5 Small-Cap REITs Poised To Profit

Summary

• Small caps fly under the radar and can offer better long-term growth potential.
• However, because they lack the same Wall Street coverage and investor interest, they can remain undervalued for quite some time.
• Let’s look at five of my favorite small-cap REIT picks.
• I do much more than just articles at iREIT on Alpha: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »

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One of the great things about owning small-cap stocks is that they’re under-analyzed and therefore garner less institutional support. So investors often underestimate what they can accomplish, leaving them with lower valuations.

In other words, they fly under the radar and can offer better potential for growth over the long term.

Of course, the tradeoff for investing in large-cap stocks can also be easily traced back to institutional buyers. With so much attention from ETFs, mutual funds, and the like, they get more analyst coverage and therefore much lower risk tolerances.

Alternatively, small caps can remain undervalued – especially in down markets – for extended periods of time. Collectively, they’ve always been seen as higher-risk bets.

However, while they don't have the diverse revenue streams or stable cash flows as the big boys… they're attractive for certain investors who are willing and able to take on more risk.

Knowing that, I looked at a few small-cap ETFs such as:

• Invesco DWA SmallCap Momentum ETF (DWAS), based on the Dorsey Wright SmallCap Technical Leaders Index
• Invesco S&P SmallCap Momentum ETF (XSMO), based on the S&P SmallCap 600 Momentum Index, which includes 120 stocks in the affiliated collection with the highest “momentum scores
• Vanguard Small-Cap Growth ETF Shares (VBK), which tracks the CRSP U.S. Small Cap Growth Index.

Here are their one-year price performances, where the SPDR S&P 500 ETF Trust (SPY) outperformed them by a wide margin.

(Source: Yahoo Finance)

And here’s their three-month price performance, showing a similar story.

(Source: Yahoo Finance)

Let’s discuss all of that.

The Power (and Problems) of Small-Cap REITs

Smaller stocks can create a buoy effect since they’re more susceptible to Mr. Market’s moods. And greater volatility naturally deters buying action and often invites selling too.

Now, as I often tell iREIT on Alpha members, the key for any real estate investment trust ('REIT') portfolio is diversification. I can’t overestimate its importance.

The legendary Benjamin Graham taught this as a fundamental principle of investing: Over time, diversification is the key to performance stability and capital preservation.

You might have outstanding results if you put a huge amount of money in one stock. But which one is going to go up like that? Nobody can foretell the future.

iREIT follows just under 150 equity REITs (and around 20 mREITs). Among those, let’s break down market cap categories as follows:

• Small-cap: less than $1 billion
• Mid-cap: $1 billion to $5 billion
• Large-cap: $5 billion and higher.

(Source: iREIT)

As shown above, the average size of the 22 small-cap REITs is $547 million. And so far in 2022, they’ve returned -6.6%. They also underperformed their mid- and large-cap alternatives last year.

The worst-performing year-to-date are:

• Power REIT (PW), down 34.9%
• GEO Group (GEO), down 23.4%
• NewLake Capital (OTCQX:NLCP), down 16.9%
• Gladstone Commercial (GOOD), down 16.4%.

(Source: iREIT)

Meanwhile, the top-performers are:

• Whitestone (WSR), up 18.6%
• Braemar Hotels & Resorts (BHR), up 15.6%
• Global Self Storage (SELF), up 2.1%
• Chatham Lodging (CLDT), up 0.7%.

One of our model portfolios at iREIT on Alpha is called the Small-Cap Portfolio. It’s returned over 35% annually since inception in January 2016.

(Sharesight)

To once again point out how volatile small-cap stocks can be, look at Power REIT, our top 2021 pick…

(Source: Yahoo Finance)

It generated returns over 160%, an intense amount for a single year’s investment, to say the least.

1 Small-Cap REIT Poised to Profit

But that was last year. This is 2022. So let’s discuss Postal Realty Trust (PSTL), a small-cap REIT with less than $250 million as a market cap.

It owns properties in 49 states and was founded by Andrew Spodek, who now serves as its CEO. In May 2019, it and its 270-property portfolio listed for $77 million.

Since then, it’s acquired 656 additional properties comprising approximately $281 million and returned 9.9% annually. Also during that time, rent has grown 310% and its dividend has grown 61%.

PSTL has raised its payout for nine consecutive quarters now… with its Q3-21 dividend rising approximately 4.7% year-over-year.

As the only “pure-play” post office REIT, we’re attracted to its opportunities in a highly fragmented market. Around 25,517 of the 31,000-plus total postal properties are privately owned and leased to USPS.

