How To Retire: Buy Better Stocks

Summary

• If you’re an investor or aspire to be one, don’t fear the reaper.
• Look him or her in the face - from a safe distance of six feet.
• Consider changes to the way you live with all of this time to think on your hands.
• Then use what might just be our “new normal” to add fuel to your retirement portfolio’s fire.
• This is a great opportunity to build a higher-quality portfolio filled with stronger dividend-growth stocks.
• I do much more than just articles at The REIT Forum: Members get access to model portfolios, regular updates, a chat room, and more. Get started today »

In retirement, the world is your oyster! Image source

You can succumb to the overwhelming air of uncertainty we’re all experiencing in one way, shape or form, or you can twist the definition of uncertainty in your favor:

Uncertainty equals a world of infinite possibilities.

Why does uncertainty have to be a bad thing? One person’s uncertainty is another’s opportunity. An opportunity to assess your current situation and do something in response to it. You have opportunities that you didn't have before!

In other words, this pandemic and the ensuing quarantine have offered us a truly once in a lifetime chance to be better. Certainly, we have all experienced wakeup calls, even rude awakenings, but nothing quite compares to the individual and collective shockwaves brought by a virus that has severely disrupted and, hopefully, set a course to change the way we live.

No matter the extent to which Coronavirus has impacted you and your loved ones, you’re missing an opportunity to be better if you don’t view this as an opportunity to be better.

So exactly what does this hopeful “new normal” look like and what does it mean for retirement investors?

Cutting Expenses

One of the best ways to accelerate retirement savings is, obviously, to invest more money. If nothing else, adding shares of dividend-producing stocks gives your income generation efforts a kick. We’re big on looking at seemingly lofty, non-traditional ways to cut expenses and invest more, ranging from discouraging college for your kids to rethinking the American Dream. And while we’re not sold on the impact of giving up your latte every morning, the stay-at-home orders and subsequent hoarding of items such as toilet paper, rice, beans, peanut butter, and macaroni and cheese would make anyone pause.

It might be that the quarantine has forced you to cut expenses. Maybe you’re out of a job or collecting reduced income. If that’s the case, you’re learning what you can and can’t live without. Maybe you’re doing just fine on cash flow, but you think twice while you’re at the store about what to buy and how much to spend, both for your own financial well being and to leave enough for other people. Maybe you have noticed that you don’t miss eating one or more meals in a restaurant each day. Maybe you enjoy the benefits of cooking at home and spending less money eating out. There are endless examples along these and similar lines.

Whatever your new perspective is on spending - assuming you have one - you can convert it to work for your retirement portfolio. If you have reduced income (or no income), you’re finding a way to make do with less. When less becomes more (you’re rehired, you find a new job, you secure some other source of income), do you think it might be possible to live off of what you were living off of during the quarantine and save/invest the rest?

Working More, Or Less

For some investors, staying at home means a glimpse of life at home in retirement. Minus the ability to travel, you’re getting an unplanned sneak preview of what it might look like to be at home more. It’s one of the unknowns of retirement as people consider it - will I be alright with this new life, which might include more time around the house, particularly if I don’t have the financial means to travel extensively? You’re able to, to some degree, assess how you’ll react to the retired life.

If you don’t like the taste of it you might be getting right now, you can make the decision to push your target retirement age back. Of course, this decision has all types of positive ripple effects for your portfolio and cash situation. It might allow you to delay collecting Social Security, increase your benefit, and keep healthy amounts of cash flowing into your savings and investment accounts.

On the other hand, maybe you sort of like the feel of not waking up each morning for work or the presumably more leisurely pace of being/working at home. If that’s the case you might entertain the idea of retiring early. There’s no time like the present to gameplan for that. You can literally do much of the above as you rebalance your portfolio to prepare from the prospects of having to draw from it sooner than you originally expected.

Uncertainty = Possibility

Bottom line - you’re likely living a different life today than you were a month ago. In some respects, it sucks. Take the time you need to feel self pity for yourself and compassion for others. But now is not the time to get bogged down to the point you find yourself in a rut. Now is the time to:

• Reassess or rebalance an existing, healthy retirement portfolio

• Make a blunt assessment of a not-so-healthy retirement portfolio

• Start a retirement portfolio

• Consider retiring earlier or later than originally planned

• Aim to live on your presumably scaled-back quarantine budget (or close to it) on the other side of this

All of this, of course, after you make sure you have used the shock of the Coronavirus quarantine to ensure you’re checking all the boxes on sound personal finance and preparation.

Learning to Analyze Stocks

You may find this is a great time to learn more about investing. You can capitalize on the downturn in the economy and the downturn in share prices. It's an opportunity to catch some great dividend growth investments on a nice sale.

