30 years of real estate investing experience and has acquired, developed, or brokered over $1B in commercial real estate transactions. He has been featured in Barron's, Bloomberg, Fox Business, and many other media outlets. He's the author of four books, including the latest, REITs For Dummies.
Brad, with his team of 10 analysts, runs the investing group iREIT® on Alpha, which covers REITs, BDCs, MLPs, Preferreds, and other income-oriented alternatives. The team of analysts has a combined 100+ years of experience and includes a former hedge fund manager, due diligence officer, portfolio manager, PhD, military veteran, and advisor to a former U.S. President. Learn moreAnalyst’s Disclosure: I am/we are long VTR, SPG, DLR, CONE. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (154)
Ebola affected a part of the world easily isolated and which contributed and still contributes less than 0.1 % of anything in global terms
The supply chain shut down emanating from China and the impact on leisure/travel/shopping will be enormous if Corona is not contained ... I would be very very afraid
Using a "mental allocation" of about 50% of the value of 100 shares (the broker requires much less), you'd be miles ahead to effectively buy SPG today at 101 (!!!). rather than to buy the stock outright.
Simon may be best of breed, but no matter how competent the management, and how low their cost of capital, etc., etc., etc., any mall investment is swimming against the Amazon tide which has so many ramifications that as Brad T says, he's underweight the sector. Wise advice from the best.
