The State Of REITs: August 2020 Edition

Summary

• After a recent rally, the REIT sector faded back slightly in July, averaging a -1.31% total return.
• Large cap REITs led with a solid return of 5.13%, while micro caps badly underperformed with an average return of -9.38%.
• 46.11% of REIT securities had a positive total return in July.
• Timber and Data Center REITs led all property types in July, while Hotels and Shopping Centers suffered the largest declines.
• Large cap REITs have outperformed small caps by 28% over the first seven months of 2020.

REIT Performance

With July’s -1.31% average total return, the REIT sector has now seen monthly losses in 5 of the first 7 months of 2020. REITs have endured an average loss of -23.58% over the first seven months of 2020. The REIT sector underperformed the NASDAQ (+6.82%), S&P 500 (+5.51%) and Dow Jones Industrial Average (+2.38%) in July. The market cap weighted Vanguard Real Estate ETF (VNQ) significantly outperformed the average REIT in July (+3.64% vs. -1.31%) and has suffered much smaller losses year-to-date (-12.29% vs. -23.58%). Due in large part to the decline in share prices of small cap hotels with negative consensus FFO/share, the spread between the 2020 FFO multiples of large cap REITs (22.3x) and small cap REITs (8.7x) narrowed in July as multiples rose an average of 0.5 turns for large caps and 2.0 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.

Source: Graph by Simon Bowler of 2^nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article

Large cap REITs (+5.13%) saw the largest recovery in July and mid caps (+2.38%) also solidly outperformed. Micro caps (-9.38%) and small caps (-3.68%) added to their already brutal 2020 losses in July, falling further behind their larger peers. Year to date there has been a very strong correlation between total return and market cap size. Large cap REITs (-5.33%) have thus far in 2020 outperformed micro caps (-38.86%) by more than 3300 basis points.

Source: Graph by Simon Bowler of 2^nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article

10 out of 20 Property Types Yielded Positive Total Returns in July

50% of REIT property types averaged a positive total return in July, with a 25.2% total return spread between the best and worst performing property types. Timber (+14.68%) and Data Centers (+11.06%) had the best average returns. All 4 Timber REITs achieved double-digit positive returns in July led by Weyerhaeuser (WY) with a return of 23.82%. Lumber prices soared in July, bouncing back to above pre-pandemic levels due to heavy construction from homebuilders as well as a huge spike in home remodeling. This is providing a strong tailwind to the recovering Timber REITs, which could continue for some time. Lumber futures surged to a record high during the first week of August as lumber demand remains extremely robust.

Hotels (-10.52%) was the worst performing property type in July as business travel remains at unprecedentedly low levels and leisure travel has only marginally recovered. Even as businesses have been allowed to reopen and people have started to resume more of their normal activities, few have begun traveling again due to fear of Covid-19. Additionally, the economic collapse that occurred when governors around the nation mandated the closure of most businesses for multiple months has left many people without a job or with far less money to be used for travel. The Hotel REIT that has been hardest hit has been Ashford Hospitality (AHT), which fell 45.75% in July and now has a dismal -85.95% return year to date. Ashford’s debt was already dangerously high prior to this pandemic and now with revenues severely depressed the risk of insolvency has grown greater.

Source: Table by Simon Bowler of 2^nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article

Infrastructure (+32.96%), Data Centers (+24.38%), Land (+18.90%) and Industrial (+8.66%) are the only REIT property types that remain in the black after the first seven months of 2020. Hotels (-58.86%) and Malls (-53.05%) continue to underperform all other property types year to date. 80% of REIT property types have averaged a negative return, with 60% reaching a double-digit negative return thus far this year.

Source: Table by Simon Bowler of 2^nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article

The REIT sector as a whole saw the average P/FFO (2020) rise 1.1 turns during July (from 12.2x up to 13.3x). The average FFO multiples rose for 50% of property types, fell for 45% and held steady for 5% in July. Infrastructure (28.0x) continues to trade at the highest average multiple of all property types followed by Manufactured Housing (27.3x). Hotels (-5.4x) are trading at a dismal double-digit negative FFO multiple as the hotel sector continues to be severely impacted by fears of Covid-19. Malls (4.7x), Corrections (4.5x) and Shopping Centers (8.6x) are the only property types trading at a positive single digit multiple.

Source: Table by Simon Bowler of 2^nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article

Performance of Individual Securities

Ashford Hospitality Trust had the lowest total return (-45.75%) of all REITs in July, a month full of capital structure maneuvers and dismal earnings for the struggling hotel REIT. AHT kicked off the month by announcing a 1-for-10 reverse stock split. This was followed by an exchange offer less than 3 weeks later in which preferred shares could be swapped for 2.64 common shares or for a mix of cash and common shares. On July 29^th, AHT released shockingly bad Q2 2020 earnings, posting FFO/share of -$12.32. This fell far short of the already dismal -$6.8 FFO/share consensus. July’s sharp price drop pushed Ashford’s year-to-date performance down to -85.95% overtaking CBL Properties (CBL) as the worst performing REIT of 2020.

Corepoint Lodging (CPLG) outperformed the REIT sector in July with a strong +32.78% return. This upward spike in share price was in sharp contrast with the vast majority of the hotel sector of which 15 of 18 REITs had a negative July return. This comes after CPLG outperformed hotel peers in June as well (+6.31% vs. -2.95%). Despite back-to-back recovery months, CPLG remains far below where it began the year but somewhat less beaten down than peers (-44.83% vs. -58.86%).

46.11% of REITs had a positive return in July and only 19.34% are in the black year to date. During the first seven months of last year, the average REIT had a solid +20.80% return, whereas this year the average REIT has seen a dreadful total return of -23.58%.

