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Brad Thomas

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Summary

Shares of American Tower have fallen more than 8% the last couple of weeks.

This weakness has piqued the interest of many investors looking to enter this industry space.

They want to know if the recent sell-off justifies a buy rating or not.

This idea was discussed in more depth with members of my private investing community, iREIT on Alpha. Get started today »

This article was coproduced with Nicholas Ward.

In recent quarters, we’ve seen nearly every stock that’s somehow attached to the 5G revolution experience strong price appreciation. From popular handset players like Apple (AAPL), to semiconductor names like Qualcomm (QCOM) and Broadcom (AVGO), to infrastructure names like Ericsson (ERIC)…

Investors who got in at the right times have made out well in recent years.

The notable exceptions to this trend would be the largest wireless carriers themselves, AT&T (T) and Verizon (VZ). That’s largely due to the low multiples the market gives them for their high debt loads and low growth prospects.

Put simply, many income-oriented investors have decided to play this megatrend elsewhere. That includes through the cell tower real estate investment trusts (REITs) we cover at iREIT:

American Tower Corporation (AMT)
Crown Castle International (CCI)
SBA Communications (SBA).

Shares of all three continue to be in high demand, with each producing strong double-digit returns year to date. But does that make them good buys?

Today, we answer that question for just one of those entries: The one our new iREIT IQ quality scoring system gives the highest rating of its peers.

That would be American Tower, whose shares have fallen more than 8% during the last couple weeks.

This weakness has piqued the interest of many investors who’ve been hoping to get into the larger industry. And while we’re still very bullish on where this story can go, bullish stories don’t make for automatically appropriate investments.

Let’s explore how and why.

A Cell Tower REIT Industry Overview

The cell tower REIT industry can be easily explained through a graphic American Tower provided in a recent shareholder presentation.

As you can see below, it and its peers typically own and/or operate cell towers and the land beneath them, then lease space on both to their tenants, which provide wireless communications services to their customers.

(Source: AMT Q2 Investor presentation)

We appreciate this business model quite a bit, and with good reason. Once the land is purchased and the tower infrastructure is in place, revenue is easily scalable at relatively low costs.

Plus, as more tenants sign contracts for the same towers, cell tower REITs see dramatic rises in:

Revenue
Gross margins
Returns on investments.

Again, that’s without the need for additional investments.

On the fixed-cost side of the equation are ground rent, utilities, tower maintenance, taxes, and insurance. But those remain fairly stable and predictable.

All of this is fairly unique and therefore makes cell tower REITs fairly, if not very, attractive to investors. They have relatively easy access to solid growth, which shows in the strong returns they’ve produced in recent decades.

(Source: AMT Q2 Investor presentation)

Sector Growth Remains Attractive Too

As a whole, the cell tower REIT industry continues to experience strong secular tailwinds – both in the U.S and international markets – thanks to the ever-increasing rise of mobile devices and increased data demands.

(Source: AMT Q2 5G Update)

We certainly don’t expect to see an 80% data usage compound annual growth rate moving forward. The wireless market is maturing, after all.

Even so, companies operating in this space still expect strong, double-digit growth in mobile traffic, and therefore continued tailwinds for their properties and profits.

(Source: AMT Q2 Investor presentation)

The combination of increased devices and usage per device equates to very strong total demand growth. Right now, mobile data usage is growing at a 30%-40% rate in the U.S. And we expect international growth to stay strong as well, as Internet penetration continues to proliferate in developing markets.

(Source: AMT Q2 Investor presentation)

One negative trend to be aware of comes from the improvements made to the technology that drives mobile networks. These have pushed the cost per gigabyte (GB) of data down dramatically in the U.S.

Since 2006, American Tower estimates that tower leasing costs in this regard have declined at about 35% CAGR – a negative trend that will likely continue into the future.

To some degree, that is. Judging by more recent data, it’s likely to be less pronounced going forward.

For instance, in 2018 and 2019, the estimated leasing cost per GB rate fell by less than 20%. So data demand is outpacing lowered leasing costs…

In which case, AMT’s operating metrics remain solidly profitable.

(Source: AMT Q2 5G Update)

American Tower, the Business Model

The names of the two highest-quality companies that we track in the cell tower REIT space are actually somewhat ironic.

Crown Castle International, for one, has staked much of its future growth plans on small-cell growth within the United States, whereas American Tower appears to be the better international growth play.

Founded in 1995, AMT now runs a portfolio of more than 181,000 communications sites, with only 41,000 located in the U.S. Roughly 140,000 are in international markets.

Looking at the graphic above, it’s clear AMT has been focusing on international growth opportunities in recent years. Over the last 10, it’s deployed roughly $46 billion in capital toward this end.

The majority of this has come in the form of mergers and acquisitions.

(Source: Q2 ER Slide Show Presentation)

The company’s investment rate has stayed fairly consistent over the last decade or two, highlighted in the presentation above. While COVID-19 concerns have caused management to pull back a bit, return on invested capital continues to trend in the right direction.

