Summary

EPR has pulled back sharply due to the coronavirus.

Sometimes, lightning strikes and an investment has both a high current yield and strong dividend growth.

EPR set growth on the back burner for a couple of years. In 2020, they have substantial acquisitions in the pipeline.

With growth resuming in 2020, EPR enjoys the trifecta of a high current yield, strong dividend growth, and capital gain upside.

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Co-produced with Beyond Saving

In a recent article, we noted that EPR Properties (EPR) hit the “sweet spot” of having a dividend that would be likely to continue growing. Sure enough, EPR announced they would be increasing their dividend for an 11th consecutive year to $4.59/year, up from $4.50/year.

Coronavirus Fears Creates a Unique Opportunity

EPR has been dumped by investors due to extreme coronavirus fears, as EPR has exposure to entertainment activities including movie theaters, TopGolf, ski slopes, water parks, and their newest addition – casinos. EPR’s properties appeal to those who want to go do something. Mr. Market is acting as if all these activities will stop due to fear. EPR has lost 19% of its value over the past two weeks, creating a golden opportunity.

Data by YCharts

EPR’s Strong Outlook

There are numerous reasons why we believe that EPR is the most attractive REIT opportunity in the market today. Having a monthly dividend, a 16% yield, and being well positioned to continue having regular dividend increases, creates the cherries on top.

Usually, high-quality dividend growth stocks do not make the cut for our portfolio, the reason being that most of them are extremely expensive and usually have very low yields.

EPR provides us a very high-quality portfolio, an attractive valuation, and having taken a couple of years of being net sellers. EPR is ready to return to growth in 2020. We cannot only get a quality high yield today but we also can look forward to more aggressive dividend growth in the future.

Solid Triple Net Exposure

EPR is a “triple-net” REIT, which utilizes triple-net contracts similar to those we see from Realty Income (O) or National Retail Properties (NNN). The lease structure is very straight forward, and the tenant is responsible for all of the property costs: Taxes, maintenance, insurance, and their utilities. The leases are the commercial version of an “absentee landlord.”

For the tenants, the big benefit is that rent is lower and landlords are usually eager to sign very long-term leases. We frequently see the triple-net structure on buildings that were built by the tenant. They invest to build to their specifications and then do a “sale-leaseback” where they sell the property and then immediately enter into a long-term lease. This frees up capital for the tenant to then invest in building new locations or into their daily business.

For landlords, the major appeal is that the property has a long-term income stream, requires little manpower from the landlord and the risk of expense inflation lies with the tenant. For public REITs, the triple-net structure has proven to be fantastic for investors as it provides a high level of predictability for cash flow and allows the REIT to operate with relatively few employees.

Also note that the triple-net structure means that the tenant is responsible for all of the equipment at the location. EPR’s tenants often have millions of dollars worth of equipment that cannot easily be moved. A retail store can easily move from one location to another, moving ski hills, water slides and movie screens is another matter entirely.

It’s All About The Experience

Where EPR sets itself apart from triple-net peers is their niche. EPR brands themselves as leaders in the “experiential economy.” Instead of owning properties where people go to buy things, EPR looks to own properties where people go to do things.

Source: EPR Presentation

Among their tenants, EPR counts movie theaters, TopGolf, ski slopes, water parks, and their newest addition – casinos. EPR’s properties appeal to those who want to go do something.

While we could pack several years of fun into going around and conducting “due diligence” on all 282 of EPR’s experiential properties, it’s important to remember that this is a real estate business. Success isn’t entirely measured by how much fun the properties are – just ask Six Flags (SIX).

When we are buying real estate, what do we want?

A prime location: We want to own a property that’s more likely to increase in value. After all, in the long run, we want to be able to sell if we decide to.

Quality tenants that are able to pay rent and highly incentivized to continue to rent the property.
Like with anything we buy, we want to get it at a good price.

If you buy a piece of real estate in a prime location, with a quality tenant, and for a very discounted price, your real estate future is set. The top locations will help ensure your tenant will stick around, and if they can’t, finding a replacement tenant will be easier. Additionally, you will have the option of selling the investment for a profit in the future as quality real estate tends to appreciate in value.

Having a quality tenant provides stability and allows you to lock in a 10-year-plus lease with confidence that the tenant will be able to pay.

In commercial real estate, “price” is usually measured by the capitalization rate. This is a measure of the property level NOI (net operating income) divided by the price paid. It’s a measure of the cash flow produced by the property, relative to the amount you paid for the property. EPR hits every single one of these nails on the head.