We'll highlight a few opportunities with stocks we own. Each of these stocks is within our personal portfolio and our portfolio is used as the basis for our research service. You're learning about the same stocks we invest in.

Sun Communities

Sun Communities (SUI) is our largest equity REIT position:

• Over the last three years, we've purchased SUI six times and haven't reduced our position by single a share. This has been a cornerstone in our portfolio and we intend to keep it that way.
• SUI collected rent on 98% of its manufactured home properties in April (similar to last year). The RV parks are at 92% for annual, transient revenue is more volatile.
• COVID-19 will have a clear negative impact, but the precise magnitude is hard to nail down. Early estimates suggest a negative impact for Q2 around $15 to $18 million (13% to 16% of trailing annualized FFO).
• This is a great REIT at a good price. We can't forecast the exact bottom (despite successfully buying on the 52-week low), but see current values as a good time to begin building a position.

Positions in SUI

SUI has been one of our favorite equity REITs to purchase. Over the last few years, we’ve purchased shares six times and haven’t reduced the position by a single share. If we filter our positions to only show SUI, these are the positions:

Source: The REIT Forum Google Sheets

Note: The purchase on 3/23/2020 was on the day of their 52-week low. That's a mix of luck and skill. We didn't know that it would be the bottom. We did know that we wanted more shares. We did know that we were shocked to see shares under $100 again. When shares plunged, we sold off other positions to free up cash because we knew we wanted more SUI.

Since SUI is one of our largest single positions and our largest position in any common share, we want to highlight why SUI gets such a large weight in our portfolio.

FFO Per Share Growth Machine

The manufactured housing REIT delivered incredible growth in the share price, but they also delivered growth in FFO per share:

Source: Author’s chart with data from REITbase.com

The result is exceptionally high annual growth rates in both recurring FFO per share and AFFO per share:

Source: Author’s chart with data from REITbase.com

The results are strong throughout the financial statement:

Source: SUI

Overview of Sun Communities

Source: SUI

They own and operate manufactured housing parks and RV communities. They do it very well.

The mix of communities is:

• 63% MH
• 29% RV
• 8% Mixed

Those properties are diversified throughout the United States and include some properties in Canada:

Source: SUI

The 2020 Guidance

Guidance was quite positive, but like most REITs they are pulling guidance due to the difficulty of forecasting the current-year impact of COVID-19:

Source: SUI

Are They Still Collecting Rent?

We predicted that manufactured housing would have an exceptionally high level of rent collections compared to most other property types. As of April 21, 2020, they had collected approximately 98% of the rent due on their manufactured home properties.

Revenue from transient customers on RV properties is harder to estimate, but 92% of their rent from annual customers on the RV side already has been collected for April.

They provided a great deal of information on their Q1 2020 earnings release. The Same Community Net Operating Income (a measure for year-over-year growth) came in at 6.7% for the first three months. That gave them a great start to the year.

Further, their first quarter “Core FFO” came in at $1.22, just above the top end of their prior guidance range.

Rexford Industrial

• We’re adding Rexford Industrial (REXR) to coverage. We’ve been watching the REIT quietly for some time and waiting for the right opportunity. Low yield of 2.11%, but a great fit for buy and hold.
• REXR scores high across our most important criteria. They have low leverage, an excellent runway for growing FFO per share, and a good management team to see it through.
• Industrial real estate in Southern California is a huge market, but the market is fragmented into several smaller (less efficient) investors. REXR has an incredible growth opportunity.
• Shares trade at a moderate premium to NAV, but we expect that to be common for the foreseeable future. Most of the best REITs have consistent premiums.

Industrial REITs have delivered exceptional growth over the last several years as the sector benefits from a shift toward online sales. The industrial property type has seen significant increases in rental rates and property values. There are several good industrial REITs to choose from, but we’re continuing to pick our favorites in the sector. We continue to emphasize REITs with lower risk ratings and stronger growth profiles. These kinds of REITs (low risk, high growth) have generally outperformed for many years.

For Rexford Industrial the main strengths are:

1. Outstanding property quality in a fragmented market.
2. An edge in evaluating physical real estate and sourcing deals.
3. Exceptional balance sheet, prepared for growth.
4. Strong management team.
5. Shares frequently trade over NAV, enabling accretive growth.

The downsides are:

1. Investors need to accept a high price to FFO multiple and low dividend yield.
2. Investors need to be ready to pay a premium to NAV to open positions.

