As most investors recognize, high quality REITs, also referred to as SWANs, can expect to have good access to capital during most market cycles. In addition, these best in breed companies are able to thrive through these cycles because of their superior competitive advantages.
As part of our REIT research practice at iREIT on Alpha, we seek out the best opportunities by always insisting on quality and value. Because of our long-term focus, we have been able to deliver superior results by analyzing underlying cash flows that support sound dividend growth practices.
As David Swensen with Yale Investments explains, “People should stop chasing performance and just put together a sensible portfolio regardless of the ups and downs of the market.”
And that’s precisely the reason we created a conservative allocation of REITs known as the Durable Income Portfolio. By developing a blueprint heavily weighted to high-quality SWANs, we have been able to deliver reliable performance dating back to August 2013.
As you can see (above), the Durable Income Portfolio has returned an average of 20.5% per year (and around 20% year-to-date).
Of course, we credit the success of this portfolio to the blueprint in which we have maintained enhanced exposure to the highest-quality REITs. While the $2 trillion REIT universe provides us with a large ocean to cast our nets, the SWAN cosmos is much smaller.
Therefore, we must make sure that when we invest in these high-quality companies there must be considerable due diligence, with an emphasis on 1) sustainable competitive advantages, 2) dividend growth, and 3) valuation.
And although all three of these are important, valuation is critical, because ultimately that’s what drives much of the success in our fundamental analysis. As Benjamin Graham remarked:
“Selecting securities with a significant margin of safety remains that value investor’s definitive precautionary measure.”
We just finished our 2020 REIT Forecast (for iREIT on Alpha members) in which we explained that “so far in 2019, REITs posted the best investment performance since 2014, based on resilient economic fundamentals and an improved outlook for real estate.”
In other words, “REITs have delivered total returns in excess of 27% in 2019, almost tripling our prediction. Many of our Strong Buys last year are now Holds as a result, and we’ve become more cognizant of the fact that we’re now in the longest expansion in America’s history.”
Yet, we believe that there’s still an opportunity for investors to own shares in high-quality REITs. Thus, we will now provide you with our 2020 Sleep Well At Night REIT list in order of our lowest to highest conviction names.
Top 10 SWANs for 2020
Before getting started, let’s take a closer look at the list of SWANs using quality indicators such as our R.I.N.O. scoring tool, S&P credit ratings, and payout ratios (based on FFO per share). We sorted the list in the order of the lowest R.I.N.O. value to the highest (scale is 1-5):
As you can see, Federal Realty (FRT), Digital Realty (DLR) and Simon Property (SPG) score the highest based on our quality-based R.I.N.O. model. Now let’s take a look at the growth prospects for these 10 REITs based upon analyst consensus estimates for 2020 (note: data provided via FAST Graphs).
No surprise to see Ventas (VTR) and Tanger Outlets (SKT) forecasting negative Funds from Operations growth in 2020. We have written extensively on these two REITs (latest VTR article here and latest SKT article here). We’ll provide a recap on all of the SWANs below (keep reading).
Now, let’s examine the growth forecasts for 2021. Keep in mind, there are fewer analysts who provide estimates after 2020, so we include the number of analysts who reported (note: data provided via FAST Graphs).
As you can see, all 10 REITs provide positive growth forecasts in 2021, even Ventas (+3%) and Tanger (+2%). Notably, Digital Realty has 13 analysts weighing in on the 7% growth forecast in 2021.
Now let’s take a closer look at a few valuation metrics starting with the dividend yield:
Using FFO data, there are a few ways to screen for value. Let’s start with the current P/FFO compared with the normal five-year normalized P/FFO. We list these from cheap to cheapest:
Note that W. P. Carey (WPC) and Digital Realty are included, even though their P/FFO is higher than their historical five-year average. We will discuss that below (keep reading). Also, it’s plain to see how cheap Tanger and Simon are trading these days.