That’s what sets AMT apart from CCI: Its willingness to maintain a focus on high-margin tower sites by expanding into new markets. While margins might not be as high as they could be in the exact markets it’s been targeting, AMT’s current demand metrics are somewhat similar to those that we see in the U.S.

In short, we prefer its lower-risk expansionary efforts compared to CCI’s recent dive into fiber and small cell infrastructure.

(Source: AMT Q2 Investor presentation)

AMT Just Continues to Impress

With all those strong mobile demand metrics, it seems safe to assume that AMT’s operating metrics are equally impressive.

And so they are.

Over the long term, AMT’s revenue, adjusted funds from operations (AFFO), and dividend growth performances have been stellar.

(Source: AMT Q2 Investor presentation)

Admittedly, that exact pace of growth has slowed in recent years. AMT reported its second quarter earnings in late July, which showed a continuation of those low single-digit increases.

Specifically, total revenue rose 1.2%, net income by 3.2%, and consolidated AFFO by 1.6%.

To be sure, foreign exchange rates played a role in this. There was a significant forex headwind during the quarter, counteracting the almost 10% uptick in total tenant billings.

(Source: Q2 ER Slide Show Presentation)

Until we see a weaker dollar, that kind of downplaying force will continue – another potential downside to AMT’s international growth plans. At the same time, increased tenant billings do show its revenue stream to be well diversified. And management continues to believe it’s setting itself up for reliable long-term growth.

That’s why it continues to invest, spending $128 million during Q2 to acquire 350 communication sites. Once again, these were primarily located in international markets.

AMT did update its full-year 2020 guidance, calling for:

Revenue growth of 3.4%
Net income growth of -6.6%
Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) growth of 3.9%
Consolidated midpoint AFFO growth of 4.2%.

And, yes, these full-year estimates factor in negative forex concerns.

Valuation Matters…

As stated in the intro, quality isn’t – or shouldn’t be – everything when it comes to making investment decisions. There’s also valuation to consider.

The COVID-19 pandemic and consequential shutdowns have fueled the already manic love for 5G investments. And, before that, the trade war with China prompted concerns that shifted investor attention from semi-conductors to other options.

Like cell towers.

In terms of bottom-line resiliency and reliability, it just doesn’t get much better. Hence the reason why investors have flocked into blue-chip stocks.

Like AMT.

Starting in early 2019, its price-to-AFFO multiple rose above its long-term historical average. And it’s stayed there consistently since – for the first time since 2014.


(Source: FAST Graphs)

If you were to extrapolate the double-digit AFFO growth trend from 2012-2018 into the 2019-2020 areas, the premium shown in the chart above would appear to make sense. However, that didn’t happen last year or this year.

The growth rate of the orange and blue lines represent AFFO growth multiples. And they’ve clearly stagnated compared to the black line, which represents price.

The result is an irrational disconnect between market sentiment and the stock’s underlying fundamentals.

Looking ahead, analysts don’t expect AMT to re-establish double digit bottom line growth. That’s something the markets seem willing to wave away for now, especially due to the forex factors.

It admittedly is hard to blame AMT’s management team for the strong dollar. However, from a valuation standpoint, it doesn’t make sense to be buying in at current prices.

Even factoring in future growth through 2023, investors are buying AMT shares at $245, or around 30x AFFO. In so doing, they’re setting themselves up for lackluster performance, assuming we see mean reversion back toward the company’s long-term average of around 22x.

That’s highlighted by the yellow 2.34% annual return figure below. The larger FAST graph indicates it will take roughly three years of strong growth for AMT’s bottom line to catch back up to its current premium.

(Source: FAST Graphs)

In Conclusion…

Even though American Tower shares have fallen roughly 8.2% since their Sept. 16 highs, shares still appear to be overvalued. That’s why we maintain our Hold rating.

While the recent selloff has gotten investors excited – particularly those who’ve been sitting on the sidelines for years, waiting for weakness in the cell tower space – we still think it’s too early to jump into AMT.

Shares still have to fall another 18% or so before they’d hit our buy range around $195. That should give investors an adequate margin of safety and attractive future return prospects.

Unfortunately, that simply isn’t the case here at $245. And wishing doesn’t make it otherwise.

Author: Brad Thomas

Source: Seeking Alpha: American Tower: A Moat-Worthy REIT To Own When The Price Is Right

It’s time to panic!

That’s what the markets were told in late February, and they ended the month with that same sense of dread.

COVID-19, more commonly known as the coronavirus, was out and about, you see. Therefore, there was only one conclusion…

It was time to panic!

Believe it or not, I’m not trying to mock anyone. I’m only trying to point out how emotion-driven the markets can be.

There was so very little logic involved in the Dow’s first 442-point “dip” on Feb. 24, its 956-point drop on Feb. 25, its 200-plus point stumble on Feb. 26, or its 759 point fall from grace on Feb. 27.

