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REITs For The Right Reason

Summary:
By Carol K. Summary These are my favorite REITs with fully intact dividends as of 7/29/20 REIT 90% payout requirement for 2020 pushed to Dec 31, 2021 There is no free lunch, i.e., the risk/reward tradeoff A REIT really is not a bond proxy, not even the safest REITs Most of my favorite REITs are not super high yielding as I choose to trade the reward of higher divies with a lower risk profile.  Nevertheless, their dividend yields are much higher than U.S. Treasuries and offer an inflation hedge with exposure to real assets. My filter was to first look for REITs that, as of 7/29/20,  have fully intact dividends, which does not mean that can’t change going forward.  Any change to current dividend policy will likely be announced during this quarter’s earnings release, or in Q4,

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By Carol K.

Summary

  • These are my favorite REITs with fully intact dividends as of 7/29/20
  • REIT 90% payout requirement for 2020 pushed to Dec 31, 2021
  • There is no free lunch, i.e., the risk/reward tradeoff
  • A REIT really is not a bond proxy, not even the safest REITs

Most of my favorite REITs are not super high yielding as I choose to trade the reward of higher divies with a lower risk profile.  Nevertheless, their dividend yields are much higher than U.S. Treasuries and offer an inflation hedge with exposure to real assets.

REITs For The Right Reason

My filter was to first look for REITs that, as of 7/29/20,  have fully intact dividends, which does not mean that can’t change going forward.  Any change to current dividend policy will likely be announced during this quarter’s earnings release, or in Q4, depending on the performance of the economy.

COVID Disruptions

REITs pay out 90% of taxable income (REITs pay no income tax) to shareholders in the form of a dividend.  This policy was altered earlier this year due to the economic disruption caused by Covid-19  as many REITs are now not receiving full rents or none at all.

REITs have until Dec 31, 2021 to make their 90% distribution requirement for 2020.

The conventional wisdom was that the REITs which had suspended or cut dividends during 2020 would reinstate them in full or at least partial amounts or full no later Q3 or Q4 to meet this tax requirement.  However, some REITs that have cut or suspended dividends may not even reinstate even partial dividends by late 2020, which complicates their attraction as an income-generating investment.

Risk/Reward Tradeoff

As with most any asset, REITs offering a higher yield generally involve more risk.  The safest REITs with fortress balance sheets tend to yield less than those, which hold riskier assets, balance sheets, and lower credit ratings.

The above impacts the valuation metrics of a REIT, including its weighted average cost of capital (WACC).

Sectors

Bearish –  I am bearish on the following REIT sectors

Hotel REITs

All the major players in this sector have cut or suspended dividends. The bloodbath has not been quite the shock.  I see nothing in this sector attractive until a vaccine is widely available, the economy improves, and folks begin traveling en masse again.  The exception is the specialized gaming hotels/casinos, which I address later in the post.

Office REITs

Though office buildings are not going away, the sector is suffering as companies were already reducing their real estate footprint before Covid-19,  we expect this trend to grow exponentially as the work from home them continues to gain steam.  Companies have discovered many job functions can be performed remotely just as well as in the office.  Even if workers still come to the office just a few days a week, the business sector won’t require the same expanses of space they did during the old normal.   The difficulty here is determining the survivors.  Even Class A buildings in AAA markets (NYC, LA, S.F., CHI, ATL, etc) will be pressed to achieve full occupancy in the future.  Trying to pick the survivors is just too tricky and risky and not worth the reward at current prices, in our opinion.

Retail REITs

There have been many dividend cuts and suspensions in this sector.  I don’t see any upside in mall REITs in the medium-term (12-18 months), and the consensus among REIT analysts is there will only be one or two healthy survivors in the long-term, one of which will no doubt be Simon Property Group, (SPG).  CBL Associates (CBL) is in forbearance with its creditors with no guarantee of successfully emerging, and its stock is trading at 19 cents per share this afternoon (July 29).  Macerich (MAC) and Taubman Centers (TCO) do have trophy assets. Still, it’ll be a rough road going forward, risky with no guarantee the dividend will make a recovery “worth the wait” for the return to normalcy.

