Best REITs On Sale

Summary

• Investors have been so excited by the reopening that they are dumping the best growth REITs.
• We view this as another great contrarian opportunity to focus on buying high-quality REITs.
• The sector momentum is clearly negative, but AFFO growth remains strong.
• Looking for more investing ideas like this one? Get them exclusively at The REIT Forum. Learn More »

This research report was produced with assistance from Hoya Capital Real Estate.

We've got a few articles coming up to highlight some of the opportunities we're seeing today. With investors piling into retail landlords, they've been ignoring several of the best opportunities.

AFFO Growth

We're going to highlight two of the REITs we purchased recently. Each of these REITs is down from our initial entry point because the high-quality REITs have been punished. So what qualifies as high-quality REITs? Well, cell towers, manufactured home parks, industrial REITs, and data centers have demonstrated exceptional growth in AFFO per share over several years. That's where investors should be looking for strong growth REITs.

Industrial REIT

Terreno Realty Corporation (TRNO) is an industrial REIT with exceptionally low leverage, plenty of room to grow, and exceptional scores on corporate governance. This is the kind of REIT we expect to regularly trade at a substantial premium to NAV and to use that premium to issue shares and grow the portfolio.

We like to see that in long-term investments because it gives the REIT a clear path to grow total returns to shareholders even faster than the underlying portfolio would support. While the portfolio for TRNO is filled with high-quality industrial properties, it's the governance that shines and suggests that a large premium to NAV could be sustained for a long time.

We previously considered TRNO (last summer) and determined it was too expensive relative to peers. Recent underperformance relative to the sector has solved that issue.

We highlighted TRNO in our February Portfolio Update as one of our "Top Picks We Don't Own" and indicated we were interested in buying shares so long as prices didn't spike. Prices did climb in February, but they recently dipped back down to be similar to the prices from our Portfolio Update. TRNO carries a risk rating of 1 due to its exceptionally low leverage.

In our February Mid-Month Updates on Opportunities, we mentioned TRNO was up 3% in February and we would prefer it not rally since we had not opened a position yet.

We finally purchased TRNO as the shares began to dip:

Source: Schwab

The index card is shown below:

Source: The REIT Forum

Terreno AFFO Per Share

Among the factors, TRNO runs extremely low on leverage (which drives a higher AFFO multiple) and invests heavily in properties with rent levels that are far below market rent. Consequently, current period revenue (and NOI) is significantly less than the portfolio would be capable of producing. Simply rolling those leases up to market rates would create a major increase in revenue, which would be further amplified in NOI (since expenses wouldn't scale up at the same rate), and then further amplified in AFFO (due to the modest leverage and overhead costs).

They're also investing in areas where the properties will tend to trade at very low cap rates because the "market rate" for rent is expected to grow substantially faster. So even if the company rolled all leases to market rates in the next quarter (which can't be done due to the contracts), within a few years they would most likely be in a position again where the rents were low.

Given those factors, the amount of AFFO per share produced in any given year (for the foreseeable future) will still be well below market rates leading to a significant long-term ramp in AFFO per share.

Why would the rents keep growing faster in those places? Because industrial rents are cheaper than other types of rents and these locations are in areas where property values (or occasionally other restrictions) will prevent the construction of much new industrial space. Yet high population density means companies want distribution centers within that space because it is so useful for enabling rapid deliveries.

Given those factors, we believe investors should be wary of trying to value TRNO simply on a comparison of AFFO multiples.

Cell Tower REITs

For cell tower REITs, we're going to highlight SBA Communications Corp. (SBAC), though we are also bullish on their two largest peers.

When we introduced targets on SBAC (in mid-January), shares were at $268.08 and we had a neutral outlook (target buy under $252.00). Since then, our target price remained at $252.00, until 3/1/2021 but shares of SBAC dipped to $246.00. That's not a huge discount to the target, but it is a huge discount to recent pricing. Shares of this cell tower REIT have been declining pretty hard over the last several months and substantially underperformed peers American Tower Corp. (AMT) and Crown Castle International (CCI).

Price Target Update

In our review for price targets at the start of March, we decided to raise the target on SBAC by 1%. Consequently, the new target price is a bit over $254.00. While prices have been falling, fundamentals remain strong.

We purchased shares at $246.00.

Source: Schwab

Note: We already own positions in American Tower and Crown Castle International. SBAC's dividend yield is less than 1%, so it won't be a fit for all investors. It also carries a 3.5 risk rating, which is higher than we normally target for long-term positions. The higher risk rating is driven exclusively by the higher net-debt-to-EBITDA used by the company. While the downward trend looks negative on a technical basis (for SBAC), the trend for AMT and CCI looked better as of 2/26/2021 and there is an enormous overlap in the asset type. We often buy a good REIT when the price is falling while peers are relatively steady.