As The Atlantic put it over the weekend:

“… stock markets around the world plunged as distressing news about the spread of the novel coronavirus continued to accumulate. In the United States, the three major stock indexes… fell more than (10%) below their recent peaks, a sharp decline that qualifies in Wall Street terminology as a market “correction.” “One investor quoted in The Wall Street Journal called it a ‘bloodbath.’”

Because, again, it was time to panic.

Who’s Afraid of the Coronavirus?
Let me give you a helpful tip about life: Coronavirus or not, there’s always something to panic over.

Sometimes it’s personal. Sometimes it’s familial. Sometimes it’s national. Sometimes it’s global.

But there’s always something out there waiting to go “boo!” I won’t provide you with the full list of bogeymen monsters lurking around potential corners up ahead. After all, the point of this piece is to assure you (and point you in the right direction) not to freak you out any more than you already are.

While, yes, there are always precautions we should take and future-focused thinking caps we should wear, there’s no point in obsessing over everything that could potentially happen in the future. It would be completely counterproductive.

In this case, we’re much better off considering the past, particularly some health scares the world has faced this century. Faced and survived with the vast majority of its population intact.

For example, do you remember the Ebola virus? Remember how panicked everyone was about that epidemic?

WorldAtlas.com writes that:

“The world’s most widespread Ebola virus disease outbreak happened in West Africa in 2013 and lasted until 2016. Liberia, Sierra Leone, and Guinea were the worst affected countries. Major loss of life and socioeconomic losses were suffered during this epidemic… After a peak in October 2014, things started getting under control as international efforts started bearing fruit. Finally, on March 29, 2016, WHO (the World Health Organization) terminated the status of the epidemic as an emergency of international concern.”

There were 28,646 cases reported, with 11,323 deaths during that time frame – a pretty abysmal survival rate for an already rotten issue.

Yet the markets survived anyway, going on to hit new record after new record in the years after.

The Coronavirus Is Out to Get Your Portfolio! Or Is It?
Compare that to COVID-19, or the coronavirus. As of March 2, the World Health Organization was saying there were 88,948 confirmed cases.

Of those, 80,174 were in China, where 2,915 deaths were recorded. That’s a 3.6% death rate, which is stellar compared to Ebola, but far less impressive compared to your ordinary, average health concern.

Outside of COVID-19’s country of origin, 8,774 individuals have been diagnosed, with 128 deaths. That’s a 1.46% death rate for those who have contracted it.

And, incidentally, on a global level, 99.9886% of the world’s population has not been affected so far. I’d say that’s a pretty decent indication that the world will keep spinning tomorrow and companies won’t completely crumble today.

Yet, still, it’s time to panic, as evidenced by how the markets behaved on Tuesday, March 3.

So let’s break the situation down to its very basics…

Simply put, you can only do so much to avoid getting the coronavirus. And you can’t really do anything at all about whether the markets will be fear- or greed-fueled.

But that doesn’t mean you should take your money and run. Even if you’re a retiree.

Perhaps even especially if you’re a retiree.

If you have a portfolio of solid companies with reliable dividends, it largely doesn’t matter what the markets may do.

Your share prices will still increase over time apart from the occasional blip. (You know: the logic-less dips, drops, trips, and falls from grace.) But, up or down, those stocks will continue to pay you every quarter or every month – steadily, reliably making you money.

That way, no matter what everyone else is doing, you don’t have to panic.

I call it the sleep well at night (or SWAN) phenomena. And it’s well worth the investment through stocks like those we cover below.

Real Estate Investment Trusts to Snuggle Up To
For starters, let’s explore the real estate property sectors that are most risk exposed right now:

Lodging (-15.8% week over week)
Senior housing (-13% w/w)
Malls (-11.4% w/w).

Fortunately, we’re already “underweight” in lodging and malls, though we did take advantage of the current chaos with regard to some of those stocks.

In the lodging sector specifically, we bought further into Hersha Hospitality (HT) and Apple Hospitality (APLE). This was for our High-Yield REIT portfolio platform – which currently offers dividend yields over 6% – and our Small-Cap REIT Portfolio.

Moving on to malls, we’re not adding too much exposure there considering continuing store closures and downsizing. Tread lightly…

Even so, we did pick up a few more shares in:

Simon Property Group (SPG)
Tanger Outlets (SKT)
Kimco Realty (KIM)
Urban Edge (UE)

Now, we are concerned about the pullback in tourism. Consumers are currently shying away from public gathering places and eating out. And there could be more of that to come.

(We wrote a recent article on Forbes here).

As such, we’ve been bearish about EPR (EPR). Its high concentration in experiential assets – including its $1 billion gaming bet – will probably drag it down for now.

The coronavirus could have a similar impact on senior housing REITs. The Center for Disease Control believes that those at highest fatality risk are the elderly or people with underlying health conditions.

