Who Wants A Slice Of The Great American REIT Pie?

Summary

REITs were formed around 60 years ago after President Dwight D. Eisenhower signed legislation that created a new approach to income-based investing alternatives.
As much as I love REITs, I must remind folks that you should never put all of your eggs in one basket.
Enjoy your REIT pie, regardless of how you slice it.
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Happy 4th of July Text Over Blue Lights Texture Background and American Flags — IrisImages/iStock via Getty Images

For my patriotic readers, don’t worry. This “Let REIT Freedom Ring!” title is meant as the furthest thing from disrespectful or exploitative.

I’m extremely grateful to be American. And I very much appreciate what and who have made it what it is. Though, to prove as much, I’m going to take another risk in sounding like I’m not…

This time, it’s by quoting American humorist Erma Louise Bombeck, who once said:

“You have to love a nation that celebrates its independence every July 4, not with a parade of guns, tanks, and soldiers who file by the White House in a show of strength and muscle but with family picnics where kids throw frisbees, the potato salad gets iffy, and the flies die from happiness. You may think you have overeaten, but it is patriotism.”

Erma was being somewhat silly in the moment, but she was far from stupid. Born in 1927, she wrote a syndicated newspaper column about suburban home life that was a smash hit from 1965 to 1996.

Incidentally, she wrote it right up until the day she died.

Quite the American success story right there, thanks in large part to her:

Attention to detail
Insights into those details.

That’s why I can dig into her 4th of July comments just as much as into an apple pie. (And probably more so than “iffy” potato salad.)

Because, as she hinted at, we celebrate Independence Day the way we do because it is in tribute to actual independence.

The American Way That Allowed for REITs

In the United States of America, nobody is forced to stand up and salute the flag. Even more significant, we’re allowed to voice our disgruntled opinions with whoever is in office – despite the probable social media consequences of such these days.

That’s why we tend to celebrate every 4th of July with friends and family and eating way too much. Because our Constitution reiterates our right to live without government coercion.

And yes, acknowledging that most definitely is patriotism.

That encourages us to innovate, sparking such globally popular ideas and inventions as:

The personal computer
Modern-day internet
Modern-day automobiles
Modern-day flight
Anti-lock brakes
Magnetic resonance imaging (MRI) technology
Cellphones
The polio vaccine
The electric lightbulb
3D printing
The Hubble Space Telescope
Wi-Fi.

And that’s just the short list.

I know that some people somewhere will dispute some of those. I’m already expecting to see some comments that attempt to educate me on certain items I included.

So let me acknowledge right here and now that America doesn’t exist in a bubble. We are inspired by outside ideas and immigrated ideas as well, such as the malls we’re now realizing we’re overrun with.

Even so, those ideas were put to the most sustainable and effective action here in the U.S. – not because America automatically boasts smarter people than anyone else.

I’m sure my fellow Americans reading this can easily think of very dumb people they share borders with. And if nobody comes to mind right away, just go take a drive on your local highway. I’m sure you’ll change your mind quickly enough.

But the thing is that our government was specifically designed to give people room to breathe. And when a country allows citizens to largely go about their own business… they end up creating business and opportunity for everyone else.

That’s no doubt also why real estate investment trusts, or REITs, came about too.

History the REIT Way

In my new book – due out this month and already available for pre-order – The Intelligent REIT Investor Guide – I write how:

“… few assets are more illiquid than commercial real estate such as office buildings, shopping centers, apartments, and the like. They’re also very expensive to own and operate, which made them a ‘boom and bust’ business in the past. Fueled by unreliable information (or at least a serious lack of good information), fortunes could be lost on these purchases.

“Then again, fortunes could also be made – provided one already had a small fortune to begin with. Commercial real estate was the quintessential ‘you’ve got to have money to make money’ example before the mid-twentieth century. It was a wealthy man’s game until REITs came along.”

As I also explain:

“The concept was really spawned by a real estate management company in Boston, Massachusetts, that used a business trust vehicle to avoid paying double taxes on its holdings. It was ultimately taken to court over this, with the court’s decision basically boiling down to ‘if it walks like a duck and acts like a duck, it’s probably a duck.’ And so ended the earliest REIT ancestor.”

Yet the American Dream isn’t stopped by a single government decision. And so that firm went right back to work in designing something that could be legally acceptable.

The result was that “Congress accepted the accurate argument that small investors were unable to benefit from commercial real estate investing” as it was. So “it agreed to allow a new business classification using mutual fund rules as a model.”

That’s how the “little guy” got yet another shot at pursuing happiness, this time through commercial real estate.

