Almost 90 days ago I wrote an article titled “Cash Is King” that generated over 479 comments and over 35,000 page views. In case you missed it, here are a few nuggets from that article:
- Our primary objective is to be tactical REIT investors and that means we will not be rushing out to deploy capital just to get exposure to cheap REITs.
- We will be stress testing each prospective REIT in granular detail to determine whether it's worthy of ownership.
- Now is not the time to become a high-yield REIT investor, always focus on nothing less than quality, quality, quality.
In that same article, I explained that we were debuting the all-new Cash Is King Portfolio that follows that same philosophy. I wrote,
“Future investment decisions should be made on data, not emotions. The only way to navigate these periods with sanity and resilience is to have a very long-term view.”
I don’t know about you, but the last 90 days have been stressful, as I have been working mostly at home, up until my recent decision to travel to the office for a few hours a day. However, in a recent blog post I explained,
“Although all of us are paying the price of sheltering in place (i.e. cabin fever), there are obvious benefits, and by taking advantage of the irrational market behavior, we have been able to generate significant alpha.”
As you may recall, we put together a simple property sector risk model to demonstrate the lowest and highest risk categories. For the most part, we have adhered to sticking with property sectors that were either in the yellow (medium risk) and green (lower risk) categories:
Over the last 30 days, as the U.S. economy has begun to thaw out, and we have gained more clarity as it relates to certain property sectors such as healthcare, restaurants, and student housing. Yet, we are still fearful of other sectors such as lodging, malls, theaters, and offices. (Stay tuned for my next article on 3 of the most dangerous property sectors).
The purpose for our new Cash is King portfolio is to generate above-average returns as it relates to mispricing and the “temporary” impact on certain business models. However, we also must be careful not to get too excited to jump into certain property sectors based on enthusiasm.
Regardless of Covid-19, our stock selection criteria have not wavered, as we are always analyzing companies based on their fundamentals. Although certain REITs have seen a temporary decline in earnings, despite rent impairments in some sectors, most leases remain in force, providing resilience to REIT earnings.
Cohen & Steers estimates that “global REIT earnings will decline about 4% in 2020—a historically bad outcome for real estate, but far better than the 25% earnings decline expected for companies in the MSCI World Index.”
Since we began to put capital to work in the Cash is King portfolio, we purposely avoided the property sectors that are slowest to recover. That’s not to say that we will not eventually get back into them, but we recognize that the key to avoiding landmines is to adhere to our time-tested quality scoring model.
And one of the best ways for us to screen for quality stocks – REITs or otherwise – is to consider the companies' cash flow, Cohen & Steers “believes REITs have two to three years of liquidity on average, though some of the higher-leveraged or more cyclical companies may require equity infusions.”
In fact, as one of the cofounders of Dividend Kings, I have learned that there is a strong correlation to Dividend Kings (50+ years in a row of dividend increases) and Cash Flow Kings. As my friend and co-founder of Dividend Kings always says,
“Earnings growth determines Market Price in the long run."
5 REITs That Have Generated An Average Of 77% In Less Than 90 Days
In a recent blog I explained that “since inception (early March) shares in the new Cash Is King Portfolio has returned 41.47%.” Here’s a snapshot of that portfolio compared with the REIT ETF proxy, Vanguard Real Estate ETF (VNQ).
This portfolio now has 26 REITs weighted significantly with Net Lease, Healthcare, and Commercial Mortgage. However, the portfolio composition includes shopping centers, data centers, self-storage, campus housing, lodging, industrial, and other.
Here are the 5 top-performing picks:
As you can see, these REITs include:
- Ladder Capital (LADR): +114.0%
- Four Corners Property Trust (FCPT): +78.7%
- Essential Properties (EPRT): +66.9%
- Ventas, Inc. (VTR): +63.5%
- Hannon Armstrong (HASI): +53.21%
Let’s take a quick look at each of these picks in order to provide you with the details as to why we included them in the portfolio and why we were not fearful to deploy capital during these turbulent times.
Climbing the Ladder
Ladder Capital is a commercial mortgage REIT that has been extremely volatile over the last 90 days. Since the beginning of the pandemic, shares fell as low as 79% (to around $3.00) and since have rallied by over 100% (latest price of $8.57). But a lot has happened over the last 90 days, so I’ll provide a recap:
January 16th: LADR raised $750M of 4.250% senior notes due 2027 in a private placement, the largest single-tranche senior notes offering issued in the commercial mortgage REIT sector since LADR started in 2008.
