Dividend Cuts And Overdue Rent: REIT Earnings Recap

Summary

• Did the rent get paid? Rent collection and dividend cuts were the primary themes of the most newsworthy and consequential REIT earnings season since the Great Financial Crisis.
• Rent collection was largely a non-issue for residential REITs, who collected over 95% of April rents. Industrial, office, self-storage, and healthcare rent collection metrics were similarly strong.
• Economic shutdowns ravaged the economically-sensitive property sectors and punished highly-levered REITs. 50 equity REITs - primarily retail and lodging REITs - announced a cut or suspension of their dividends.
• 2020 was poised to be a solid year of growth for REITs prior to the pandemic. Even with a faster-than-expected reopening, fundamental metrics are likely to be the weakest since at least 2009.
• Equity and Mortgage REITs have rebounded significantly in recent weeks, but sector-level selectivity remains especially critical. "Essential" sectors like residential, industrial, and technology will bifurcate from troubled sectors.
• This idea was discussed in more depth with members of my private investing community, iREIT on Alpha. Get started today »

Real Estate Earnings Recap

Did the rent get paid? Rent collection and dividend cuts were the primary themes of the most newsworthy and consequential REIT earnings season since the Great Financial Crisis. In this Real Estate Earnings Halftime Report, we break down rent collection statistics for every property sector and analyze the recently released NAREIT T-Tracker data to review the REIT fundamentals over the past quarter and forecast what they could mean for the rest of 2020.

(Hoya Capital Real Estate, Co-Produced with Brad Thomas)

Earnings season is now officially complete for the equity and mortgage REIT sectors with a few late-reporting stragglers reporting results this week. While the real estate sector is far from out of the woods - and several troubled REIT sectors are still very much in the thick of it - REIT earnings season was a pleasant surprise for many investors expecting the worst. Rent collection proved to be largely a non-issue for residential, industrial, and office REITs, as each sector has collected over 90% of April rents. Retail REITs, however, struggled to collect rent from "non-essential" tenants. We detail the rent collection from each individual REIT at the end of the report.

After a historically violent market plunge that saw the Equity REIT ETF (VNQ) dive nearly 45% and the Mortgage REIT ETF (REM) plunged an eye-popping 70% in a month's time, solid rent collection metrics and optimism about a faster-than-expected economic reopening have breathed new life into a sector that was seemingly on its death bed just two months ago with many pundits expecting a repeat of the Great Financial Crisis in which the broad-based REIT indexes plunged roughly 75% from its peak in February 2007 to its trough in March 2009 as seizing credit conditions caught over-extended REITs flatfooted. Equity REITs have rallied 35% from their March 23rd lows while Mortgage REITs have surged 64% from their April 3rd low.

This rebound occurred despite a mounting list of dividend cuts. We've now tracked 50 equity REITs in our universe of 165 names to announce a cut or suspension of their dividends, the vast majority of which have come from the retail and hotel REIT sectors. Apart from their sector affiliations, the equity REITs that have cut or suspended their dividends have been almost exclusively companies in the smallest third of market capitalization within the REIT sector and in the highest third in terms of leverage metrics. Earlier this before the pandemic, we published The REIT Paradox: Cheap REITs Stay Cheap where we encouraged readers to limit exposure to the highest-yielding and highest-leveraged names based on our study of outperforming factors.

Assuming that the coronavirus outbreak continues to moderate and economic reopening plans progress at the recent pace, we think that the worst of the pain as it relates to dividend cuts is probably in the rearview mirror, and we'd wager that at least half of these companies end-up resuming their dividend at some point in 2020. At the beginning of the pandemic, we outlined a framework for analyzing each property sector based on their direct exposure to the anticipated COVID-19 effects as well as their general sensitivity to a potential recession and impact from lower interest rates. Within the COVID-19 sensitivity chart, we note that the vast majority of REITs to succumb to coronavirus dividend cuts have been in the "High" COVID-19 risk category.