Giving Credit Where Credit Is Due, American or Otherwise

I won’t go into all the REIT history details as I do in The Intelligent REIT Investor Guide. But I will note that the category was “officially defined and authorized by Congress in the Real Estate Investment Act of 1960.”

A lifetime ago (i.e., February 17, 2020), I published “5 Great American REITs for Presidents’ Day.” And I’m going to quote that too just to drive home this now global but originally American concept.

“… REITs were formed around [60] years ago after President Dwight D. Eisenhower signed legislation that created a new approach to income-based investing alternatives…

“With the signing of the REIT Act (contained in the Cigar Excise Tax Extension of 1960), Eisenhower helped to pave the way for REITs to own large-scale, diversified portfolios of income-producing real estate through the purchase and sale of liquid securities. Eisenhower fully intended to encourage the investment in real estate – and inspire investors to participate by cleverly enhancing a new kind of investment.”

This is the same president who signed the Federal Aid Highway Act that helped cities and suburbs alike grow as much as they have… allowing REITs to flourish even more.

For those already in the know, let me give credit where credit is due. Eisenhower was first inspired in that move by “the ease of travel on the German autobahns.” That comes straight from the National Archives, incidentally.

The German system is impressive, without a doubt. Like I said earlier, Americans are hardly the smartest people ever.

We’ve just historically had a whole lot of government-acknowledged license to imagine, invent, innovative, and invest freely.

Which is why we have REITs like the following to investigate – and possibly invest in – before, after, or even during our 4th of July picnics this year.

Sky-High Apple Pie a La Mode Opportunities

A few days ago, I penned an article on a few of our top strong buys, and while this collection of REITs doesn't necessarily hold the most popular names, we consider them high-conviction picks because of their above-average total return potential.

Alternatively, I decided to focus this July the 4^th article on 3 of the most popular REITs that we consider Buys. As you will find out below, we like them for all of the right reasons – quality + value – and we consider these terrific picks to share with your friends and family while sipping on a cool beverage while watching fireworks.

So without further ado, let’s take a closer look at 3 Great American REITs to Buy right now:

Realty Income

Most know Realty Income (O) as The Monthly Dividend Company^{® ,}a net lease REIT that is an S&P 500 company dedicated to providing stockholders with dependable monthly income.

What makes this REIT really special is the reliable and dependable income that is generated via the portfolio of 6,662 properties leased to 600 customers. Breaking it down further, the portfolio has 56 different industries represented and 96% of total rent is resilient to economic downturns and/or isolated from e-commerce pressures.

Importantly, while most movie theaters were shut down in 2020 (O has 5.6% exposure to theaters), this REIT was able to continue to generate positive AFFO per share growth (only 2 other net lease REITs did that).

Another important differentiator for Realty Income is the strong balance sheet that deserves the “fortress” adjective because this REIT is one of only eight U.S. REITs with two A3/A- ratings or better. The company has ample liquidity to scale its business to new heights, inclusive of the proposed VEREIT (VER) merger set to close later in the years (Q4-21).

A few days ago the company announced it had priced an upsized public offering of 8 million common shares (from 7.25M) for expected gross proceeds of ~$519 million. We took advantage of the pullback to grab a few more shares, and Realty Income now represents over 7% of the Durable Income portfolio.

We consider this bellwether an attractive buy today based upon our quality rating (of 96 out of 100) and valuation score (71 out of 100).

To be clear, this valuation score is no screaming buy, but the shares are trading at a modest discount to our fair value target and the P/AFFO multiple of 19x suggests the company could move closer to a 22x multiple upon successful integration with VER. Analysts are forecasting 6% growth in 2022 which translates into a 15% 12-month total return forecast.

Source: FAST Graphs

Omega Healthcare Investors

Our next “Great American” REIT pick is Omega Healthcare Investors (OHI), a skilled nursing REIT that owns 954 properties that include over 96,000 beds. The dividend yield is now 7.4%, and we are attracted to the company because of its high quality score (89 out of 100) that also puts the REIT in the top 8% of our coverage spectrum (based on quality).

COVID-19 was particularly impactful on the skilled nursing sector; however, the Federal and many State governments provided necessary and timely financial relief to the industry. And OHI has collected more than 99% of its rents in the Q1-21, April, and May 2021.

Most importantly, the secular tailwind of improving demographics will remain in place after this pandemic as OHI is poised to take advantage of the so-called “silver tsunami”.

OHI has also maintained a strong balance sheet: 5.12x debt to adjusted proforma EBITDA, 5.6% of gross assets are encumbered, and no material debt maturities until 2023. The company has $1.4 billion of liquidity and the payout ratio is 79% (based on AFFO).

