- The REIT sector plummeted in March, suffering a -28.79% average total return.
- Micro-cap and Small-cap REITs severely underperformed their larger peers during the March selloff.
- 93.33% of REIT securities had a negative total return in March.
- Land and Data Center REITs led all property types in March, while Malls and Hotels saw the most severe declines.
- 95.2% of small cap REITs trade at a Price/FFO discount to the average large cap REIT.
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The coronavirus-induced stock market collapse, which began on February 24th, accelerated during March and sent stocks dramatically lower. The REIT sector saw even more severe losses than the broader market. After suffering back to back declines in January and February, the average REIT fell much further in March with a total return of -28.79%. This amounts to a devastating first quarter loss of -33.39%. The REIT sector badly underperformed the NASDAQ (-10.12%), S&P 500 (-12.51%) and Dow Jones Industrial Average (-13.74%) in March. The market cap weighted Vanguard Real Estate ETF (VNQ) massively outperformed the average REIT in March (-19.42% vs. -28.79%) and has suffered much smaller losses year-to-date (-24.16% vs. -33.39%). The spread between the 2020 FFO multiples of large cap REITs (18.9x) and small cap REITs (9.2x) significantly widened in March as multiples fell an average of only 1.3 turns for large caps and a staggering 2.9 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.
Although REITs of all sizes performed poorly in March, micro-cap REITs (-42.95%) saw by far the largest declines. Large cap (-15.73%) and mid cap REITs (-21.18%) averaged significantly less severe losses than their smaller peers. Large cap REITs continue to outperform year to date, averaging a first quarter return of (-18.52%), which is less than half the losses seen by micro-caps (-42.95%) and small caps (-39.97%).
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
2 out of 20 Property Types Yielded Positive Total Returns in March
Only 10% of REIT property types averaged a positive total return in March, with a massive 59.58% total return spread between the best and worst performing property types. Data Centers (+4.28%) and Land (+2.74%) had the best average returns. The strong performance of Data Centers was due largely to the fact that it is the property type that is arguably most insulated from the impact of the coronavirus and may even benefit from it due to increased internet traffic and thus data usage. Data Center REIT QTS Realty Trust (QTS) announced on March 26th that it still expects to maintain previously stated rental churn guidance of only 3%-6% and that usage of their Service Delivery Platform has accelerated during March as a result of the expanding number of people working from home during the shelter-in-place restrictions imposed by many states.
Malls (-55.29%) were the worst performing property type in March, declining sharply throughout the month due to the announcements that most enclosed malls would be shuttered indefinitely to help reduce the spread of the coronavirus. Percentage rents represent a tiny fraction of revenue for most mall REITs and thus the lack of revenue received by tenants during this shutdown does not have a major direct impact their REIT landlords. However, the indirect impact to these REITs may potentially be devastating. Tenants that are no longer receiving revenue may seek rent concessions (most likely either a deferral or reduction) to help them stay afloat until the malls re-open. This could result in a significant temporary decline in cash flow to these REITs. With the notable exception of Simon Property Group (SPG), mall REITs entered this crisis with balance sheets that may not be strong enough to endure extended cash flow disruptions. As projections for the duration of shelter-in-place restrictions continue to be extended further into the year, investors have priced in increasingly dire outcomes for Malls as well as REITs of most other property types.
Land (+13.51%) and Data Centers (+1.4%) are the only REIT property types that remain in the black after the first 3 months of 2020. Hotels (-58.65%) and Malls (-56.66%) have experienced greater losses than all other property types year to date. 90% of REIT property types have averaged a negative return, with 85% reaching a double-digit negative return thus far this year.
The REIT sector as a whole saw the average P/FFO (2020) decline very sharply during March (from 15.9x down to 12.3x). During March, the average FFO multiples rose for 10% of property types and fell for 90%. While multiples plummeted for nearly all property types in March, Land and Data Centers both saw multiple expansion. Land (22.8x) now trades at the highest average multiple of all property types followed by Manufactured Housing (21.6x). Malls (3.6x) now trade at the lowest multiple, due largely to the fact that numerous enclosed malls around the country are closed indefinitely due to efforts to slow the spread of the coronavirus. There are now four other property types that trade at single digit multiples: Corrections (5.1x), Hotels (5.6x), Shopping Centers (6.7x) and Advertising (9.3x). All other property types still average a double-digit FFO multiple.