March 13th: Billionaire investor Carl Icahn said his largest short position is in commercial real estate.
March 16th: LADR files to renew its $100M at-the-market program (note: Seeking Alpha originally posted the article as a new equity raise, and that was incorrect)
March 22nd: Tom Barrack warns on collapse of commercial mortgage market
April 2nd: A Bloomberg headline reports LADR as having retained Moelis & Co. for strategic advice. LADR took margin call and provides liquidity report with more than $300 million of cash after paying its quarterly dividend.
Now, since that time LADR has made several strategic moves to bolster its liquidity position including:
- Sold $170 million of loans for ninety-six cents on the dollar.
- Including $300 million referenced above, LADR had $470 million in cash
- Repaid $203 million of maturing loans and cost reduction efforts that will result in annualized savings of approximately $3 million.
- Largest loan of $150 million was paid off
- Goldman Sachs underwrote a commercial real estate collateralized loan obligation (or CLO) comprising ~$500M of loans at ~65% advance rate on a matched-term, non-recourse, and non-mark-to-market basis. (+~$200 million of liquidity).
All of these initiatives generate around $1 billion in liquidity.
Then, as an abundance of caution, LADR lands deal with Koch Industries' real estate investment arm to provide new debt financing to bolster its balance sheet. Koch provided LADR with a $200 million senior secured credit facility backed by existing loans and not linked to mark-to-market pricing.
The credit facility from Koch gives LADR extra flexibility to work with existing borrowers by easing near-term pressure on underlying loan collateral.
This means that since April 1st, LADR has managed to use its over $1 billion of liquidity to pay off debt ($600 million Home Loan Bank) and retain close to $870 million in cash.
Of course, last week LADR also decided to rightsize its dividend from $.34 per share to $.20 per share (a 41.2% decline). Shares are now yielding 9.0%.
The dividend cut was obviously priced in and analysts forecast LADR to generate an average of $.72 in core earnings in 2020 (-55%) and $.97 per share in 2021 (+35%).
Source: Yahoo Finance
Quality Rent Checks Keep Coming In
Four Corners Properties Trust is a Net Lease REIT that has also seen substantial price volatility, shares were down by more than 50% when we decided to jump in. While many of the high yield investors were chasing EPR Properties (EPR), we explained that we were “steering clear of EPR and recommending Four Corners Property Trust instead."
Four Corners is the only public net-lease REIT focused primarily on the acquisition and ownership of restaurant properties. The company started when Darden Restaurants (DRI) spun off 418 restaurants across five brands and the company (now owns 426 Darden properties and 273 others under additional brands).
As I explained in late March “FCPT’s portfolio of tenants is 72% investment-grade by annualized base rent, with positive operating trends. And it has the second-strongest tenant earnings before interest, taxes, depreciation, amortization, and restructuring (EBITDAR)-to-rent coverage (of 4.8x) in the net lease REIT sector.”
Now that’s where the “cash is king” concept comes into play, in another article I explained that “FCPT collected 89% of rent in April and 83% of May’s rent as of the 6th. Given its large exposure to Darden, we’ll admit we did expect to see above-average rent collection.”
I added that “seven analysts estimate FCPT will grow FFO per share by 6% in 2020. That figure has dropped by just $0.01 per share over the previous 30 days, suggesting that FCPT is likely to maintain a large majority of its rental collection.”
Give the extraordinary price appreciation we have since dropped the “Strong Buy” rating, and as I pointed out, “there’s more clarity regarding Darden’s liquidity, the U.S. economy opening back up, and America’s hunger for high-quality dividend growth stocks like FCPT.”
Source: Yahoo Finance
An Essential Net Lease Pick
Essential Properties Trust is another Net Lease REIT and also happened to be our #1 REIT pick in 2019. As I explained back in December 2019,
“EPRT was a perfect selection for our New Money Portfolio strategy as we were able to capitalize on the margin of safety concept that resulted in extraordinary returns in 2019.”
Fortunately, we sold out of the position before Covid-19, and now we find the company in our all-new Cash Is King Portfolio. In a recent article I explained,
“…we believe that EPRT is poised to generate exceptional returns over the next few months. We are initiating a Strong Buy based upon our projected 12-month forecast that shares could return in excess of 25%. We’re adding EPRT to our Cash is King portfolio.”
Again, make all of our decisions based on fundamental analysis, so let me walk you through our reasoning (source):
- EPRT has a completely different platform than EPR as the company focuses on smaller-box properties (averaging $2 million) with alternative uses and well-located real estate with at or below market rents.