With that said, skilled nursing REITs such as Omega Healthcare (OHI) could find themselves in more demand.

We also remain bullish with regard to Ventas (VTR), Healthcare Trust of America (HTA), Physicians Realty (DOC), and LTC Properties (LTC). And we nabbed a few shares of Medical Properties (MPW) as well, close to our $20 fair value price.

Moderate Coronavirus Risk
In this heightened state of awareness, we’re neutral on apartments (-12.8% w/w), industrials (-14.3% w/w), and self storage (-7.5% w/w).

Apartments are highlighted by their healthy demand, with the U.S. economy producing an annual 2.2 million non-farm jobs last decade.

Sadly, we don’t see too many bargains here. But we have warmed up recently to the prison sector, which is technically (though less traditionally) a form of housing.

CoreCivic (CXW), for one, remains one of our top-conviction Strong Buy picks. Shares were yielding 10.9% at last check.

For their part, industrial REITs see no signs of slowing as fundamental shifts in supply-chain patterns and e-commerce keep providing healthy demand. Most all of them are trading at sound value, with the exception of WPT Industrial (OTCQX:WPTIF), STAG Industrial (STAG), and Plymouth (PLYM).

For self storage, supply is the bigger issue. Rents are no longer necessarily cheap, and demand can at times border between need and discretionary spending.

With that said, we like Extra Space (EXR) and Public Storage (PSA) in this sector.

Source: Yahoo Finance

Low Risk (Unless Conditions Worsen Significantly)
Office (-12.99% w/w), data center (-12.6% w/w) and net lease (-12.9%) REITs are probably the lowest-risk property sectors right now. We’re already overweight on the latter two and took advantage of the recent pullback to purchase more shares.

Specifically, we like Digital Realty (DLR.PK) and CyrusOne (CONE). A slowing economy could impact IT spending, it’s true. But cloud and data growth are secular-driven trends that aren’t so easily influenced.

The net lease sector always has been recognized for its predictable sources of income. Its tenants are generally longer duration (10 years-plus) who therefore provide sustainable cash flow and dividend growth.

These REIT’s spread has been hurt by share price pullback. However, retreating 10-year figures remain supportive of the underlying value proposition.

Because of that, we recently staked out new positions in Vereit (VER) and Store Capital (STOR).

We also see value in a few specialty REITs such as Ladder Capital (LADR) and Iron Mountain (IRM). And Landmark Infrastructure (LMRK) also has popped back up on our Buy list as we allocate more capital to our Small-Cap and High-Yield portfolios on iREIT on Alpha.

In the end, we view the latest “Black Swan” event as a REIT SWAN (sleep well at night) opportunity. As always, thank you for the opportunity to be of service and happy SWAN Investing.

We want to make sure your retirement works right for you.

Author: Brad Thomas

Source: Seeking Alpha: The Most Reliable REITs For Retirees: The Coronavirus Edition

If you’ve been paying attention this year, you may have noticed how I – and my closely connected colleagues –have spent a decent amount of time writing about certain speculative picks.

It’s true that some speculative stocks can do very well for themselves – within reason. I wouldn’t have written about the ones I have as possible portfolio plays otherwise.

Now, I don’t really think penny stocks are the way to go as a general rule, if ever. While I can’t tell you the exact percentage of them that make investors money versus don’t…

Let’s just say it isn’t good.

Because as tempting as the potential rewards might be, the risks are intensely unattractive.

That’s why I only ever publish positive perspectives on speculative stocks after very careful research and intense levels of transparency… the same way I publish everything else.

It’s also why I’ll add in cautions to seek “1 percent or less exposure” to those recommendations, as I did with CorePoint (CPLG) earlier this month. That way, if you do decide to take a bite of the forbidden fruit, it won’t cost you paradise.

3 High-Quality at Your Fingertips

The majority of your portfolio should be filled with high-quality stocks, including high-quality REITs. That’s the main premise of this article, and the stocks you’ll find below are nothing less.

Simon Property Group (SPG) is a dominant S&P 100 company and landlord to 233 retail real estate properties including Malls, Premium Outlets® and The Mills® comprising 191 million square feet in North America, Europe and Asia. This juggernaut owns trophy malls and outlets and the tenants in the U.S. portfolio generate annual retail sales of more than $60 billion.

While most mall REITs have witnessed negative earnings growth, due to continued store closures, Simon has continued to generate impressive growth because of its disciplined risk management practices. Notably, Simon has achieved a fortress balance sheet (A-rated by S&P) and very healthy dividend coverage (payout ratio is around 65%).

Simon’s dividend yield is 6.0 percent and given the strong development pipeline ($1.8 Billion) generating yields of 8 percent, the stalwart REIT should continue to generate stead and reliable dividend growth. The company recently announced a 2.4 percent increase in 2020, and we maintain a Strong Buy with expectations for shares to return around 20 percent in 2020.