For the convenience of reading this table in a larger font, the table above is available as a PDF as well.

Dividend Yield

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 07/31/2020) 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.

Source: Table by Simon Bowler of 2^nd Market Capital, Data compiled from SNL.com. See important notes and disclosures at the end of this article

Valuation

NAV Data as of July 31^st, 2020

The REIT sector median discount to Net Asset Value narrowed yet again in July from -17.3% to -14.2%.

Data Centers REITs continue to trade at the largest premium to NAV, seeing their median NAV premium rise from 18.7% to 29.1% during July. Self Storage began the month of July trading at a discount to NAV, but ended the month at a slight premium (+2.9%). Malls (-46.9%) and Shopping Centers (-41.7%) remain at the largest NAV discounts. This reflects expectations of further NAV erosion as the struggles that brick-and-mortar retail already faced in recent years have been magnified by the pandemic and resulting government-imposed lockdowns. Community Healthcare Trust (CHCT) saw a double digit percentage gain in share price during July with little change in consensus NAV and continues to trade at the largest premium (+85.5%) of all REITs.

Mall REIT Macerich (MAC) is again trading at the largest discount to NAV (-67.2%). MAC overtook Paramount Group (PGRE) as the most discounted REIT after Macerich’s share price dropped sharply (-14.94%) in July. Fellow mall REIT Pennsylvania REIT (PEI) continues to hold the dubious honor of being the only REIT with a negative consensus NAV. PEI trades at $1.18/share, but has an NAV of -$3.36/share. The negative impact of the economic shutdown was disproportionately magnified for PEI due to excessive leverage and heavy exposure to Pennsylvania, a state with more severe lockdown policies than most.

REIT Premium/Discount to NAV by Property Type

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. A statistical anomaly arose in the data this month and is reflected in this table. The NAV discount of PEI at the end of July was -135.12%, which is mathematically accurate when applying the traditional NAV premium/discount formula, but actually reflects a substantial premium given that PEI now has a negative consensus NAV and positive share price.

For the convenience of reading this table in a larger font, the table above is available as a PDF as well.

Takeaway

The large cap REIT premium (relative to small cap REITs) significantly increased during 2019 and has further expanded during the first seven months of 2020. Investors are now paying on average over 2.5 times as much for each dollar of 2020 FFO/share to buy large cap REITs than small cap REITs (22.3x/8.7x - 1 = 156.3%). Excluding hotels, whose earnings have been decimated by both the government-imposed economic shutdown as well as fears of the coronavirus, the small cap REIT average FFO multiple is 11.3x and the large cap REIT premium is 89.6% (22.3X/11.3X – 1 = 97.3%). 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. After a strong July, large cap REITs (+5.38%) on average trade at a premium to NAV for the first time since February. Mid cap REITs (-5.43%) are also trading at their smallest discount to NAV since February. Small cap REITs (-17.52%) trade at a moderate average discount, whereas micro caps average a brutal -41.57% discount to NAV.

The percent of rent collected by REITs that report rent collection figures continued to improve in July. Casino REIT VICI Properties (VICI) led with 100% rent collection, followed by Alexandria Real Estate Equities (ARE) (99.3%), Gladstone Commercial (GOOD) (99%), Highwoods Properties (HIW) (99%), Gaming and Leisure Properties (GLPI) (99%) and Four Corners Properties Trust (FCPT) (99%). The fact that VICI has continued to receive 100% of rent every month despite the government mandated closure of most of their properties demonstrates the value of a strong triple net lease and the importance of having tenants with good balance sheets. Rent collection by shopping center REITs remains below that of non-retail peers, but meaningfully improved in July over Q2 collections.

Despite this strong improvement in REIT fundamentals, the average REIT failed to attain a positive total return in July. This was due largely to the major headwind of heavy sector rotation out of REIT ETFs and into gold and bond ETFs. REIT ETFs suffered more than $2 billion of net outflows in July. This was nearly as brutal of an exodus from REIT ETFs as was seen in March (-$2.07B vs. -$2.15B). Year to date, REIT ETFs have seen over $5 billion of net outflows.

This rampant selloff of REIT ETFs results in widespread indiscriminate selling of the individual holdings of these ETFs. This can result in mispricing as these securities are being sold due to sector rotation out of REITs rather than based upon the fundamentals of each individual company. This creates opportunities for investors to scoop up quality REITs at unwarranted discounts. By carefully analyzing REIT data and industry trends, active investors have the opportunity to outperform ETFs.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I am/we are long GOOD. 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.

2nd Market Capital and its affiliated accounts are long GOOD. I am personally long GOOD. This article is provided for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer. Information contained in this article is impersonal and not tailored to the investment needs of any particular person. It does not constitute a recommendation that any particular security or strategy is suitable for a specific person. Investing in publicly held securities is speculative and involves risk, including the possible loss of principal. The reader must determine whether any investment is suitable and accepts responsibility for their investment decisions. Simon Bowler is an investment advisor representative of 2MCAC, a Wisconsin registered investment advisor. Positive comments made by others should not be construed as an endorsement of the writer's abilities as an investment advisor representative. Commentary may contain forward looking statements which are by definition uncertain. Actual results may differ materially from our forecasts or estimations, and 2MCAC and its affiliates cannot be held liable for the use of and reliance upon the opinions, estimates, forecasts and findings in this article. Although the statements of fact and data in this report have been obtained from sources believed to be reliable, 2MCAC does not guarantee their accuracy and assumes no liability or responsibility for any omissions/errors.