We should point out that subsequent to 2/26/2021, we saw more weakness in the sector including a material drop in AMT and CCI.

SBAC Buyback

SBAC repurchased shares at $290.89 during Q4 2020 and repurchased more shares at $262.12 already during Q1 2021. That supports our idea that the current valuation is attractive.

AFFO Growth

The REITs we're discussing here have something in common. They've demonstrated exceptional strong growth in AFFO per share. There are plenty of other things to like about the REITs as well, but investors can start there. Prior AFFO per share growth was strong. Future AFFO per share growth is expected to be strong. Revenue growth should be strong. The property type remains in demand.

Conclusion

Investors have been piling into the retail landlords. While a recovery in those retail landlords makes sense following the vaccine and the reduction in infections, the magnitude of the shift is absurd. We'll be going into more depth on this trend in some upcoming articles.

While we see far too much money plowing into retail landlords, a shift out of "growth" REITs is creating another sale opportunity. We're able to buy many REITs we've had our eye on for over a year. While these REITs had some decline during the very bottom of the March 2020 plunge, we had countless more attractive opportunities at that time. You could hardly pick a stock without picking a winner.

Now there are far fewer opportunities, but we're getting a great valuation on several of the best stocks again.

Ratings:

• Bullish on TRNO, SBAC, AMT, CCI

Analyst’s Disclosure: I am/we are long TRNO, SBAC, CCI, AMT. 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.

Comments

[EliasMouawad]

Nice article. It was a good timing to buy SBAC

[Colorado Wealth Management Fund]

@EliasMouawad Thank you.

[GearDownBigShifter]

Is there an etf that covers these funds?

[Colorado Wealth Management Fund]

@Daan1 I don't know of one which is exclusively buying these shares, but there are several ETFs that include them as a small to medium portion of the overall portfolio. I like to be able to pick individual REITs. In particular, right now I'd rather be buying individual tower REITs than an ETF that includes a bunch of retail REITs. While the next few weeks could see anything happen, over the course of a few years the growth in AFFO per share for the tower REITs and weak (or sometimes negative) growth for the retail REITs should create a substantial gap in performance.

[Philipsonh]

One can own many of these products by purchasing a fund ( cef, etf , holding company ) that owns them and pays a much higher yield due to leverage, to spread the risk; Multiple entities hold these type of products.

[Jeff Swan]

The yield on TRNO is too low for me at only 2.08%.

[Colorado Wealth Management Fund]

@Jeff Swan Sure, the board could pay out more of AFFO, but what would it help? Investors who want high yield wouldn't suddenly buy at 2.5% and investors like me wouldn't change our opinion. We may even consider it to be pointlessly paying out excess. We covered the reason for the high AFFO multiple (and resulting low yield) in the article, so it doesn't make sense to write it again.

[user1416]

TRNO still seems a little expensive to me. I recently opened a position in STAG to go along with my PLD. Not adding to CCI or AMT yet, but may do so with CoreSite.

[Keep it Country]

@user1416 

I agree it seems expensive. Some of the metrics in this report are impressive. The population density chart stands out to me. I have been long STAG for a while and recently picked up TRNO on this small dip.

s23.q4cdn.com/...

[Invader from Earth]

Retail is at LEAST a year away from being fully “back in business!” Yikes! REITs are out for now...

[Colorado Wealth Management Fund]

@Invader from Earth It's just the retail REITs that are suddenly and substantially over valued.

[Keep it Country]

Great article CWMF. TRNO is well positioned to prosper in coming years with great balance sheet. Pricing power in high density areas with no new supply will payoff!

www.nytimes.com/...

[nsolot]

@Jackson Falls NH Another reason to own the REITs that lease distribution facilities to Amazon, FedEx, UPS, etc.

[Sebstin]

most of these stocks are below 21 EMA range. Not a good buy at this time.

[Colorado Wealth Management Fund]

@Sebstin Schedule an email to yourself for 5 years from today with a link to this article. Let me know what you think of the ratings at that point. Let's see if they:
1. Delivered positive returns
2. Beat VNQ
3. Beat KBWY

[wmflynn]

There are plenty of dividend stocks, REITs and Preferreds paying more than double these dividends %'s, and a solid portfolio can be built around these. A REIT at 2% with growth upside while waiting years does not make the cut for me. With interest rates rising, AAA corporate bonds will soon be paying 4% like back in 2018 - not sure of the logic here.

[Colorado Wealth Management Fund]

@wmflynn Price appreciation and earnings growth is regularly undervalued. The board could easily declare a higher dividend rate. Would that make the company more valuable? Not to me.

[wmflynn]

@Colorado Wealth Management Fund Thank you, I will revisit my thinking and very much appreciate your analysis.

[Chillin' Out]

Thanks for the hard work: you and Hoya are terrific.