Shopping Center REITs

Almost all Shopping Center REITs have cut or suspended dividends, even grocery store anchored shopping centers.  Logic dictates that neighborhood grocery-anchored shopping centers will survive over the long-term as most tend to provide essential goods and services; it hasn’t been reflected in the share prices, however.  There is also a huge disconnect and REITs with assets that offer many small services, such as hair & nail salons, cafes, and coffee shops, which have been hard hit.  Because a grocery store is still full and thriving with in-store shopping, curbside pickup, or delivery, it doesn’t necessarily translate that the shopping center is doing as well.  The larger grocers often make up 50-75% of rental income in these centers.

Bullish –  I am bullish on the following REIT sectors, which should still thrive in the current environment, and are still paying their dividends:

Healthcare REITs

The Healthcare REIT sector is large and very diverse.  I would avoid Senior Housing, Skilled Nursing Facilities (SNFs), and diversified healthcare REITs with extensive exposure to these sub-sectors, such as Ventas (VTR)  and Welltower (WELL).  Senior Housing has become very unattractive due to COVID.  Even though the demographic trend is positive, the market is currently rethinking the long-term safety of nursing homes.  SNFs are too dependent on the direction of the political winds, and some tend to be very reliant on Medicare/Medicaid reimbursement.  Though they offer higher yields, it also corresponds with the higher risk of individual SNF operator failure/bankruptcy or payments being dictated by politics.  A classic example of “there no free lunch” idiom

The best areas of Healthcare REIT investing are  Medical Office Buildings (MOBs), and it’s close cousin, Life Sciences buildings.  Of the MOBs, I have two potential picks, and one is a personal favorite and holding, Healthcare Trust of America (HTA), the premier MOB REIT operating in prime markets with many on-campus or campus adjacent medical facilities serving prominent academic and non-academic medical centers in major population centers. My other MOB favorite is Physicians Realty Trust (DOC).  Similar to rival HTA, Physicians Realty focuses on quality tenants, with 60% of tenants rated as investment-grade.

DOC has outperformed HTA over the past six months (DOC -8.82% vs. HTA -4.91%), but unlike HTA, which has raised its dividend every year since 2015, DOC has only increased the dividend twice since 2014.  Rent collections have been over 95% for both HTA (98%) and DOC (96%), even during this time of canceled appointments and closed medical practices. Physicians, dentists, imaging services (MRI/CT scan), and labs have primarily continued to pay their rent in full and on time.

I hold HTA and looking to initiate a position in DOC on the next pullback.

I also like Alexandria Real Estate (ARE), which engages in the acquisition, leasing, and management of properties in the Life Sciences/Pharmaceutical research/Biotechnology sectors, including top-tier academic medical research centers (like UCSF and Harvard).  I consider ARE to be both recession and COVID-resistant as these companies have deep pockets of funding.  Moreover, while office or H.Q. level workers may be able to work from home, scientists and research assistants cannot do their lab work at home and rely on highly specialized, costly equipment in temperature-controlled environments. ARE’s portfolio is concentrated in the Greater Boston, SF, Houston, and LA/SD metropolitan areas. The dividend yield is 2.4%, admittedly low, but at its current valuation provides room for capital appreciation as well as a growing dividend — a very relevant stock in the age of a global pandemic.  I am long ARE and plan to add future pullbacks.

Data Center REITs

Data Center REITs, own…wait for it…data centers.  Data centers (D.C.) are often perceived as a real estate play in the technology sector.  They house the servers,  not just tech sector darlings but almost all major companies, which rely on D.C.s to store their data.  Though it’s a growing industry,  I believe much of the growth is likely already priced in.  D. dividend yields are typically lower than other REITs at around 2.3%.  Investors could see long-term growth in the sector take off, boosting price appreciation and the total return, outperforming some of higher-yielding but lower growth REITs.  My faves in the data center space are Digital Realty Trust (DLR) and CoreSite Realty (COR).  I am long DLR.

Industrial REITs

I’m limiting my focus here to REITs specializing in single-tenant net lease warehouses and distribution centers. These properties are in demand regardless of whether buying takes place online or in a physical store as the merchandise has to be stored somewhere while in transit to homes or to local stores.  Prologis (PLD) is one of my favorites in this sector, but the current dividend yield is fairly low for a REIT at 2.3%.