REIT Fundamentals Were Steady Heading Into Pandemic

Apart from the retail sector, REITs entered 2020 on a path of steady growth led by the residential, industrial, and technology sectors. REIT metrics generally improved from 2017 through early 2020 as same-store NOI growth actually ticked up to 2.48% in the first quarter from 1.89% in the prior quarter while dividends per share climbed to the highest rate since 2016 even as FFO metrics were weighed down by a sharp decline in reported FFO from retail and lodging REITs. We expect same-store NOI growth to decline by roughly 3-5% in 2020, driven primarily by double-digit declines in the retail sector while FFO and dividend per share growth will likely dip 10-25% before rebounding by a similar amount in 2021, a pullback that's roughly half-as-dramatic as the nearly 40% decline during the GFC.

It's been a story of "haves and have-nots" in the REIT sector over the past half-decade and that bifurcation will surely intensify further 2020. All three of the residential sectors recorded same-store NOI growth of at least 3.6% in the first quarter while industrial REITs recorded similarly strong growth at 4.6% growth. While office REITs delivered a strong Q1, we believe that their long-term outlook took a substantial hit as we usher in a new "work-from-home" paradigm. While all REIT sectors are expected to see at least a modest decline in near-term same-store NOI growth and FFO growth relative to pre-pandemic expectations, declines in the retail, office, and lodging sectors are likely to weigh on the overall REIT index over the next several years.

Occupancy rates ticked down in the first quarter to 93.6%, retreating from the record-highs set in 4Q19, and are expected to pull back at least 200-400 basis points over the next year amid the coronavirus fallout. Residential REITs were the lone sector to record positive quarter-over-quarter occupancy and actually climbed to fresh record-highs in Q1. We forecast that occupancy rates in this NAREIT data series will bottom out at around 90% in early 2021, supported on the upside by resilient occupancy in the residential and industrial sectors, before rebounding back above 92% by 2022. By comparison, occupancy levels dipped as low as 88% during the Great Financial Crisis in 2010.

The historically large REIT development pipeline continues to represent a source of "shadow leverage" that could become a risk in the event of a sustained downturn, and we expect REITs to significantly scale back on in-house development over the next several quarters until the dust settles. Before 2005, only a handful of REITs had in-house development teams, but that has changed significantly over the last decade, and many large REITs are now among the most active real estate developers in the country. The development pipeline ended 1Q20 at roughly $43 billion, pulling back from the $49.2 billion level as of 4Q19. We forecast that we'll see the size of the pipeline in this data set to dip below $30 billion by the end of 2020.

External Growth Will Likely Grind To A Halt In 2020

Before the pandemic, REITs were beginning to get back to doing what they do best: utilizing their access to equity capital markets - one of their primary competitive advantages over private market peers - to accretively grow via external acquisitions and internal development. Somewhat counterintuitively, low equity valuations for REITs (as measured by Net Asset Value discounts or low FFO valuations) tend to be self-reinforcing, making accretive external growth all-but-impossible. We forecast that external growth for the vast majority of REITs will grind to a halt in 2020 given that most REIT sectors now trade sharp discounts to NAV and to post-recession average FFO multiples.

Additionally, uncertainty remains regarding the post-pandemic pricing and liquidity of private-market real estate. Green Street Advisors' Commercial Property Price Index declined by 9.4% in April with prices of every property sector seeing sequential declines over the past month. Transaction volume, however, has been extremely light since the start of the pandemic, making it difficult to gauge private market values. We estimate that hotel and retail assets have likely seen a 10-20% decline in private market values while office and healthcare assets are likely lower by 5-15%. Residential, industrial, and technology real estate prices, we estimate, are roughly flat during this time.