I’ve used this weakness to buy DLR at $146, CONE at $65 and CCI at $148. Further weakness will merely allow me to add.

On CCI vs SBAC — CCI’s presentation at Morgan Stanley on 3/4 noted (1) current growth of 10% and its projected full cycle (long term) growth rate of at least 7% - 8% per year and (2) strength of US market combined with increased safety of not having to deal with currency risk. 7-8%/year growth means YOC likely exceeding 7% in less than a decade.

I’d love to get it 2 or 3 turns cheaper: I have a limit order in to triple my CCI position at $132. Fingers crossed.

[Chillin' Out]

Oops, DLR at $126. Fat fingers.

[Colorado Wealth Management Fund]

@Chillin' Out Best of luck. I'm liking CCI a great deal at these prices.

DLR at $126 is clearly a much better deal than DLR at $146. Well, seems clear to me. Obviously, many investors like it better at a higher price.

[Russell A]

Yes, I know one should resist attempting to time the market, but I feel this sector rotation (in REITs and the market broadly) is just starting. Love these names, but I wonder if we are a little too early. Bought AMT in Feb and its already down 10%.

edit: Also - keep up the great work! And congrats on your success in being named #2 in TipRanks! Great achievement.

[Colorado Wealth Management Fund]

@Russella1221 I'm down at least that much on my first purchase of AMT, but down a bit less on the others. Happy to build that position.

Maybe the price dips further, but the fundamentals remain strong. I'm happy with that. At least for REITs, I think the rotation has already reached absurd levels. The disparity in value between the tower REITs and the shopping center REITs is hilarious.

What's better, high single digit growth or roughly flat growth?

So why are shopping center REITs around 20x AFFO and tower REITs around 22x.

[Russell A]

@Colorado Wealth Management Fund You are completely correct. I just think cell towers / data centers continue to get lumped in with the ongoing sell off in tech. The inflation scare may continue, especially with already talks of a 3rd stimulus / infrastructure bill later this year.

Regardless, the only logical thing to do is just continue dollar cost averaging as these names sell off irrationally. I just have to keep reminding myself that :) .

[Colorado Wealth Management Fund]

@Russella1221 Agree entirely. Can't say when it ends, but I do like the prices for building up positions.

[Capt. Spaulding]

Thank you for your thoughts. Always good to have your insights.

My two cents: I agree that there will come a time to step up and buy the tower REITs. But putting their fundamentals, outlooks, and valuations aside and considering technicals alone, the charts look like grim death. Just one more thing to consider.

Cheers,
Capt. Spaulding

[urbanjames]

Hi Colorado, love the article. VERY excited to see these quality names down into the buy zone. AMT and CCI now my numbers 1 and 3 REIT holdings. And will load up more on TRNO this week (and hopefully PLD plz!)

Just one quick thing I noticed: TRNO is not listed in the "Safe Income Portfolio" on Google Sheets despite its Risk Rating of "1".

Thanks again for all the fantastic work you and your team do.

[Colorado Wealth Management Fund]

@urbanjames Thank you. I clearly need to add it. It fits the criteria very well.

[MsASmith]

@Colorado Wealth Management Fund

[MsASmith]

@paganm
What do you think of REIT preferreds for DLR? It’s at a premium now.

For those of needing income, I’m thinking WPC and DOC, always avoid malls.

[Chuckx]

Looking at charts of CCI, AMT and DLR - they all popped to all-time highs after the crash and have been getting bled out since July. Now down to their pre-pandemic prices after getting crushed the last few weeks.

Just wondering why these fell so much while REITs like O and WPC have just been going sideways for 9 months. I do understand why O and WPC don't go up.

Just reversion to the mean? Got too far out over their skis? Got pegged early as stay-at-home beneficiaries?

Their charts scare me, which means I should buy, lol.

[Colorado Wealth Management Fund]

@Chuckx Market got too excited going hard for quality, (including stay at home beneficiaries) then gradually lost the excitement.

[Chuckx]

@Colorado Wealth Management Fund

OK that makes sense to me, thanks.

[davidbdc]

Just curious why you'd choose TRNO instead of PLD. PLD is the 800 pound gorilla so to speak and they have a higher dividend yield.

When I last looked at TRNO there were a few things that concerned me. The good thing is that it is internally managed. They are growing. They seem to be decent at development.

The things that concerned me. 1. They are very concentrated geographically - in some areas where government is likely to impose future costs. 2. They seem to sell some properties after they develop them - this doesn't really make sense to me when your thinking long term. 3. Even though the dividend is low the payout ratio (when I looked at it) was up around 70%. 4. Its a Maryland corporation - my own experience is that the reason to incorporate in Maryland is to allow management to run the company however they'd like with horrendous barriers in place for any shareholder led change. (Doesn't mean this management team is bad - just not my own personal preference). 5. They had a decent chunk of floating rate debt. (their overall level of debt was fairly low).