Another way to measure value is to consider the company’s current share price with iREIT’s Fair Value price. As you can see below, W.P. Carey and Digital Realty are still within 5% of our established Fair Value target:
Finally, in order to rank the top 10 SWANs, we decided to design a spreadsheet to combine the R.I.N.O. scores with the deepest value picks. In order to do that, we assigned a numerical value to each REIT based on their discount (or premium) to fair value and then add that to the R.I.N.O. score. So, here are the top 10 SWANs for 2020, screened and sorted by iREIT:
The Top 10 REIT SWANs in 2020
#10: Healthcare Trust of America (HTA) has become an impressive healthcare REIT, and although shares aren’t cheap, we believe the combination of value and quality makes this company an easy pick. In terms of quality, we prove HTA with a quality (R.I.N.O.) score of 4.0 which is made up of (1) a strong balance sheet (BBB rated and $1 billion of liquidity with very limited near-term maturities), (2) highly diversified portfolio (23.7 million square feet), (3) strong internal and external growth (+2.5% same-store and 2% rent growth), and growing dividend (increased annually since listing in 2013).
While HTA has maintained its equity cost year-to-date, we believe shares remain attractive, given the healthy dividend yield of 4.2% (well covered with a payout ratio of 76%) and earnings growth of 5% (analyst consensus) for 2020. Collectively, we see value in this SWAN that’s expected to generate low double-digit returns in 2020. Note: We recommend leaning into the position at the current price (buy on pullback).
#9: W. P. Carey is a Net Lease REIT that barely made the 2020 SWAN list. Up until a few weeks ago, we had a Hold rating on the company, but over the last 90 days, shares have pulled back by around 12%, moving closer to our fair value target price. As we explained on Our Marketplace service, “shares have dropped twice that of National Retail Properties (NNN) and three times as much as Realty Income (O)” and shares are “trading at 17.8x P/FFO, or around 200 basis points below the closest direct peers (O and NNN).”
In terms of quality, W.P. Carey scores well, with a R.I.N.O. score of 4.0. Several factors were considered such as capital allocation (BBB rating by S&P), risk management (we like the international exposure and the removal of the non-traded REIT business) and dividend record (increased its dividend every year since going public in 1998). The payout ratio is higher on an FFO basis, but for net lease REITs, we prefer using AFFO, in which Carey scores well, at 83%. We expect to see the dividend increase by around 4% to 5% in 2020 and we forecast returns in the low double digits for 2020. We maintain a buy.
#8: Public Storage (PSA) is a self-storage REIT that deserves a spot on the Top 10 SWAN list. In terms of quality, the company scores a solid 3.5 (our R.I.N.O. model) and if it weren’t for the fact that the company was a little too stingy with dividend growth, we would have given the company a R.I.N.O. score of 4.0 or better. Public Storage did not increase the dividend in 2009, in 2018 and in 2019. Other than that, the balance sheet is impressive, rated A by S&P and with very little debt on the balance sheet (because the company prefers to issue preferred shares to fund growth).
Self-storage supply has put pressure on self-storage REITs and that’s the primary reason that shares have fallen, and we recently upgraded PSA to a Buy (from a Hold). Recognize that PSA has a commanding scale advantage (2,444 facilities in 38 states and 35% of Shurgard Self Storage) and cost of capital advantage (the lowest leverage ratio as REITs go) thanks to management’s use of low cost preferred stock over the past decade (debt/capital ratio is just 13%). Shares have fallen by around 14% over the last 90 days, creating a wider margin of safety, in which investors can capitalize on total return potential in the low double digits (as viewed below).
#7: Ventas, Inc. made it to our Top 10 SWAN list based upon its balance sheet strength and skillful risk management practices. Arguably the senior housing operating segment (or SHOP) has put pressure on growth prospects, as identified previously, with a -3% FFO growth forecast in 2020. However, the 2021 analyst consensus forecast provides a picture of improved growth prospects of around 3%. Keep in mind that Ventas’ US SHOP exposure represents 25% of the company’s NOI and 8% is from its Canadian senior housing properties where SS NOI grew 3% in Q3-19. We’re not concerned that income will continue to erode, as the large majority of the revenue is generated from durable rent payers in the medical office, life science, and senior housing net lease categories.