After a lull in external acquisition activity from 2015 through 2018, REITs were back in "external growth mode" by early 2020, powered by a strong year of share price appreciation in 2019. REITs acquired $72.5 billion in assets in 2019 while disposing of $39.5. The $32.9 billion in net acquisitions was the largest annual net "buy" since 2016 and that momentum continued into Q1 during the early stages of the pandemic with REITs acquiring another $4.2 billion in net assets. However, we forecast that REITs will be net sellers by the end of 2020 if share price valuations remain near current levels and forecast that a handful of REITs in troubled sectors are likely to be taken private.

Speaking of M&A activity, the "merger mania" theme of early 2020 that saw a flurry of announcements and countless rumors seems like a distant memory. Two M&A deals that were announced in 2019 have closed this year with Prologis (PLD) closing on its acquisition of Liberty Properties (LPT) in February and Digital Realty (DLR.PK) closing on its acquisition of Interxion (INXN) in March. One deal remains pending - Simon Property's (SPG) ill-timed deal to acquire Taubman Centers (TCO.PK) which was announced in February which is likely to close in July. Meanwhile, Front Yard Residential's (RESI) $2.3 billion acquisition from private equity firm Amherst Residential that was announced in February was terminated in May and there have been no new M&A announcements since the start of the pandemic in late February.

($ amounts in millions)

Access to capital - or lack thereof - was the accelerant that turned a bad situation into a dire one for REITs during the financial crisis. Many REITs were forced to raise capital at firesale valuations during the Great Financial Crisis to stay afloat, resulting in substantial dilution to equity shareholders and contributing to the roughly 70% plunge in the Equity REIT ETF during that time. REITs entered this period of volatility with a "war chest" relative to their position in 2008 as REITs raised more capital in 2019 than in any prior year since the recession. While still relatively "early" in the pandemic-induced recession, few REITs have had to raise capital since the start of the pandemic, a good indication that a repeat of the GFC appears unlikely at this point.

Sadly, the REIT IPO pipeline is likely to remain stagnant in 2020 given the unfavorable market environment and steep NAV discounts. Just two REITs, Postal Realty Trust (PSTL) and Alpine Income Properties (PINE) went public last year, raising a combined $250 million in equity and This quiet year for REIT IPOs comes after five REITs went public in 2018, the largest two being casino REIT VICI Properties (VICI) and cold storage operator Americold Realty (COLD). IPOs in the major property sectors have been few and far between over the past half-decade. Before the COVID-19 outbreak, we had expected an uptick in IPOs in 2020 but may not see any IPOs until 2021.

Rent Collection In the "Essential Sectors"

Apartments REITs collected 96.2% of April rents. Two REITs reduced their dividends: Preferred Apartments (APTS) and Independence Realty (IRT).

Manufactured Housing REITs collected 97.0% of April rents while Single-Family REITs collected 95.0%. No REIT reduced its dividend.

Healthcare REITs collected 96.1% of April rents. Four REITs reduced or cut their dividends including Welltower (WELL) and Sabra Healthcare (SBRA).

Storage REITs collected 94.6% of rents. No storage REIT cut its dividend.

Industrial REITs collected 91.7% of April rents. No REIT cut its dividend.

Office REITs collected 92.1% of April rents. Three REITs cut their dividends: City Office (CIO), Armada Hoffler (AHH), and American Assets (AAT).

Rent Collection In the "Non-Essential Sectors"

Mall REITs collected 22.0% of April rents. All mall REITs besides Simon Property (SPG) and Brookfield Property (BPY) suspended their dividends.

Shopping Centers REITs collected 59.4% of April rents. Eight shopping center REITs cut their dividend including Kimco (KIM), and Brixmor (BRX).

Net Lease REITs collected 73.0% of April rents. Four REITs cut dividends including EPR Properties (EPR) and VEREIT (VER).

Hotel REITs reported occupancy of 59.4% in Q1, a drop of nearly 18 percentage points, and April occupancy averaged roughly 20% among those that reported. All hotel 18 REITs slashed their dividends.

Technology Sector Performance

Cell Tower REITs are one of two sectors in positive territory this year and rent collection has never been in question. No REIT cut dividends last quarter.