PSTL is well positioned to be the go-to consolidator. It already has decades of experience acquiring and managing postal assets.

In the meantime, its diversified balance sheet featured around $4 million of cash as of Q3-21. And PSTL’s gross debt is comprised of around $44.5 million of floating-rate debt from its revolving credit facility and $83 million of fixed-rate debt.

(Source: FAST Graphs)

PSTL shares are trading at $17.74, about 17% below our buy target with a p/AFFO of 16.6x. We expect it will continue to grow its dividend, which currently features a 5.1% yield.

Analysts forecast adjusted funds from operations (AFFO) growth of 5% in 2022 and 7% in 2023. And, as shown below, we forecast shares to return in excess of 20% in 12 months.

This warrants a Strong Buy.

(Source: iREIT)

Our Second Small-Cap REIT We Like the Look Of

In early January 2021, I wrote an article for iREIT on Alpha members explaining that:

“(Power REIT) has pivoted to cannabis real estate. But more specifically, the company invests in cannabis greenhouses, a unique specialty category… After conducting due diligence and speaking with management at PW, we decided to purchase 375 shares (at $26.71) for the Small Cap REIT portfolio.”

As previously mentioned, this trade returned 160% before we sold it later that year. And we bought again recently as shares pulled back dramatically.

PW, with its $160 million market cap, is currently diversified into three industries:

1. Controlled-environment agriculture (greenhouses)
2. Solar farmland (600 acres of land leased to over 107 megawatts)
3. Transportation (112 miles of railroad located in Marcellus Shale territory.

And it’s expanding greenhouse properties for food and cannabis cultivation on an accretive basis.

PW has a significant acquisition pipeline in excess of $100 million at various stages of negotiations. Plus, its existing portfolio of controlled-environment agriculture assets have potential expansion opportunities.

The REIT’s recent acquisition yields under 19% thanks to its sculpted rent schedule for cannabis properties.

Also, $65 million of recent transactions should return approximately $65 million over the next three years – which can be used to invest in additional assets and could add approximately $12 million to FFO, assuming a 100% re-investment and an 18% FFO yield on investment.

CEO David H. Lesser has 35-plus years of experience in real estate and has spearheaded efforts in expanding PW’s greenhouse portfolio. Importantly, PW insiders own a bit less than 20% of common shares.

(Source: iREIT)

PW shares are trading at $48.18, around 20% below our buy target, with a 17.2x p/FFO. Compare that to Innovative Industrial Properties’ (IIPR) 29.1x.

PW doesn’t pay a dividend currently because of its net operating loss. But we suspect that will change this year.

Analysts forecast FFO growth of over 8% in 2022 and 70% in 2023. As shown below, we forecast shares to return in excess of 70% in 12 months and maintain a Strong Buy.

(Source: FAST Graphs)

Profitably Poised Small-Cap REIT No. 3

Alpine Income Property Trust (PINE) is a net-lease REIT with a $223 million market cap and 113 properties in 32 states. It listed shares in 2020 by spinning properties from its external manager, CTO Realty (CTO).

One of our attractions to PINE is how its total enterprise value is low, this allows shareholders to invest below-replacement costs in a portfolio rooted in higher-growth major markets in the U.S.

We also like how this small-cap REIT has grown its quarterly dividend by 35% since the beginning of 2020. It now provides the highest dividend yield with one of the lowest implied payout ratios – of 69% based on 2022 AFFO – of its peer group.

We were among the first to initiate coverage on PINE. So we’ve watched it thoughtfully grow its portfolio with high-quality net-lease properties by more than 250% since inception. Currently, 74% of its annualized base rent - ABR - is from credit-rated tenants.

Also, nearly half of PINE’s ABR comes from leases with contractual rent increases attached. About 9% comes from ground-lease assets, where it owns the land and tenants have a meaningful investment in the improvements.

PINE is a textbook small-cap pick that trades “under the radar.” Its 3.3x valuation discount to its peer group average implies significant upside.

(Source: iREIT)

PINE shares are trading at $19.12 – about 7% below our buy target – with a p/AFFO of 12.1x compared with Agree Realty (ADC), which trades at 18x. PINE’s dividend yield is 5.5%, and analysts forecast growth of just 1% in 2022 and 2% in 2023.

Yet we believe most of its total return will come from multiple expansions. So we expect shares will return over 20% in the next 12 months and maintain a Strong Buy.