Federal Realty (FRT) is another solid retail pick that invests in shopping centers and mixed-use properties. While most REITs were forced to cut their dividend during the last recession, Federal Realty forged ahead utilizing its smart capital allocation strategies to build upon its impressive dividend record.

This is what’s allowed the company to achieve what literally no other REIT on earth has, 50 years-plus of consecutive dividend growth. To do that, the company has maintained a safe balance sheet (A-rated by S&P) so it was immune from capital markets shutting down.

Federal Realty’s portfolio includes 105 well-situated shopping centers, totaling 24 million square feet of leasable space, leased to 3,000 tenants, in some of the most densely populated, fastest-growing and most affluent cities in America. It also owns nearly 2,700 apartment units as part of its increasingly mix-use portfolio.

Shares are now trading at a 4.5 percent discount to our Fair Value, that equates to a dividend yield of 3.3 percent and a price to funds from operations multiple of 20.1x. The dividend is well-covered, and we believe shares could return between 10 percent to 15 percent over the next twelve months.

Our final high-quality pick is CyrusOne (CONE), a data center REIT that has seen shares beaten down lately due to a slow down in hyperscale demand. What this means is that the growth rates of the large giants – Amazon, Microsoft, and Google – has slowed, but CyrusOne has other demand drivers that help balance the revenue stream.

More recently, and partly as a result of the hyperscale slowdown, CyrusOne decided to rightsize its employee count, pointing to the Chinese hyperscale market that has died down considerably, due to tariffs.

After discussing this with the CEO in detail, I am convinced that the company is making the necessary steps to cut costs in the U.S., and I am even more convinced that the European business should continue to accelerate, providing sound diversification to the business model.

Shares topped $77.60 last September and have since fallen to $61.84. We find the valuation extremely attractive, based upon the dividend yield of 3.2 percent and expected growth of around 10 percent in 2020 and 2021. We recently upgraded our recommendation to a Strong Buy, based upon the generous returns of 25 percent we forecast over the next twelve months.

I own shares in SPG, FRT, and CONE.

Author: Brad Thomas

Source: Forbes: The Cream Rises To The Top: 3 High-Quality REITs On Sale

Have I mentioned lately that I love looking over the comments you readers leave on my published articles?

I know I have, but let me say so again anyway: I love looking over the comments you readers leave on my published articles.

Truly. My subscribers and even my more random readers can make my day with these interactions.

I’m not even talking about the comments containing compliments. (How’s that for alliteration?) At least, I’m not just talking about them. They are, admittedly, very welcome.

But the comments that offer food for thought or suggestions for future articles are equally valuable, if not more so. That was certainly true of what kalu0003 posted on a piece I published on Monday, Jan. 6.

At the bottom of “The Top 10 Best REIT Performers Over the Last Decade,” said individual wrote:

Brad – given what you know of the REIT space – what would you suggest as the next 10 years’ REITs worth putting money (into) now? In other words, what (are) the best REITs for the next decade in your view? Thanks.

Since that sounded like an excellent question to me, I promptly wrote back that I’d be answering it shortly. So, thank you for the suggestion, kalu0003.

Here’s your proper reply…

In Investing, “Waiting” Isn’t a Four-Letter Word
In the original article, I focused on the “worthwhileness” of waiting: How time isn’t always our enemy. When it comes to investing, it’s actually very much on our side.

“In the case of the markets, waiting pays off both figuratively and very, very literally – at least when it comes to well-placed, well-researched investments.

“It can take a $10,000 portfolio and turn it into $50,000, $100,000, or even $500,000. It really depends on the power of time.”

Incidentally, think about what it can do with a $20,000 portfolio, a $50,000 portfolio, or a $100,000 portfolio!

“To prove this, just look at the U.S. market’s rise over the last 20 years.

“The Dow went from 11,501.85 on Jan. 3, 2000, to 28,538.44 on Dec. 31, 2019.

“The Nasdaq went from 4,186.19 to 8,972.60.

“The S&P went from 1,469.25 to 3,230.78.

“Those are significant differences! Moreover, those are significant differences during a 20-year period that involved one significant and one enormous crash: The dot.com debacle in 2000 and the housing market bubble bursting in 2007. Plus the recessions that followed.”

The same applies to a decade’s worth of investment time. No doubt, this present decade’s, to be specific.

And while I plan to thoroughly enjoy the next 10 years as much as I possibly can – learning and growing from them, and enjoying the many moments while they’re happening – I also look forward to having learned and grown after they’re all said and done.

What exactly will I learn and how much will I grow? That’s still to be discovered, of course. But I will make one prediction right here and now…

I fully expect to be writing an article in late 2029 or early 2030 about how the truism that “this time around wasn’t different” was once again proven correct.

Strong Stocks, Strong Finish
I can’t tell you how many times I’ve heard someone argue “This time it’s different!” about particular stocks or larger market trends.