While the SHOP segment has its challenges, Ventas has done an excellent job of mitigating risk by maintaining an impressive balance sheet (BBB+ rated by S&P) that consists of 5.9x leverage (vs 6.2x for industry average) and interest coverage of 4.3x (vs 3.1 industry average). The balance sheet is tied for the best in the industry, and that’s why the company was recently able to sell 11-year bonds at 3% and refinance already low-cost 4.25% debt. We believe that Ventas could eventually become the first A-rated healthcare REIT and that’s why we score (using R.I.N.O) the company 4.2. We maintain a Buy with annual returns targeted at
#6: Regency Centers (REG) is one of four retail REITs in our exclusive Top 10 SWAN list. One key differentiator for this REIT is its focus on necessity-based grocery-anchored shopping centers. With around 425 properties, Regency owns shopping centers located in stronger trade areas than its peers, with demographics meaningfully above the peer average. The company’s attractive target market investment strategy – investing in dominant grocery centers – provides it with a highly sustainable competitive advantage that produces “best-in-class” results. Regency’s grocer sales average around $650 PSF annually, vs. the national average of $400 PSF, and this suggests that the portfolio is backed by recognizable chains such as Public, Kroger, Whole Foods, H.E.B., and Safeway.
In terms of quality, Regency also scores well with a R.I.N.O. of 3.9. That’s an indicator of financial strength. The company also is rated investment grade (BBB+ by S&P) and has the lowest payout ratio (of 61%) in the shopping center sector. The company did cut the dividend in 2009, but it has bounced back nicely, and we expect to see the company growing its dividend by around 2% to 3% in 2020. We believe shares are 7% undervalued, illustrating the potential for shares to return low double digits annually in 2020.
#5: LTC Properties (LTC) is an outlier on the SWAN list, but we believe the company deserves a spot due to its disciplined risk management practices. While the company has limited scale advantages ($1.7 billion of investments), it makes up for the strength of the balance sheet. The company’s debt to enterprise value is 26.7% and debt to annualized adjusted EBITDAre is 4.4x. It has $534.6M available for borrowing under its Unsecured Credit Agreement @ 115 bps over LIBOR.
Although smaller than most peers, LTC has been able to successfully navigate the choppy senior housing environment by being selective with its underwriting. As of Q3-19, approximately 94% of properties were covered under master leases and this serves to mitigate risks of default, the latest of which relates to Texas-based operator, Senior Care Centers. While the company saw a modest decline in FFO in 2019, it’s expected to normalize in 2020 and 2021 (3% growth forecast) and we expect to see the company growing its dividend again in 2020. Shares have pulled back by ~13% over the last 90 days and this has allowed us to upgrade shares from a Hold to a Buy. We are targeting shares to return low double digits in 2020.
#4: Digital Realty is the only tech-related REIT in the 2020 SWAN list, and remember, there are many high-quality REITs – such as American Tower (AMT) and Crown Castle (CCI) – but they obviously did not pass the “valuation” test (because they have no margin of safety). However, Digital Realty has recently pulled back (-9% over last 90 days), creating an opening for us to upgrade shares from a Hold to a Buy. The primary reason for the price decline is related a recently announced an agreement to combine with InterXion Holding (INXN), a Netherlands-based information technology services company.
While strategic in nature (“this $8.4 billion transaction will create a leading global provider of cloud and carrier-neutral data center solutions with an enhanced presence in high-growth major European metro areas”), integration risk provides uncertainty related to execution and short0term dilution. However, we are confident the company can restore its long-term growth trajectory (7% forecasted in 2021) and ability to generate impressive total returns. We maintain a Buy.
#3: Federal Realty has a quality (R.I.N.O.) score of 4.6, the highest in our coverage spectrum. The company scores well in all areas: (1) Fortress balance sheet (rated A- by S&P), (2) highly-diversified (105 shopping centers, totaling 24 million square feet of leasable space, leased to 3,000 tenants and nearly 2,700 apartment units), (3) extraordinary dividend record (52 years in a row of dividend increases and payout ratio of just 65%).
The potential for above average returns is high, as shares are now trading at -5% below our fair value price and -22% below the historical P/FFO average. Although some would moan at the 3.3% dividend yield, I say “cry me a river” because the opportunity for price appreciation is supported by a “backlog that includes 4.3 million square feet of redevelopment opportunities and room for 1,675 apartment units. That’s enough to boost apartment count alone by 60%.” Consensus growth is promising with 3% forecasted in 2020 and 6% in 2021. We maintain a Buy with annual returns targeted in the low double digits in 2020.