I got the feeling that they have benefitted tremendously due to the bull market in the industrial space and had their IPO at the "right" time - and they have done quite well - but I don't see the next 10 years being as rosy. Recycling properties is ok as far as it goes but doesn't really get you to long term growth. If the bull market will continue then I'd agree they will likely do well. But longer term I think there are some specific risks outside of their control and when I look at PLD's cost of capital of 2.3% (versus 4% when I had looked closely for TRNO) and the higher dividend I view it a better investment with much less risk.

But time will tell :)

[Colorado Wealth Management Fund]

@davidbdc Need to reply from desktop. Can't do this one from phone.

[Colorado Wealth Management Fund]

@davidbdc Replying from desktop.
1. Somewhat. We also own a position in REXR, which is far more concentrated geographically. We diversify for our portfolio by owning other REITs as well.
2. I don't mind if they sell properties when they believe it is wise to recycle capital. Respect your different opinion on it though.
3. The payout ratio is low because AFFO per share is still far below the long-term earnings potential of teh portfolio.
4. The REIT has the highest score among REITs for ethics. They've also opted out of MUTA and prevented opting in. See their presentation and scan for the slide on corporate governance.
5. The overall level of debt is so low relatively to their total value that any floating rate exposure would be a non-concern for me.

[davidbdc]

@Colorado Wealth Management Fund
Between the two you must feel very confident in the Los Angeles Industrial Real Estate market.

And I won't claim to be knowledgeable about that particular market - perhaps its supply constrained with enough locked-in demand to spur continued growth. But it also elevates the political/cost risks associated with development.

Betting on that market may turn out well. I'd just leave you with the thought that I'd make sure you really believe in the management team. A 20% loss of capital takes a long time to get back through a 2% dividend.

A side note, I saw your CMO, NLY, NRZ trade was looking good yesterday - congrats.

[5ofDiamonds]

"Best REITs On Sale" @Colorado Wealth Management Fund Best REITs on Sale vs. REITs on Best Sale :-) In any case, I nibbled on $AMT $CCI $COR $CONE recently. $DLR is getting close. My 1c.

[Colorado Wealth Management Fund]

@5ofDiamonds I like those REITs. Own each except COR. Less familiar with them.

[State72]

Thanks for the insight. Building positions in AMT and CCI so SBAC will have to wait.

[Colorado Wealth Management Fund]

@State72 I've been building those also. Great choices.

[NotHalfFast]

I like AMT here. Divi yield approaching 2.5% and committed to growing the div annually. Market not happy with price being paid for transformative acquisition, but this was a one of a kind opportunity. Mgmt’s track record merits faith they know what they’re doing. Think the opportunity in India is under appreciated and Sprint churn being over emphasized by investors.

[Colorado Wealth Management Fund]

@NotHalfFast Did you hear their latest presentation? They said Sprint Churn over and over. Like they were focused on explaining why they could end up with multiple years where AFFO per share growth comes in below 10%, rather than talking about how they are one of the only REITs running such high growth.

[NotHalfFast]

@Colorado Wealth Management Fund I did. Complexion of company changes when recent deal closes. No other tower co will be as diversified geographically. Big opportunity to increase the # of tenants per tower. I like the increased exposure to higher growth markets. Two years at most before the normalization. I’m a patient long term investor.

[Colorado Wealth Management Fund]

@NotHalfFast Right there with you. This one pays off very well when a long horizon.

[Shaine]

Thanks!

[Philipsonh]

The only problem with these reits is that they are not appealing to income oriented investors. Normally we look to get 4%+ annually in dividends and do not wish to have to sell shares of a holding in order to get the income we prefer, because we MAY have to sell at a loss. Great author, though.

[Colorado Wealth Management Fund]

@Philipsonh If you diversify the portfolio, you can use some positions like preferred shares to help boost the average yield on the portfolio while awaiting the dividend growth.

[Philipsonh]

@Colorado Wealth Management Fund
I understand that point, sir, but if a stock is paying out 2% annually, it will
be many years before it pays out 4% on an investor's cost basis. Many of us are seniors who need current income. I have only one holding that pays under 4% and that is a situation where a special dividend is expected later in the year. Your choices are fine for younger folks or those who have no need for additional income. I am a follower of yours . Folks on other blog sites compliment your articles; so, we hope you continue with your good work.

[Chuckx]

@Philipsonh

Don't know what age/stage of retirement you are in, or whether you are eking by on the divs or get more than you need. But don't forget about what RMDs can eventually do to your income stream if you have all high-yield/low growth and you get to the year where your RMD starts becoming larger than the amount of divs you're throwing off. It snowballs.