They’ve said it both to justify getting into very risky positions and staying out of very worthwhile ones. But, in either case, let me assure you that there’s nothing new under the sun.

As such, very risky positions are never going to be worth it. And very worthwhile ones always are.

It might just take time to prove so.

Since resisting risky opportunities that promise riches galore isn’t always easy for us mere mortals to do though. I know we won’t be in the midst of this amazing run-up we’re currently experiencing forever.

There will be blips. There will be dips. There will even be flat-out debacles – as with the dot.com ridiculousness we saw so many years ago – and burst bubbles, as with the housing crash some of us are still a little (or a lot) traumatized by.

So, you’d better believe there will be recessions in our future. (Though we predict any near-term ones will be more “garden-style variety.”)

Maybe they’ll happen sometime soon. Perhaps, they’ll happen three or five or eight years down the road. But they are going to happen based on government greed or investor foolishness. Because both factors never change.

They’re only handled differently for different stretches of time.

The way to prepare for any and all of that is to select sure-thing stocks – or at least, stocks that have the best chance of being sure things. After careful research and consideration, I believe the following 10 REITs fit that bill.

They’re built on solid concepts by strong management that keeps them on a long-term profitable track. And because of that, time is on their side.

Just wait and see…

10 Must-Have REITs to Own Over the Next Decade
Before getting started, let me explain the rationale for our stock selection strategy.

As the above picture illustrates, we believe that technology will continue to play a large role in REIT returns over the next decade. When we refer to the “trifecta” blueprint, we often cite three “technology” sectors that should generate robust growth:

Cell towers
Data centers

We also consider other growth sectors like manufactured housing and healthcare to be important. Both cater to the aging demographics that will be driving earnings and dividends over the next decade.

Finally, we consider quality and valuation to be the most important pillars for success. We utilize a broad range of fundamental tools to help investors select the best REITs.

For example, we developed a quality scoring platform called R.I.N.O., which stands for REIT Indicator Numerically Optimized.

In addition, we have numerous valuation tools at our disposal that help us select REITs that are trading at the widest margin of safety.

While we’d like to include REITs like Realty Income (O), Prologis (PLD), and Crown Castle (CCI), to name a few, we purposely selected these 10 REITs because we believe they provide attractively priced securities.

Thus, for investors looking to build a REIT portfolio from scratch, these 10 are good candidates. Overall, we suggest building on them – or whatever combination you choose – so that there’s 5% exposure for each REIT over time.

In other words, we believe that 20 REITs is a reasonable number for a REIT portfolio.

#1 – Urban Edge Properties

Urban Edge (UE) is a shopping center REIT we recently upgraded to a Strong Buy. Although it doesn’t have a well-established track record yet – having only spun off Vornado Realty Trust (VNA) in 2015 – we’re attracted to its strong business model.

It includes 73 shopping centers concentrated in large metropolitan areas in some of the most densely populated markets in the country (62 of the properties are located in the DC to Boston corridor).

While Kimco Realty (KIM) has been long-time pick for us (returning 49% in 2019), we believe Urban Edge is the better long-term choice, given its attractive valuation. It currently trades on both the:

Most attractive historical relative NAV valuation
Widest implied cap rate spread in the shopping center sector.
The dividend yield is 4.67%, and we believe there’s an enhanced opportunity to generate annualized returns of 25% or higher.

Urban Edge trades at $18.85 per share with a price to funds from operations (P/FFO) multiple of 16.1x. Since listing, Urban Edge has returned -0.60 annually.

In short, we see great potential to its high barrier-to-entry portfolio that includes many high-volume, value, and necessity retailers, such as Home Depot (NYSE:HD), TJX (NYSE:TJX), Best Buy (NYSE:BBY), Lowe’s (NYSE:LOW), and Walmart (NYSE:WMT).

Price: $18.85

P/FFO: 16.1x

Dividend yield: 4.67%

Payout ratio: 75%

S&P: N/A

2019 total return: 49%

2020 FFO per share forecast: 2%

2021 FFO per share forecast: 7%

#2 – Physicians Realty Trust

Physicians Realty (DOC) is a medical office REIT that’s returned 11.3% annually since listing shares in 2013.

We like it because of its focus on high-quality medical office buildings (MOBs). The portfolio is spread across 31 states, with no MSA representing more than 8% of leasable square footage or tenant responsible for more than 6% of annual base rent.

DOC’s MOB-specific portfolio achieved same-store (SS) growth at the top end of management’s 2%-3% target range throughout 2019. Plus, it exceeds its closest peers in occupancy and remaining lease term. Occupancy is at 96% (at Q3-19), and weighted average lease term is 7.3 years.

Momentum toward off-campus care is accelerating, with more procedures removed from the CMS “Inpatient Only List” each year. We believe that, over the next decade, DOC is well positioned to benefit.