- EPRT has a much more diversified portfolio in which the top 10 tenants produce 23% of total revenue (compared with EPR that generates 65% of revenue with top 10 customers).
- We believe that there’s a very good chance that EPRT gets back to full recovery as the portfolio is newly assembled with long duration leases with solid unit-level rent coverage.
- EPRT could pay dividends for over four years without any rent checks whatsoever
- EPRT has low leverage and this makes the dividend more sustainable than many of the net lease REIT peers.
- We consider EPRT the very best net lease REIT to buy today given the fact that the portfolio is purpose-built to mitigate risk factors.
Source: Yahoo Finance
The Ventas Advantage
Ventas, Inc. is a large-cap S&P 500 diversified healthcare REIT that has outsized exposure to senior housing properties, a segment that remains challenged as occupancy declines and expenses increase with no Federal Aid forthcoming as of yet.
Although we recognize that Ventas is a higher risk REIT due to its senior housing rent coverage ratios, we opted to take a position in the company due to its diversified model that includes MOBs (medical office buildings) and Life Science properties.
We thought by now Ventas would have cut the dividend as a measure to preserve its $3.2 billion war chest of cash.
In Q1-20 occupancy was 86.6% (with SHOP Opex expected to increase by 10%); however, the company collected 96% of rent from MOB, all rent from NNN Healthcare, and offered a 25% deferral for NNN Sr. Housing tenants.
Management seems rather guarded as it relates to the dividend and I suspect that the company will make that decision sometime in June. The company’s closest peer, Welltower (WELL) cut the dividend by 30% that will save around $110 million per quarter.
Source: Yahoo Finance
One of the Most Predictable Names
Our final “top 5” Cash is King pick is Hannon Armstrong and in terms of cash flow, we find this particular REIT one of the most predictable payers in our coverage spectrum. You may recall an article we wrote in early April explaining,
“…we are including HASI in our recently announced "Cash is King" portfolio that makes this our ninth pick within the last two weeks. We see strong potential with this name given its highly defensive drivers and repeatable sources of income.”
In that same article I explained,
“From a liquidity standpoint, the aggregated commitment for the firm's lenders is $450 million and is in addition to the existing ATM equity issuance program. While some REITs are being forced to cut distributions and negotiate with lenders due to a credit crunch, Hannon Armstrong is not among them.”
What caught my attention is the fact that HASI’s dividend yield of 6.9% was “higher than any other point in HASI's publicly-traded history outside of a short period following its initial public offering.”
The yield is now 4.63% and this means that the share price has moved up quite a bit since we added to the Cash is King Portfolio on April 10th.
Source: Yahoo Finance
As a REIT analyst, my objective is to always think long-term, and avoid trying to take short cuts. Many people think that the fastest way to obtain the best returns is by short-term trades. Not me.
When I began my career as a real estate investor, over thirty years ago, I learned that real estate is a long-term strategy. By doing the necessary due diligence and obtaining the strongest sources of cash flow, I was able to generate a net worth in excess of $15 million before I was 35 years old.
I remember building my very first shopping center. I secured the land and began to assemble the strongest tenants that would survive and allow me to generate high-quality income to last.
That shopping center is around 25 years old now and there has been only two vacancies since then. And the tenants that are no longer there have been replaced by stronger tenants (location, location, location).
That’s precisely how I look to build REIT portfolios.
My objective is to seek out powerful sources of income in which the company has strong competitive advantages. The sharper the differentiation, the stronger the competitive advantage, and as Benjamin Graham explained.
“It is the consistency in the products that creates consistency in a company’s profits. Consistency and durability are attributes for competitive advantage.”
So now you have it, and it should be no surprise, that cash flow is king!
Mr. Market obviously panicked in early March and we took advantage of the opportunity to create significant wealth by adhering to the principles of fundamental analysis. After all, REITs are simply securities that are used to generate equity to invest in real estate.
Although Mr. Market did not provide a value for the above-pictured shopping center (I developed), he does provide stock values in real-time that oftentimes reflect his mood of the minute. But as Warren Buffett explains,
"...like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to ignore him or to take advantage of him, but it will be disastrous if you fall under his influence."
Well, the Cash is King portfolio is +44% in less than 90 days...so I would say that we were able to take advantage of Mr. Market. And we will continue to screen for high-quality REITs worthy of ownership.
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.
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