Prime Locations

For the past 23 years that EPR has been a public company, they have sustained an occupancy level that has never dropped below 97%. More often than not, EPR has maintained an occupancy level above 99%, which is where it’s now.

Any REIT can maintain a 97%-plus occupancy in a given year, and when 97% is what occupancy looks like in the heart of a recession and 99%-plus is what it looks like during an average year, something is being done right!

The reason EPR is able to maintain such high occupancy levels is due to a few factors. First, EPR focuses on buying high-quality locations. These are locations that perform above-average for the tenant and are unique enough that they are not easily replaced.

While some of their property types like ski resorts or water parks are obviously unique in a locality, we can see EPR’s selectiveness in movie theaters. While theaters are everywhere, EPR’s portfolio performs well above average. EPR owns approximately 3% of the US/Canada theater market, and those theaters account for 7% of total theater revenue.

Source: EPR

This means that even when theaters go through a consolidation phase, EPR’s locations are the ones that tenants decide to renovate and upgrade, not the ones they decide to close.

Quality Tenants

EPR counts all three major movie chains, operators like Vail Resorts (MTN) and TopGolf among their tenants. These tenants are dominant in their industries.

Rent coverage for their properties averages 1.92x EBITDAR. This means that their tenants can comfortably pay rent.

While many of their investments like ski resorts or waterparks are seasonal and can be impacted significantly by uncontrollable events like the weather, EPR’s operators have survived numerous cycles. EPR’s revenue is based on rent, so the year-to-year performance of their tenants is not particularly relevant.

Additionally, the tenants of these properties are very committed to the location. The businesses that EPR leases to have many millions of dollars worth of equipment that cannot be easily removed from the property. Often, their very identity is tied to the specific property.

An 16% Yield Opportunity that will not last long!

The final ingredient is getting a great price. EPR announced a huge acquisition for 2020. They are buying a casino for approximately $1 billion. While details have not yet been released, it was disclosed on the earnings call that they expect to have a blended cap rate of 8% on the transaction.

In a world where most triple-net investments trade at 5-6% cap-rates, 8% is a steal. In plain English, this means that EPR will be getting approximately $80 million/year in NOI from the property. This is typical of the types of cap rates that EPR usually invests at.

There are a few reasons that EPR gets higher than average cap rates. A large part is that the properties they buy tend to be rather large and infrequently sold. Gas stations, chain restaurants, pharmacies and other types of properties we usually see in triple-net portfolios are frequently bought and sold. There are thousands upon thousands of them. Casinos are a bit more rare, even if they are more common than they were 20 years ago.

Second, most of these properties would be very expensive to convert to an alternative use. This means that if the property is vacated, there’s not a lot of residual value. What can a ski slope be used for other than skiing? Old movie theaters are often best torn down.

On the other hand, the uniqueness of the properties in the locality are what makes them especially valuable to the tenants. EPR has done a fantastic job over the past 20 years in mitigating risk by choosing premium locations. The tenants of their properties might change, but they remain in business because the locations attract customers. EPR has unparalleled expertise to operate in the experiential segment.

Conclusion

EPR is a high-quality REIT that has superior expertise in their niche. Mr. Market is offering it at a low price. Experienced companies have provided resiliency in income generation with returns superior to most real estate assets. EPR has demonstrated this by maintaining consistent occupancy rates in the high 90s. For the past decade, EPR has increased their dividend every year.

Today EPR is offering a yield of 16% which is close to its lowest price in over in the last five years. Remember that interest rates have continuously declined during this same period, with the 10-year Treasury yields now below 1%, high-quality REIT valuations tend significantly to go up in price as interest rates decline. This makes EPR even much cheaper today than it was in over 10 years. EPR’s outlook is most solid and will considerably strengthen. It already has a $1 billion acquisition expected to close in Q2, with another $400-$800 million planned on top of that, with minimal dispositions planned for the year.

Mr. Market is providing a golden opportunity to load up on this high-quality, high-dividend stock. With a monthly pay and fat dividend, EPR should be a cornerstone of any high yield portfolio. Don’t miss this opportunity to load up on this REIT. You will regret it if you don’t! EPR is set to be the biggest winner is your high-dividend portfolio.

Author: Rida Morwa

Source: Seeking Alpha: The Most Undervalued REIT, Yield 16%: EPR Properties

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