Performance of Individual Securities
Hotels have suffered a collapse in RevPAR (down 80% year over year the week ended March 28th) driven by a freefall in occupancy rates due to both the shelter-in-place policies implemented by numerous states as well as the travel bans on a litany of disproportionately-infected countries being utilized to reduce the spread of the coronavirus. While these measures are likely to meaningfully reduce the number of Americans infected with the virus and the number of resulting deaths, they have had a devastating impact on the hospitality industry.
As a result of this sudden drop in occupancy, it is no longer profitable to keep certain hotels open. Many Hotel REITs are electing to selectively close some properties indefinitely. Some examples include: Condor Hospitality (CDOR) has announced the closure of 2 properties for an estimated 30-90 days. RLJ Lodging Trust (RLJ) announced that it will temporarily close more than half of its properties. Pebblebrook Hotel Trust (PEB) announced on March 23 rd that it had already suspended operations at 28 properties and planned to suspend operations on the remaining 26 by the end of March.
Hotel REIT Braemar Hotels & Resorts (BHR) had the lowest total return (-76.90%) of all REITs in March and is now the 2nd worst performing REIT of 2020. Braemar ended 2019 with a dangerously low fixed charge coverage ratio of only 1.25x, which left BHR with the ability to endure only a minor decline in EBITDA. BHR suspended the common dividend, but that savings may not be nearly enough. Given the magnitude of the disruption and the likelihood that it could last for many months, BHR is among the Hotel REITs that is least likely to survive the pandemic. BHR is certainly not alone in facing painful share price declines, 4 of the 8 lowest total returns in March were hotel REITs and 1 was a diversified REIT with significant hotel exposure. These other badly beaten down REITs are Service Properties Trust (SVC) at -70.13%, Sotherly Hotels (SOHO) at -68.81%, Hersha Hospitality Trust (HT) at -66.39% and Ashford Hospitality Trust (AHT) at -65.78%.
Data Center REIT Digital Realty Trust (DLR) significantly outperformed the REIT sector with a remarkable +16.66% return in March as the vast majority of REITs saw large double-digit declines. The US economy and daily life have been rapidly and severely transformed as a result of the coronavirus and the efforts to slow the spread. While this has forced numerous businesses to close or significantly scale back operations, data center REITs thus far appear to have remained largely unscathed. As a result, 5 of the 9 best performers in March are Data Center REITs. These other strong performers are CoreSite Realty (COR) at +12.92%, Equinix (EQIX) at +9.04%, QTS Realty Trust (QTS) at +4.31% and CyrusOne (CONE) at +2.84%.
Only 6.67% of REITs had a positive return in March, with 6.63% in the black year to date. During the first 3 months of last year, the average REIT had a stellar +17.35% return, whereas this year the average REIT has seen a dismal total return of -33.39%.
For the convenience of reading this table in a larger font, the table above is available as a PDF as well.
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 03/31/2020) 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.
NAV Data as of March 31st, 2020
The REIT sector median discount to Net Asset Value significantly widened again in March from -13.8% to -31.3%.
Data Centers began the month of March at a median NAV discount of 3.1%, but due to a remarkable outperformance finished the month at a premium of 4.9%. All other property types finished Q1 trading at a discount to NAV. Although REITs of nearly every property type saw steep share price declines, Mall REITs continue to trade at the widest discount to NAV. Casinos (-26.7%), Health Care (-18.4%), Other Retail (-29.9%) and Self-Storage (-5.5%) all traded at premiums to NAV at the beginning of March, but finished the month at a discount. Safehold (SAFE) (+150.5% premium) significantly outperformed the market again in March and continues to trade at the largest premium to NAV. Mall REIT Macerich (MAC) now trades at the largest discount to NAV (-85.3%).
Due to the rapid pace of share price declines among REITs, most analysts have not yet updated their NAV estimates to reflect the likely declines in NAV that most REITs have experienced during March. As a result, the NAV premiums listed may understate the magnitude of the premium, whereas the discounts may be meaningfully smaller than that which is the current analyst “consensus”. Over upcoming weeks and months these consensus figures will begin to more accurately reflect the actual NAV of each respective REIT as analysts update their estimates.
Below is a 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.
It is very important to note that when economic fundamentals change as suddenly and sharply as they have due to the coronavirus outbreak and resulting economic shutdown, that analyst NAVs often take time to be updated and reflect the new fair value of each respective REIT. As a result, many of the following NAVs do not yet fully reflect the current (and in many cases meaningfully reduced) appropriate NAV of each REIT. While this data is certainly still worth examining, at this time it is very important to recognize that many of the consensus NAVs in the following table may overstate the present NAV of a specific REIT.
For the convenience of reading this table in a larger font, the table above is available as a PDF as well.