(Source: FAST Graphs)

Our Fourth Small-Cap REIT With Promising Potential

As referenced earlier, CTO Realty is the external manager of PINE and owns 16% of it. The REIT, which has a $350 million market cap, owns 22 properties totaling 2.7 million square feet.

These are located in markets projected to have outsized job growth: States with favorable business climates like Texas, Florida, North Carolina, Tennessee, Colorado, Nevada, and Arizona.

We consider CTO a “mini–Federal Realty (FRT).” It invests in shopping-center properties focused on grocery-anchored, traditional retail and mixed-use properties with value-add or long-term residual value opportunities.

CTO’s acquisition targets exhibit strong current in-place yields with potential for increased returns through vacancy lease-ups… redevelopments… and/or rolling in-place leases to higher market rental rate.

As for Q4, it saw strong momentum, with:

• Leasing spreads of 12.3%
• 6.4% new lease spreads (excluding acquired vacancy)
• 15.5% option and renewal spreads
• Leased occupancy of 93%.

Although too small for investment-grade ratings, CTO has solid financials. Existing liquidity stands at over $170 million with no near-term debt maturities.

Plus, 100% of its outstanding debt is unsecured. And it has a 36% net debt-to-total enterprise value with a 6.1x net debt to earnings before interest, taxes, depreciation, and amortization (EBITDA).

CTO raised its quarterly dividend ahead of its earnings release, boosting it by 8% to $1.08. This now represents a 7.1% dividend yield and highlights CTO's strong growth during its first public year.

(Source: iREIT)

It’s trading at $62.37, about 5% below our buy target, with a 14.7x p/AFFO compared to:

• Federal Realty’s (FRT) 27.3x
• Regency Centers’ (REG) 20.4x.

And while its payout ratio is elevated at 100%, CTO expects 2022 AFFO of $4.90-$5.15. That’s well above the $4.67 per-share consensus, implying over 15% growth.

As shown below, we forecast shares to return over 30% in 12 months, warranting a Strong Buy.

(Source: FAST Graphs)

And Our Last-but-Not-Least Small-Cap REIT

NewLake Capital Partners (OTCQX:NLCP) is a cannabis landlord with a market cap of around $508 million. We were among the first to cover it, with our initiation article, explaining:

“Founded in 2019, NewLake Capital Partners is a triple-net lease REIT that acquires industrial and retail properties through sale-leaseback transactions, third-party purchases, and build-to-suit projects. NLCP's tenants are some of the leading operators in the U.S. state-licensed cannabis industry.”

Like IIPR, NLCP has no debt. And its chairman Gordon Dugan pointed out to me last October:

"… we'll benefit from our existing portfolio. We'll have a massive uplift. And the big difference to us is that it's going to happen as federal clarification comes into play. And it will, and it's the ability to access debt and significantly lower our cost of capital. Right now, we have a $640 million equity market cap and we do not have a dollar of debt.”

NLCP announced a partial Q3-21 cash dividend of $0.12 per share of common stock. And then in mid-December, it declared a $0.31/share quarterly dividend and a 29.2% increase.

(Source: iREIT)

NLCP shares are trading at $23.90, about 25% below our buy target, with a p/FFO of 19.7x. IIPR, meanwhile, trades at 29.1x.

The dividend yield is 5.2% (compared with IIPR’s 3.2%).

In December, it acquired a 70,000 square-foot industrial property in Chaffee, Missouri – making for the company’s 11th state. And analysts forecast shares to grow by over 50% based on FFO in 2022.

As for us, we maintain a Strong Buy.

(Source: FAST Graphs)

In Conclusion…

All of the above-referenced small-cap picks offer strong buy characteristics. However, I must conclude my remarks with some (repetitive) caution.

Small-cap stocks like these can be extremely volatile and are more exposed to market risk than larger-cap companies. Always remember that these “little guys” have fewer buyers and sellers than larger stocks: Shares are thinly traded.

There are consequences for selling a thinly traded stock. This includes how an investor may have to accept a discount on the price to move the stock quickly.

With larger stocks, investors can find plenty of willing buyers.

Ultimately, valuation determines small-caps’ long-term performance. And although most offer mouthwatering growth prospects…

We must caution readers that it’s up to the individual investor to determine his or her unique risk profile… and tolerance to take on added risk.

I look forward to your feedback below…

Analyst’s Disclosure: I/we have a beneficial long position in the shares of BHR, CLDT, CTO, FRT, IIPR, CLCP, PINE, PSTL, AND PW either through stock ownership, options, or other derivatives. 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.

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.