(Hoya Capital Real Estate, Co-Produced with Colorado Wealth Management)
One of the best-performing REIT sectors since the start of the pandemic, Casino REITs have proven to be surprisingly resilient despite the intense struggles faced by the broader leisure industry. Within the Hoya Capital Casino REIT Index, we track the three casino REITs and their respective major casino operator tenants: VICI Properties (VICI) - which was spun out from Caesars Entertainment (CZR) in 2017, Gaming and Leisure Properties (GLPI) - which was spun-out from Penn National Gaming (PENN) in 2013, and MGM Growth Properties (MGP) - which was spun-out from MGM Resorts (MGM) in 2016.
Vegas Is Sold Out? Recent earnings reports from casino operators painted a particularly bright picture for the tourism recovery as Caesars saw occupancy rates rebound to 84% in April and commented that "weekends in Las Vegas are sold out for the foreseeable future." MGM Resorts saw hotel occupancy accelerate to 73% in April at its Las Vegas properties and commented that "March was one of the best months on record for total gross bookings with weekend occupancy in the spring and summer months tracking near 90%." TSA Checkpoint data showed that air travel rebounded to 70% of 2019 levels for the first time this past weekend, up from a low of 4% last April.
Casino REITs have delivered surprisingly steady performance throughout the pandemic despite the dramatically reduced usage of casino facilities. Critically, unlike their hotel REIT peers, casino REITs utilize an ultra long-term (15-50 year) triple-net master lease structure, leaving most of the financial and operational risk – both on the upside and the downside – to their tenants. Led by VICI, these REITs reported another quarter of spotless rent collection and average AFFO growth of nearly 9% in Q1 compared to last year and VICI sees growth of another 12.5% in 2021 at the midpoint of its guidance range.
Casino REITs blend some of the better attributes from each of the net lease, hotel, and healthcare REIT sectors, operating with some of the highest margin profiles due to the triple-net structure. This lease structure resulted in spotless rent collection throughout the pandemic despite the obvious struggles faced by tenants. In addition to the aforementioned operators, other major casino operators include Las Vegas Sands (LVS), Wynn Resorts (WYNN), Churchill Downs (CHDN), Boyd Gaming (BYD), Bally's Corporation (BALY), and Century Casinos (CNTY).
This "bond-like" lease structure does result in elevated risks from inflation and interest rates. We analyzed the details of the master leases utilized by these REITs and found that VICI is the only REIT that uses an explicit CPI-linkage in their master lease with Caesars. GLPI's master lease with PENN lacks an explicit inflation-linkage but does have a higher percentage-rent component - 4% of net revenues of facilities under the master lease - which does have indirect inflation protection. We see MGP's master lease with MGM Resorts - which lacks a CPI-linkage and has a smaller component of percentage rents - as the most exposed to significantly higher inflation.
Casino REITs emerged in a fashion similar to many hotel REITs as "spinoffs" designed to separate the capital-intensive real estate business from the operationally-intensive property management business. GLPI went public in 2013 as the product of a corporate spin-off from Penn National and now owns a 50-property portfolio of largely regional casinos. MGP was spun out in 2016 by MGM Resorts and now owns a 17-property portfolio of largely "destination" casinos with revenue streams that include a relatively more diversified mix that includes lodging, hospitality, and event revenues. VICI was formed in 2018 as part of the bankruptcy reorganization of Caesars Entertainment and owns a 27-property portfolio of both regional and destination casinos.
Much like their retail-focused net lease REIT peers, external growth through acquisitions is the modus operandi of the casino REIT sector and should continue to provide a steady source of FFO growth for the foreseeable future given these REITs' favorable cost of capital and unique competitive positioning. These three Casino REITs have acquired nearly $30 billion in assets since the start of 2016 including VICI's acquisition of the real estate assets of The Venetian from Las Vegas Sands for $4 billion in cash - the largest REIT-involved deal since GLPI purchased the Pinnacle real estate portfolio in 2016. Upon closing later this year, the deal will add 20% to VICI's annual rent and is expected to be immediately accretive to AFFO per share.
Casino REITs were slammed during the early onset of the outbreak amid the stifling economic lockdown that forced the majority of properties across the country to temporarily close. Casino REITs plunged roughly 60% between late February and early March 2020 on fears that their tenant base was destined for significant financial hardship and would struggle or refuse to pay rent. Riding a "reopening rebound," casino REITs mounted a furious comeback in the back half of 2020 and ended the year as one of the best-performing REIT sectors with total returns of 6.8% compared to the -5.5% decline from the broad-based Vanguard Real Estate ETF (VNQ).
The momentum has continued into early 2021 as the successful roll-out of the coronavirus vaccine in the United States has spurred the long-awaited rebound in leisure travel. Despite recent concerns over the impact of potential inflation on the sector, Casino REITs are higher by another 16.2% compared to the 15.9% return from the Equity REIT Index. VICI has led the way this year with gains of 23.1% - mirroring the strong performance from its primary tenant Caesars. GPLI has been the laggard this year with returns of 11.1%, also mirroring the relative underperformance of its tenant, Penn National.