The large cap REIT premium (relative to small cap REITs) significantly increased during 2019 and further expanded during each of the first three months of 2020. Investors are now paying on average more than 105% more for each dollar of 2020 FFO/share to buy large cap REITs than small cap REITs (18.9x/9.2x - 1 = 105.4%). As can be seen in the table below, there is presently a 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 Price/NAV. Large cap REITs are on average currently trading at a modest discount (-13.48%) to their respective NAVs. Mid cap REITs trade at a somewhat wider discount of -20.62%, small caps at a large discount of -39.37% and micro-caps at a staggering -60.89% discount to NAV. As stated earlier, many analyst consensus estimates for both 2020 FFO/share and NAV/share do not yet reflect the new economic reality for the United States and the resulting impact on the REIT sector. Therefore, it is important to recognize that both 2020 FFO/share and NAV/share are likely to be materially lower for most REITs.
The REIT sector has suffered a much steeper selloff than the broader market. In some downturns, REITs may be seen as a safer alternative given that nearly all properties owned by REITs will retain their functionality and that the land and improvements will retain some or most of their value. However, this downturn is very unique in that a huge portion of the economy has come to a complete stop due to government shelter-in-place directives. As a result, businesses are disproportionately being evaluated by investors based on strengths of their balance sheets and their ability to withstand a prolonged significant decrease in revenues. As a result, sectors in which companies have higher debt/EBITDA ratios have been considered riskier. Real estate companies utilize a significant amount of debt and have much higher debt/EBITDA than all other S&P 500 sectors. This played a major role in the disproportionate selloff that REITs have experienced.
Balance sheet strength also played a major role within REITs, as the property types that have higher average fixed-charge coverage ratios saw much smaller declines than those with weaker coverage ratios. REIT property types with lower net debt / EBITDA similarly experienced smaller share price declines that those that had a higher ratio.
In order to enhance liquidity and thus improve flexibility and increase the duration for which substantial revenue disruption can be withstood, many REIT drew down all or most of their credit facilities. This boost to cash on hand, paired with dividend cuts and suspensions, executive salary reductions, furloughs and layoffs has provided numerous REITs with far greater flexibility to endure an extended economic shutdown. Some REITs, such as multifamily REIT Nexpoint Residential Trust (NXRT) are using this extra liquidity to buy back shares at a price well-below NAV. Many others, such as the hotel REITs, need this liquidity to cover sizeable operating losses during this challenging period.
As can be seen in the table below, a large number of REITs have recently significantly reduced or fully suspended their common dividend. In some cases the preferred dividends have been suspended as well. These dividend reductions have been disproportionately made by Hotel REITs. This is appropriate given that the negative impact on these REITs is much more immediate, given that their “tenants” have “leases” that are as short as 1 night. Even mall REITs, which are among the most negatively impacted, still have tenants that are contractually obligated to pay rent for many more years. Some of these tenants will demand rent concessions and others will go bankrupt, which will reduce rental income to these REITs, but many others will continue to pay their rent in full. This is also true for Office, Triple Net, Shopping Centers, etc., which significantly reduces the degree to which these REITs will be harmed. Hotel REITs are the only property type that are already being fully impacted.
This is a particularly challenging time to invest, because so much has changed over such a short period of time and much of the useful data has not yet been made public. Until REITs announce the amount of rent concessions made, changes to occupancy and whether they have been able to successfully remain within the limitations of their debt covenants, investors will be operating with a partial data set. However, this also presents an opportunity. By analyzing all publicly available information and taking a more granular look at each REIT as well as their respective tenants, more diligent investors will be able to make investment decisions with a more complete data set and thus improve their chance to identify significant mispricing of individual securities. It is also a great time to not merely identify companies that are attractively positioned, but to evaluate within each company which tier of the capital stack represents the best risk-adjusted return. Due to lower liquidity, preferred shares and corporate bonds can at times trade irrationally, which sometimes creates opportunities. By carefully analyzing REIT data and industry trends, active investors have the opportunity to outperform ETFs.
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This article was written by
Simon Bowler is the Chief Communications Officer at 2nd Market Capital Advisory Corporation (2MCAC). 2MCAC specializes in the analysis and trading of real estate securities. Through a selective process and consideration of market dynamics, we aim to construct portfolios for rising streams of dividend income and capital appreciation.Our Portfolio Income Solutions Marketplace service provides stock picks, extensive analysis and data sheets to help enhance the returns of do-it-yourself investors.Investment Advisory Services
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Analyst’s Disclosure: I am/we are long QTS, SPG, CONE, MAC & NXRT. 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.
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