3 REITs That Could Rise Significantly In The Recovery

Jun. 16, 2020 8:25 AM ETMAC, MHIVF, SPG, SPG.PJ, SPY, VNQ, WELL, CXW, IVQ:CA, IVQ.U:CA80 Comments

Summary

  • Coming out of the 2008-2009 financial crisis, REITs nearly tripled in just two years.
  • Today, many REITs trade at even lower valuations when compared to back then.
  • We present three deep value opportunities that have 100%-200% upside potential in the recovery.
  • Looking for a portfolio of ideas like this one? Members of High Yield Landlord get exclusive access to our model portfolio. Get started today »

REITs dropped much more than the rest of the market (SPY) earlier this year as we entered the first bear market in 10 years. At the lowest point, REITs (VNQ) were down by as much as 43%:

Chart

Was this drop justified?

Turns out that it wasn't and the market quickly recognized that. In just a few months, the REIT market already has recovered half of its losses:

ChartThose who sold off in March lost a fortune. On the other hand, those who added to their investments have been richly rewarded.

At High Yield Landlord, we have executed 15 phases of buying (which we share with members in Trade Alerts) since the beginning of the bear market. In each phase, we accumulated more shares of our favorite ~20 REIT investment opportunities.

Most of these investments are up significantly over the past weeks, and it has led many members to ask us on the chat:

Is it too late to buy more REITs?

The answer is that it depends. Not every REIT is worth buying anymore at this point. The VNQ has repriced at a 4% dividend yield and ~18x FFO. This is not very expensive, but it's not exceptionally cheap either.

However, there are still some generational buying opportunities in certain sub-sectors of the REIT market. Yes, prices have somewhat recovered, but we are still far from the pre-COVID-19 levels, and therefore, we will continue to buy week-after-week with great discipline.

Coming out of the great financial crisis, REITs nearly triple in just two years:

Believe it or not, some REITs are today even cheaper than back then. Below we discuss three of our most opportunistic holdings that have the potential to double or triple in the coming years as market conditions normalize.

Macerich:

We reticently bought another 70 shares of Macerich (MAC). MAC is our largest mall investment and it specializes in the most urban class A malls in the nation:

source

At the current prices, MAC has by far the most upside potential in our Core Portfolio. Based on conservative 6% - 7.5% cap rates, MAC's net asset value per share is $30-44.

Just a few years back, its NAV was estimated at ~$90 per share based on more aggressive cap rate assumptions and Simon Property Group (SPG) even made an offer to buy out MAC at $95.50 per share. That was in 2016 and since then, the average sales and rents have grown even further at MAC properties.

Yet, today's share price is just $9. MAC is highly leveraged and therefore, it was hit especially hard by the pandemic and the resulting economic shutdown.

However, we believe that MAC has enough liquidity to survive the storm and it is already reopening many of its properties. We are confident that these highly urban class A malls will recover and thrive again.

Priced at 20 cents on the dollar based on conservative NAV estimates, MAC is a no brainer if you believe in the recovery of class A malls.

Invesque:

We also bought another 250 shares of Invesque (OTC:MHIVF). Invesque is our smallest healthcare REIT investment and it owns a diversified portfolio of new-built senior housing, skilled nursing, and medical office properties:

source

Invesque has great management and attractive assets. However, it has one major issue: Its balance sheet is overleveraged with a high 60% Loan-to-Value, which leaves little margin of safety.

The recent crisis is impacting its properties by delaying move ins, lowering occupancy, and increasing property expenses. The leverage was high when things went well in 2019 and so you can imagine that now in 2020, the situation has become very risky.

Why would we then invest?

If Invesque can merely survive, which we think it will, it would be set for 100%-200% upside potential as it fixes its balance sheet and market conditions return to normal.

Currently, the company is priced at just 25% of its estimated NAV, or put differently, a 75% discount to NAV. And this is based on true market transactions. Invesque exchanged units of its company against properties in a private transaction in 2019. The units were issued at $9.75 per share, reflecting its estimated NAV at the time. Today, the shares trade at just $2.7. Even if it doubled, it would still trade at a massive discount to NAV.

Will Invesque survive and recover?