In terms of valuation, OHI is trading at a 8% discount to our Buy Below target with an iV (valuation) score of 87 (out of 100). This means that the company is a very solid “buy” that is trading at a quantifiable margin of safety.

As viewed below, OHI is now trading at $36.47 with a P/AFFO of 11.6x. The closest peers are CareTrust (CTRE) – trading at 15.7x – and Sabra (SBRA) – trading at 11.3x.

Recognizing that SBRA is not investment grade and has cut its dividend, we find OHI to be cheap and the shares appear mispriced. We are maintaining a BUY and are forecasting shares to return ~18% over the next 12 months.

Source: FAST Graphs

Healthcare Trust of America

Our final “Great American” REIT pick has patriotism in the name (of the company), Healthcare Trust of America (HTA). This medical office building (or MOB) landlord owns 469 properties in the U.S., located in the top 25 markets (i.e., Dallas, Houston, Boston, Tampa. Atlanta, Miami, Phoenix, Denver, Chicago, Charlotte, Raleigh, etc.).

Around 94% of the properties (based on GLA) are located in the top 75 MSAs, most with strong academic university concentration, as the company strategically invests in some of the fastest growing markets where it can build scale.

Also approximately 74% of the tenant base is comprised of health systems, universities, and large/regional providers and 60% is credit rated.

We’re bullish within the MOB sector because of the high barriers to entry in which operations are critical. HTA’s management team has deep experience in the sector with some impressive customer relationships like Baylor, Scott & White, HCA Healthcare, Highmark, Ascension, CHS, and Tufts Medical Center.

HTA also has a strong balance sheet: Rated BBB by S&P and Baa2 by Moody’s, Debt to Adjusted EBITDAre of 5.3x, around $1.4 Billion in liquidity.

With a slow start to 2021 (+1.6% Y/Y 1Q21 SS NOI growth), HTA expects to be at the bottom end of its 2-3% SS NOI guidance range. The company sees occupancy upside from Q1's 87.9% (89.2% leased) to 92-93% over the next 2-3 years, which represents ~10¢ of incremental FFO (6% of 2021 Street estimates).

HTA’s payout ratio is in excellent shape (72% based on FFO) and we see plenty of growth ahead (analysts estimate FFO per share of 4% in 2021, 2022, and 2023). We expect eventual consolidation amongst MOB REITs and we consider HTA a consolidator in the space.

Shares are now trading at $26.88 with a dividend yield of 4.8%. The P/FFO multiple is 15.5x compared with the 5-year average of 17.7x. We’re maintaining a BUY with a total return forecast of 15% to 20% over the next 12 months.

Source: FAST Graphs

Get a Piece of the Great American REIT Pie

As most readers know, I have been writing on the Seeking Alpha platform for over a decade and during this time I’m blessed to have almost 100,000 followers. However, as much as I love REITs, I must remind folks that you should never put all of your eggs in one basket.

As far as the pie analogy goes, I recommend a minimal of 10% exposure in REITs, and for some 20% could seem reasonable. As I explain in my new book…

“A fundamental principle of investing is that, over time, diversification is the key to stability of performance and preservation of capital. So investors should act accordingly, combining that knowledge with their specific needs and investment goals.”

I went on to explain,

“if you’re simply looking for steady returns with a modest degree of risk and volatility, a REIT allocation of 15%-25% of your portfolio could very well suffice. You could even adjust it from time to time according to whether the sector looks reasonably priced or not.

If you’re looking for higher returns though and are psychologically suited to handle the risk and volatility that goes with them, then perhaps a modest 5%-10% allocation could work.

Based on both logic and historical precedent, I think most investors should find their REIT holdings fall somewhere in the 15%-20% range. That’s based on the supportable premise that these stocks can continue to deliver total returns equal to those of other asset classes with fairly low correlations to other asset classes that reduces portfolio volatility and may even increase overall investment returns.”

Enjoy your REIT pie, regardless of how you slice it…

Happy 4^th of July!

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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This article was written by

Brad Thomas

113.95K Followers

Brad Thomas has over 30 years of real estate investing experience and has acquired, developed, or brokered over $1B in commercial real estate transactions. He has been featured in Barron's, Bloomberg, Fox Business, and many other media outlets. He's the author of four books, including the latest, REITs For Dummies.

Brad, with his team of 10 analysts, runs the investing group iREIT® on Alpha, which covers REITs, BDCs, MLPs, Preferreds, and other income-oriented alternatives. The team of analysts has a combined 100+ years of experience and includes a former hedge fund manager, due diligence officer, portfolio manager, PhD, military veteran, and advisor to a former U.S. President. Learn more

Analyst’s Disclosure: I am/we are long O, OHI, HTA. 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.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.