I do prefer STAG Industrial (STAG) for several reasons.  STAG’s portfolio contains mostly warehouse and distribution center properties critical to e-commerce as well as regular B2B shipping (like the local grocer receiving shipments of paper towels or those, not my favorite Little Debbie Snack Cakes).  Located in all major markets, STAG also has an impressive presence in secondary and tertiary markets, and all are single-tenant buildings with an average remaining lease term of 5 years, 97% occupied at the end of Q2 2020. It’s top three tenants are Amazon, General Services Administration, and XPO Logistics.  Another attractive feature of STAG is its dividend is paid monthly, which is great for retirees or those relying on current income from their investments.

STAG released earnings on July 28 and beat on earnings and revenue.  The dividend remains intact at 0.12 per share, $1.44 annually, which yields 4.5%.  The REIT also reported that  98% of Q2 rent was collected, with 97% occupancy.

I have a position in STAG and look to pick it up anytime it dips under $30.

Neutral –  I am neutral on the following REIT sectors.

Residential REITs

I am ambivalent about residential REITs.

Recall in my May post, Back To Class: REITs 101,  out of principle, I do not invest in Residential REITs in the Single Family Home (SFH) space.  Many buy their future rental homes, often at a deep discount out of foreclosure or short sales, and perform minimal cosmetic improvements before putting the house into the rental market.  What bothers me, however, is the poor customer service support and lack of critical maintenance issues they provide, such as assuring renters have running water or repairing blown electrical boxes.  Most SFH REITs are owned directly or indirectly by Wall Street private equity firms, some of the biggest names in the business. Not my kind of capitalism,  driven by sheer greed.

The multifamily/apartment side of the equation offers much better prospects, in my opinion.  Yes, I get unemployment is rampant, many folks can’t pay rent and are facing eviction and the alarm bells or ringing of complete collapse for apartment REITs.  Not so fast, however.

My favorite apartment REITs develop and lease properties at the higher end of the rental spectrum.  Because, thus far, the overwhelming majority of the COVID unemployed are lower-paid service sector workers,  higher rent properties are not affected to the degree Class B/Class C properties are.  My two favorites are AvalonBay Communities (AVB) and Essex Property Trust (ESS). Avalon Bay focuses on high-quality Class A apartment complexes in major metro areas of California, New England, New York/New Jersey, Washington DC, and Seattle.  The major negative of Essex is their portfolio is concentrated on the West Coast, all in southern and northern California, and Seattle.  However, ESS properties command some of the highest rents and occupancy rates in each of the respective markets.

Specialty REIT 

Finally,  I am looking at Vici Properties ($VICI), which owns casino and gaming hotels, resorts, and entertainment/leisure properties in 23 locations across the U.S.  I know it doesn’t seem like a good story at this time.  Still, it’s one of those situations where the hotels and casinos are leased very long term to reliable gaming industry names, such as Harrah’s, Caesar’s, Horseshoe, and Bally’s.  It is also the only REIT in any sector, that I am aware of, reporting 100% rent collections since the March COVID lockdown.  Vici’s tenants are all well-funded companies who will pay the rent even if they have to borrow the money, which is not an issue, especially in the current financial environment.

Q2 Earnings Updates

Vici Properties: Casino & Gaming Hotels and Resorts, Golf Course properties
– Beat on FFO & Revenue
– Collected 100% of July rent
– Collected 100% of Q2 rent

Investment thesis intact after earnings

Avalon Bay Communities: Luxury apt communities in major coastal cities
– Misses Q2 FFO by 4 cents, a decline of 1.3% YOY
– Misses Q2 Rev = (-2.9%)  YOY
– Rent Collections as of July 28:  April 97.7%;  May 96.4%;  June 95.5%

Investment thesis intact after earnings, higher than peer group with the exception of Essex, which will release earnings after the market closes on Monday, August 03, 2020.

The information in this post represents our own personal opinions and are not investment recommendations.  We may or may not hold positions or other interests in securities mentioned in the post or have acted upon what has been written.  

All information posted is believed to be reliable and has been obtained from public sources believed to be reliable. We make no representation as to the accuracy or completeness of such information.

Gregor Samsa
This site is designed as a “go to” source for traders, investors, policymakers and any interested in markets and the global economy. We provide informed opinion, timely market information, sources, and links.

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