Data Center REITs reported the second-highest quarter for incremental annualized leasing revenue metrics at $169 million. No REIT cut dividends.

Mortgage REIT Earnings Recap

Residential mREITs were the hardest-hit real estate sector during the depths of the pandemic, but have seen conditions stabilize considerably in recent weeks amid signs of stabilization in the mortgage markets. Residential mREITs are still lower by 40% in 2020 but have rallied more than 50% from their early-April lows. These REITs reported an average decline in tangible book value of 33% from last quarter, driven primarily from losses on hedges and/or "forced selling" events rather than impairments to their underlying residential mortgage portfolio. BV declines either matched or were less than the interim updates provided by most mREITs with several REITs reporting material increases in BVs since the end of the first quarter.

Helping to power the gains in the mREIT sector over the last two months has been data showing a "stunning" rebound in housing market activity, perhaps the most critical sector of the U.S. economy. Consistent with the trends that we discussed last week in Signs of V-Shaped Housing Recovery, the Mortgage Bankers Association reported this week that home purchase mortgage applications rose for the 6th straight week and are now 9% higher from the same week last year compared to the 35% decline in early April. This follows data last week from Redfin (RDFN) which showed that homebuying demand is now 16.5% above pre-coronavirus levels while Zillow (Z) reported a 50% surge in pending home sales over the last month and that activity on their site is back to pre-pandemic levels.

Commercial mREITs weren't facing the same "existential crisis" as their residential mREIT peers, but the sector's heavy exposure to the hotel, office, and retail sectors has dragged on performance during the pandemic even as these REITs reported a far-more-modest 7% average decline in tangible book value from last quarter. Commercial mREITs remain lower by 37% in 2020 despite their roughly 50% rally from their lows in April. Hannon Armstrong (HASI), which focuses on infrastructure assets, was the lone mREIT in either sector to report a positive change in tangible book values from 4Q19 to 1Q20.

Key Takeaways From An Eventful REIT Earnings Season

Rent collection and dividend cuts were the primary themes of the most newsworthy and consequential REIT earnings season since the Great Financial Crisis. While the real estate sector is far from out of the woods - and several troubled REIT sectors are still very much in the thick of it - results were generally a pleasant surprise for many investors, helping to add fuel to the "reopening rally" over the last two months and bring the real estate sector back to levels seen in early 2019 before last year's "REIT Rejuvenation."

That said, economic shutdowns ravaged the economically-sensitive property sectors and punished highly-levered REITs which composed the vast majority of the 50 equity REITs that announced a cut or suspension of their dividends. We believe that sector-level selectivity will become especially critical as "essential" sectors like residential, industrial, and technology will bifurcate further from the troubled retail, hotel, and office sectors. We believe that employing a targeted asset allocation approach through the utilization of sector-focused real estate ETFs or individual stock selection will be especially important in the early stages of the post-pandemic recovery.

If you enjoyed this report, be sure to "Follow" our page to stay up to date on the latest developments in the housing and commercial real estate sectors. For an in-depth analysis of all real estate sectors, be sure to check out all of our quarterly reports: Apartments, Homebuilders, Manufactured Housing, Student Housing, Single-Family Rentals, Cell Towers, Healthcare, Industrial, Data Center, Malls, Net Lease, Shopping Centers, Hotels, Billboards, Office, Storage, Timber, Prisons, and Real Estate Crowdfunding.

Disclosure: I am/we are long HOMZ, AMT, ARE, AVB, BXMT, DRE, DLR, EFG, EQIX, FB, FR, MAR, MGP, NLY, NHI, NNN, PLD, REG, ROIC, SBRA, SPG, SRC, STOR, STWD, PSA, EXR, AMH, CUBE, ELS, MAA, UDR, SUI, CPT, NVR, EQR, INVH, ESS, AVB, PEAK, LEN, DHI, HST, AIV, MDC, ACC, PHM, TPH, MTH, WELL. 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.