Shares have returned 23.9% in 2019. And we see it as attractively priced today based on its 18.7x P/FFO and dividend yield of 4.9%.

Price: $18.80

P/FFO: 18.7x

Dividend yield: 4.90%

Payout Ratio: 92%

S&P: BBB-

2019 total return:23.9%

2020 FFO per share forecast: 9%

2021 FFO per share forecast: 2%

#3 – LTC Properties Inc.

LTC Properties (LTC) is a healthcare REIT comprised of approximately 50% seniors housing and 50% skilled nursing properties. Although smaller than some of its competitors, LTC maintains a more tactical approach of provided sale/leaseback and build-to-suit funding for developers and operators.

Its portfolio includes around 200 investments in 28 states with 30 operating partners.

We’re especially attracted to its highly defensive balance sheet. The company has just 27% debt-to-enterprise value and debt-to-annualized adjusted EBITDA is 4.4x.

By staying disciplined through the years, LTC has been able to maintain and grow its dividend while driving shareholder returns. It has returned 11.6% annualized since listing and 9.3% annualized over the last 10 years.

LTC has done a good job of positioning itself. It’s also excelled at identifying dispositions and removing non-strategic assets and diversifying partner concentration. The company has total liquidity of just more than $740 million, with no significant long-term debt maturities during the next five years.

Shares are trading at $45.16 with a dividend yield of 5.05% and a P/FFO multiple of 15.1x.

Price: $45.16

P/FFO: 15.1

Dividend yield: 5.05%

Payout ratio: 76%

S&P: N/A

2019 total return: 12.9%

2020 FFO per share forecast: 0%

2021 FFO per share forecast: 5%

#4 – Tanger Factory Outlet Center

Tanger Factory Outlet (SKT) is referred to as a “battleground” pick for two reasons. For one, there’s the enormous sensitivity to its dividend yield, which is now 8.9%. And then, there’s the substantial short interest involved: 57% as of Dec. 31.

We’ve covered this name extensively on Seeking Alpha, the latest of which had over 136,000 web views. That’s a record, so thank you for reading.

Withstanding the fundamentals, Tanger has drastically underperformed. It’s down 20.1% in 2019 with a mere 3.2% annualized return over the last 10 years.

Of course, though, we’re value investors here, so fundamentals drive our decisions. Thus, we believe the next decade could be more favorable.

Up until the last recession and commencing January 2000, Tanger returned an average of 21% annually. And from 2009 through 2016, the pure-play outlet REIT returned an average of 18% per year.

It’s really the last few years where Tanger has completely bombed, returning an average -18% annually from July 2016.

Even so, its fundamentals just aren’t that bad. The company had an occupancy of 95.9% in Q3-19 – a figure that hasn’t dropped below 95% in more than 25 years.

Also, in Q3, Tanger matched its all-time-high average sales per square foot of $395. That was the same as in 2016. And although earnings, or FFO, has slipped modestly since that year, the bulk of the decline has been due to dispositions.

(FFO per share was $2.23 in 2015 and is targeted at $2.25 for year-end 2019.)

Meanwhile, the balance sheet is in great shape (rated BBB by S&P), with approximately 94% of the square footage unencumbered by mortgages. The unsecured line of credit has 99% unused capacity, or nearly $600 million. And Tanger generates around $100 million of free cash flow after dividends.

The company has a considerable buffer (or margin of safety) to protect the dividend and 26-year track record of increasing it.

We are, of course, underweight malls. And we would recommend minimizing exposure to Tanger. Yet, we still believe it will generate outsized returns over the next decade – comparable to what was witnessed in the decade preceding the great recession.

Shares are trading at $15.95 with a P/FFO multiple of 7.1x.

Note: We recently published an article on our Marketplace service (The Tanger Conundrum: Why Shares Spiked Last Week), in which we explained our rationale for SKT’s likely removal from the S&P Dividend Index (SDY).

Price: $15.95

P/FFO: 7.1x

Dividend yield: 8.9%

Payout ratio: 63% (based on FFO)

S&P: BBB

2019 total return: -20.1%

2020 FFO per share forecast: -4%

2021 FFO per share forecast: 1%

#5 – CyrusOne Inc.

CyrusOne (CONE) is a data center REIT that’s returned 20.5% annualized since listing shares in 2013. We’ve often referred to it and Digital Realty (DLR) as “pair trades” since we own both and believe they’re worthy of a long-term investment plane.

We included CONE in our decade-long list, believing it should generate above-average growth over the next few years. CONE is forecasted to grow FFO per share by 10% in 2020 and 2021 according to analyst consensus.

(DLR, meanwhile, is forecasted to grow by 2% in 2020 and 7% in 2021.)

Since going public, CONE has done an excellent job improving its cost of capital. It’s done that by achieving investment-grade status from S&P – with a BBB- issue-level rating – and Fitch, which recently initiated the same conclusion.