It has six factors working in its favor:

  • (1) Mostly Net Lease Assets: ~60% of its assets are leased on a triple net basis with 13 year leases on average and no maturities in the coming four years. These are some of the newest built assets in its peer group. It continues to provide consistent cash flow and rent collection has been near 90% thus far.
  • (2) Limited Maturities and Bank Leniency: Most of its debt has a long maturity and just 14% of it will mature in the coming three years. Moreover, banks have showed their willingness to work with landlords to avoid a repeat of the 2008-2009 crisis. Even highly-leveraged hotel REITs have received covenant viewers to avoid technical defaults.
  • (3) Cash Flow Retention: Unlike traditional REITs that are forced to pay a dividend to maintain their favorable tax status, Invesque is not officially structured as a REIT, and therefore, it can retain all its cash flow to boost liquidity. In this particular situation, it's a big advantage that's often overlooked. Invesque can fix its balance sheet with its own cash flow.
  • (4) Drastic Cost Cutting: The management has aggressively cut cost on many fronts, including their own compensation to retain liquidity. They also deferred non-essential capital expenditures.
  • (5) Good Alignment of Interest: Scott White, the CEO of the company, owns more than 200,000 shares which were valued at several millions. I bet he's motivated to see that money grow again. The second largest shareholder, Magnetar Capital, is a famous hedge fund that specializes in alternative real asset investments. They own 25% of the equity and make sure that the management remains focused on long term value maximization.
  • (6) Strong Track Record: Before launching Invesque, the management led HealthLease Properties from IPO until its merger with Welltower (WELL). Investors earned ~70% in just over two years:

source

For all these reasons, we believe that Invesque has the right leadership and asset base to survive the storm despite being tight on liquidity. The recent measures to preserve liquidity and the bank's leniency also are essential to the thesis.

While there's ~200% upside potential, we want to emphasize again that this is a high risk situation and we only recommend a small position as part of a diversified portfolio. We are planning to interview the CEO for High Yield Landlord sometime in the coming weeks.

Core Civic:

Core Civic (CXW) is a specialty REIT that specializes in government properties, mostly private prisons:

source

CXW offers arguably the safest 15% dividend yield in the REIT market:

  • Strong coverage: The dividend payout ratio is 75% pre-crisis. The payout ratio will go up a bit in 2020 due to increased cost, but it's safely covered, and has even been growing in the past years.
  • Recession-Proof: Whether the economy is booming or collapsing, the need for prisons and rehabilitation centers does not go away.
  • Government Backed: CXW does not have to worry about defaulting leases because of the high credit of its partners.

Why so cheap then?

Private prisons are controversial investments with significant political risk. Moreover, the virus spreading inside its facilities could be a risk for CXW and expose it to lawsuits if no proper precaution is taken.

We believe that these risks are more than priced in and that the shares are overly discounted at 6x FFO. We are currently working on a detailed article which we will publish for members next week.

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This article was written by

Jussi Askola profile picture
55.18K Followers
Become a “Passive Landlord” with our 8% Yielding Real Estate Portfolio.

Jussi Askola is a former private equity real estate investor with experience working for a +$250 million investment firm in Dallas, Texas; and performing property acquisition in Germany. Today, he is the author of "High Yield Landlord” - the #1 ranked real estate service on Seeking Alpha. Join us for a 2-week free trial and get access to all my highest conviction investment ideas. Click here to learn more! 

Jussi is also the President of Leonberg Capital - a value-oriented investment boutique specializing in mispriced real estate securities often trading at high discounts to NAV and excessive yields. In addition to having passed all CFA exams, Jussi holds a BSc in Real Estate Finance from University Nürtingen-Geislingen (Germany) and a BSc in Property Management from University of South Wales (UK). He has authored award-winning academic papers on REIT investing, been featured on numerous financial media outlets, has over 50,000 followers on SeekingAlpha, and built relationships with many top REIT executives.


DISCLAIMER: Jussi Askola is not a Registered Investment Advisor or Financial Planner. The information in his articles and his comments on SeekingAlpha.com or elsewhere is provided for information purposes only. Do your own research or seek the advice of a qualified professional. You are responsible for your own investment decisions. High Yield Landlord is managed by Leonberg Capital.

Disclosure: I am/we are long MAC; CXW; MHIVF; 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.

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