Index Card for REXR

The quick stats are summed up in the index card below:

Source: The REIT Forum

Rexford Industrial is a pure-play REIT. This is industrial real estate in Southern California. Why do we like this real estate so much? The market is exceptionally tight with high occupancy rates (running around 98% in each of the last four years and rental rates are significantly higher than average for the United States:

Source: REXR

Because the investment is built on the location of the real estate, REXR provides a vastly more detailed map than other REITs:

Source: REXR

With 100% of its portfolio in Southern California and a market capitalization of nearly $5 billion in common equity, REXR has greater expertise than other REITs can manage:

Source: REXR

A smaller REIT simply wouldn’t have the resources to attract the top talent. A more diversified REIT wouldn’t have as much expertise in locating properties within this market. Despite REXR having a reasonable size and 100% exposure to Southern California, they still only have a 1.5% market share. That leaves REXR plenty of room to grow.

Growth

Growth in FFO per share and AFFO per share has been exceptional in the last few years, but investors might be concerned about the weaker numbers leading from 2014 to 2015:

Source: Author’s chart with data from REITbase.net

Since Southern California is so attractive for industrial real estate, investors could reasonably have expected growth to show up for every year. It didn’t. So what happened? REXR started with very high leverage. The company needed to grow the portfolio, but they also needed to reduce leverage.

To grow the portfolio while reducing leverage ratios, a REIT needs to issue new shares. Issuing new shares can be accretive to long-term shareholders. However, when the process starts with high leverage, it often has a negative impact on FFO per share. That’s acceptable.

If REXR still had the level of leverage they had when they went public, they would be a far riskier investment. From 2014 to 2015, the weighted average common shares increased by 61%. Since then it has grown around 13% to 23% per year. REXR’s debt-to-EBITDA ratio (a key factor in assigning risk ratings) came down to 3.7 as of 2019:

Source: REXR

Despite an exceptionally low debt-to-EBITDA ratio, REXR’s credit rating is still at BBB:

Source: REXR

Their current leverage ratios would suggest that a higher credit rating would be warranted. However, large companies also have an easier time getting higher credit ratings. Consequently, if REXR continues to grow while maintaining the same leverage, we wouldn’t be surprised if they got bumped up to BBB+ or even A-.

Note: We currently have a risk rating of 2.0 on REXR. If they continue to grow with similar leverage, we would expect to reduce the risk rating to 1.5. Size is a factor here.

Why does that matter? Beyond the simple fact that lower leverage leads to a lower risk rating, it also leads to a lower rate on new debt. As REXR grows, if they continue to issue new debt to maintain similar leverage, we would expect them to issue at rates significantly lower than the weighted average 3.5% on their existing debt. When an equity REIT grows and gets a lower rate on new debt, each acquisition is more accretive to FFO per share because a greater portion of the NOI goes to shareholders. The existing debt won’t start rolling off until 2022, but REXR’s acquisitions in 2019 came to nearly $1 billion. If they continue to grow anywhere near that fast, new debt would be issued to go along with new shares.

Dividend Growth

The REIT has delivered significant dividend growth to shareholders as well:

Source: Author’s chart with data from REITbase.com

We see REXR as a great fit for most dividend growth investors. We went into more depth in a major subscriber article on REXR.

PS Business Parks

PS Business Parks (PSB) is one of the best industrial REITs:

Source: The REIT Forum

They rarely go on sale, especially over the last few years. This is a great time to point out what makes the best REITs in a sector unique. PSB has regularly traded at a premium to NAV (net asset value):

Source: TIKR.com

The share price has rallied dramatically over the years, but you can see that the NAV also was climbing rapidly. That was a combination of property appreciation (industrial property values climbed) and PSB reinvesting in their portfolio. We would like to see PSB issuing new shares more aggressively when pricing is favorable. They don’t want to overpay for real estate, but if they are able to issue at the right price, it still benefits long-term shareholders.

Growth Rate for PSB

PSB has driven strong growth over the last several years:

Source: REITBase.com

The growth is driven by strong growth in same-property NOI: Strong growth in NOI is a result of a solid leasing environment (and good management). If COVID-19 really hits the United States, are you going to buy more stuff in person or online? How about that? If only one of the best REITs owning that kind of property would go on sale. Oh, it did? You’re right, the price dropped quite a bit. That’s the kind of opportunity we like to see.

Conclusion

Investors looking for solid income investments can still turn to REITs as an effective way to invest in real estate. This a great opportunity to build a stronger portfolio. Several of the highest quality companies dipped and created attractive entry points for investors. There are plenty of good choices available among the stronger companies, without needing to accept weaker stocks.

Ratings: Bullish on SUI, REXR, PSB

Analyst’s Disclosure: I am/we are long SUI, REXR, PSB. 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.