"Headquartered" in Las Vegas, gambling is one of the most highly-regulated industries in the United States. Until the 1980s, commercial casinos were prohibited outside of "The Strip," leaving the lucrative gaming business to Native American tribes, who were largely exempt from state prohibitions. The last forty years have seen a wave of legalization of commercial casinos as states increasingly realized the "tax goldmine" they were sitting on. Tax revenue from gaming, for instance, represents nearly a quarter of state tax revenues collected by Pennsylvania. Twenty-five states now permit commercial casinos and these three REITs own properties in nineteen of these states.
Casino REITs own 94 of the roughly 450 commercial casinos in the United States, one of the highest concentrations of REIT ownership within any property sector. Together, these three REITs have a combined market value of nearly $45 billion and comprise roughly 2% of the broad-based "Core" REIT ETFs. With an average dividend yield above 5%, we view the casino REIT sector as a compelling alternative to other more troubled property sectors that were hit by the wave of dividend cuts last year.
Like their net lease peers, casino REITs are some of the most operationally efficient property sectors, leaving most of the financial risk and capital expenditure responsibilities to their tenants. Like a ground lease, triple-net leases result in long-term, high-margin, relatively predictable income streams, and as a result, the sector is viewed as more "bond-like" than other REIT sectors. While these characteristics are clear positives during periods of modest economic growth and muted inflation, they become potential risks if inflation does rise considerably, particularly for fixed-rate lease terms.
One fast-developing, pandemic-fueled trend with uncertain effects on these casino REITs and their operators is the surge in online gambling, facilitated by a 2018 Supreme Court ruling that legalized sports betting at the state level. 16 states now offer some form of online gambling - either online casinos, online poker, or online sports betting - and another dozen states have some form of legislation to expand access to online gaming in their legislative pipelines. We view online gaming as a long-term headwind for physical casino demand, the value of which is largely a function of their regulatory "barrier to entry," but particularly for regional casinos that are primarily gaming facilities.
This long-term headwind, however, is offset by medium-term benefit as several of these REITs' critical tenants now have a solid foothold into the online gaming ecosystem, which should help to support the profitability and rent-paying capacity of these tenants. Of note, Caesars finalized its acquisition to buy its online gambling partner William Hill last month while Penn Gaming has seen significant success in its investment into Barstool Sports. Other key players in the online gambling industry include DraftKings (DKNG), FanDuel/Flutter Entertainment (OTCPK:PDYPY), Everi Holdings (EVRI), and GAN Limited (GAN), all of which are holdings in the Roundhill Sports Betting & iGaming ETF (BETZ), which offers exposure to online gaming.
Casino REITs pay an average yield of 5.1% - the highest in the REIT sector - and well above the REIT market-cap-weighted average of 3.1%. Unlike other higher-yielding property sectors, we again emphasize that the secular outlook for casino gaming appears relatively stronger, underscored by the above-average 5-year dividend growth rate of roughly 7% achieved by these casino REITs. At the company level, MGM Growth Properties pays the highest dividend yield at 5.6%, followed by Gaming & Leisure Properties at 5.5%, and VICI Properties at 4.2%.
In contrast to their hotel REIT peers, perfect rent collection allowed casino REITs to maintain dividends at-or-near previous levels. Only one casino REIT - GLPI - reduced its quarterly distribution last year from $0.70 to share to $0.60, but raised it to $0.65 in early 2021. VICI and MGP were two of just 52 REITs that raised their dividend last year, and MGP boosted it again in early 2021. VICI also appears likely to boost its payout again later this year when it announces its Q3 rate in September, as it has in every year since its IPO.
Casino REITs have seemingly flown under the radar over the past several years and continue to trade at relative discounts to the broader real estate sector. At a forward FFO multiple of 14.6x, casino REITs trade at notable discounts to REIT average of 21.3x despite their above-average 5-year FFO growth which is just below 10%. MGP commented in its earnings call that it believes casino REITs are "in the early innings of a sector-wide valuation re-rating and anticipate cap rates to compress meaningfully." The sector trades at a roughly 5% premium to Net Asset Value, and it is important to maintain that valuation premium for potential acquisition-driven external growth.
Below, we outline five reasons why investors are bullish on casino REITs.
Below, we outline five reasons why investors are bearish on casino REITs.
With an average dividend yield above 5%, we view casino REITs as a more compelling - and perhaps "under the radar" - alternative to other high-yielding sectors like office and retail that are facing stiffer secular headwinds. Casino REITs own properties under a long-term net lease structure, leaving most of the operational risk to their tenants. Selectivity is critical, however, as this "bond-like" structure results in elevated risks from inflation and interest rates. Through an analysis of each REITs' master leases, we showed that the inflation and interest rate exposure varies considerably between the three REITs.
Earnings reports from Casino REITs and operators painted a particularly bright picture for the long-anticipated tourism recovery, and the industry cannot afford any further setbacks. Results from VICI were particularly encouraging and we see acquisitions as a continued critical source of external growth. Further, we view "destination" casinos as more immune from the potential disintermediation effects of online gambling, and more likely to feel the immediate tailwinds from the post-vaccine recovery in global tourism.
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