#2: Simon Property Group is another recognizable SWAN coveted by many analysts and investors on Seeking Alpha. It’s easy to understand why so many folks believe that this best-in-class mall REIT could generate impressive results. For one, the company maintains an impressive low cost of capital advantage (“A” rated by S&P) which means the company has access to almost $7 billion in low-cost liquidity for development and redevelopment. More impressively, Simon can retain about $1.5 billion in cash flow after paying its dividend, which has grown 5% over the past year. This means there’s a wide margin of safety with the dividend (the payout ratio is 69% and our R.I.N.O. score is 4.3).
The other “margin of safety” indicator is Simon’s share price that has fallen by ~10% year to date. Even though Simon’s fundamentals are rock solid, sentiment (i.e. Mr. Market) has put a negative spin on mall REITs that has led to continued volatility and fear of future dividend cuts for Washington Prime (WPG) and the more recent dividend suspension for CBL Properties (CBL). We believe that Simon’s superior scale and cost of capital advantages will allow the company to not only survive the chaos but thrive. We maintain a Strong Buy conviction with targeted returns of 22% annually.
#1: Drum roll please, and I am sure many anticipated that we would include Tanger Outlets as the No. 1 SWAN for 2020. Before touching on value, let’s start with quality since we anticipate the pushback (as we did in the article last week with more than 400 comments and over 77,000 page views – web and mobile).
How’s Tanger a SWAN?
As I explained in the recent article,
“…during the same time frame (2015-2019), Tanger has improved its balance sheet, sold non-core properties, and maintained strong occupancy, while also delivering earnings growth (or FFO) of around 1.4% per year (since 2015). Yet, Mr. Market has continued to beat down the outlier mall REIT (same period below, 2015-2019): -11.3% total return annually during 2015-YTD.”
I added that,
“Fundamental analysis provides us with a clear picture of a highly successful REIT that has seen a temporary decline in earnings. And Tanger’s management team has done an excellent job focusing on leasing, reducing, leverage, buying more of its shares, and increasing its dividend – all pillars when considering deep value picks.”
These fundamentals include a strong balance sheet (BBB rated by S&P), steady occupancy (never dropped below 95% in its history), strong payout ratio (63%), and impressive dividend growth (increased for 25 years in a row and counting). Earnings declines should moderate in 2020 (forecast -4% in 2020) and begin to normalize in 2021 (analysts forecast +2% growth). We don’t subscribe to the “sky is falling theory” in which Tanger shares could drop another 10-20% due to ETF inclusions or exclusions. Shares are now trading at a very wide margin of safety, no matter what metric you want to use: -47% below iREIT’s Fair Value, -119% below historical P/FFO averages, or dividend yield of 9.5%.
Without a doubt, Tanger deserves the top 10 SWAN pick in 2020, and whether it takes a year or two (or three), we believe there is enhanced opportunity for total returns in excess of 25% annually (hence the strong buy). Here’s how Warren Buffett described Benjamin Graham:
“He was not swayed by what other people thought or how the world was feeling that day or anything of the sort.”
Likewise, I’m not swayed by opinions, only facts, and although I know I’ll get some feedback from others, good and bad, I’m maintaining my strong buy conviction – for yet another year. As Ben Graham explained:
“You are neither right nor wrong because the crowd disagrees with you. You are right because the data and reasoning are right.”
Glossary of Terms:
SWAN: An acronym that stands for sleep well at night and is used to describe high-quality blue chip stocks.
R.I.N.O.: A proprietary research tool that stands for REIT Indicator Numerically Optimized. This scoring model ranks each REIT from 1-5 based on a number of attributes such as dividend safety, diversification, and management.
FFO: Stands for Funds from Operations = Net Income + Depreciation + Amortization – Gains on Sales of Property. This is the yardstick for measuring earnings for REITs.
Author: Brad Thomas
Source: Seeking Alpha: The Top 10 REIT SWANs For 2020