CONE is managing the balance sheet with leverage in the mid-5x range. And it ended the latest quarter at 5.4x net debt to annualized EBITDA. The company has no near-term maturities but nearly $1.3 billion in available liquidity.

CONE also has generated steady growth by investing in Europe, where it remains focused on developing strong enterprise in internet exchange point (IX) businesses. It’s developing more than 50 megawatts across all key European markets combined.

Once these projects are completed, it will have nearly 150 megawatts of capacity there, representing nearly 20% of its footprint. The company said it hopes to be generating around 25% of its revenue from Europe in three years.

After generating impressive returns in 2019 of 27.4%, shares have pulled back to a favorable margin of safety. Shares are now priced at $66.99 with a P/FFO multiple of 18.7.

The current dividend yield is now 2.99% and well covered, with a payout ratio of 54%). We maintain a Strong Buy.

Price: $66.99

P/FFO: 18.7x

Dividend yield: 2.99%

Payout ratio: 54%

S&P: BB- (unsecured)

2019 total return: 27.4%

2020 FFO per share forecast: 10%

2021 FFO per share forecast: 10%

#6 – Healthcare Trust of America Inc.

Like DOC, Healthcare Trust of America (HTA) is another healthcare REIT focused exclusively on medical office buildings. Given the highly defensive nature of MOBs, we see owning both as providing enhanced predictability, given the consistent income generated from physician-focused properties.

HTA has the size advantage though, having invested more than $7 billion over the last decade. It’s demonstrated a track record for mergers and acquisitions (M&A), as illustrated by the blockbuster $2.75 billion Duke Realty (DRE) MOB portfolio that closed in 2017.

HTA also has a cost of capital advantage over its direct peers. Shares are trading at an implied cap rate in the low 5s, with debt in the low 3% range. Recent acquisitions are yielding more than 6% and 8% for development deals. So, HTA is able to generate accretive deal flow that allows it to generate predictable earnings growth in 2020 and beyond.

Analysts forecast HTA to grow FFO per share by 4% in 2020 and 2021.

HTA shares returned 24.6% in 2019, and they’ve returned around 9.4% annually since listing on the NYSE. We have a firm Buy rating on the shares today, recognizing their potential annual total return target as being around 10%.

Shares are now priced at $30.23 with a dividend yield of 4.17%. We also believe that HTA isn’t done with M&A. It has built an enviable footprint that will allow it to generate economies of scale over the next decade.

Price: $30.23

P/FFO: 18.4x

Dividend yield: 4.90%

Payout ratio: 76%

S&P: BBB

2019 total return: 24.6%

2020 FFO per share forecast: 4%

2021 FFO per share forecast: 4%

#7 – Ventas Inc.

Ventas (VTR) is a dominant healthcare REIT that’s seen shares pull back by more than 21% since Q3 19 earnings. Specifically, the Chicago-based REIT’s latest earnings report saw its SHOP (senior housing operating properties) segment decline by 5% based on SS NOI (net operating income).

SHOPs – specifically the U.S. segment that represents 25% of VTR’s revenue – was definitely the weak link in the chain and the primary reason that Ventas’ growth profile has slowed a tad.

Ventas did report positive SS NOI growth overall in Q3 19, courtesy of strong results in triple-net lease and medical offices. However, mid-line guidance for 2019 declined to -6% FFO growth and is expected to be flat for 2020.

Ventas narrowed its full-year FFO per share to a new range of $3.81 to $3.85.

Yet, here are the two reasons we remain bullish:

Ventas has a tremendous cost of capital advantage, with leverage of 5.9x (6.2 industry average), interest coverage of 4.3x (vs. a 3.1 industry average), and very strong credit ratings (BBB+ from S&P). Its balance sheet is tied for the best in the industry. That’s why VTR was recently able to sell 11-year bonds at 3% and refinance its already low-cost 4.25% debt.

Ventas has a strong scale advantage in which it can use its low-cost advantage to drive shareholder returns. Over the last decade, VTR has generated annual returns of 8.1%. Since listing, its shares have returned around 18.7% annually. We believe VTR is in much better shape today than it was a decade ago. That’s because it has spun out its skilled nursing assets to focus on more defensive sectors like MOB and life science.
Its short-term growth forecast isn’t as favorable as it could be, admittedly. Analysts forecast FFO per share to grow by -3% in 2020 and 3% in 2021.

However, we believe that, over the next decade, the company will be able to normalize the earnings profile to generate growth of 5% per year. Thus, we’re maintaining a Buy with shares now trading at $56.97 and a dividend yield of 5.56%.

Price: $56.97

P/FFO: 14.9x

Dividend yield: 5.56%

Payout ratio: 83% (based on FFO)

S&P: BBB+

2019 total return: 4%

2020 FFO per share forecast: -3%

2021 FFO per share forecast: 3%

#8 – Simon Property Group Inc.

Simon (SPG) is another “battleground” pick we’re holding for the long term. As some of you may know, we’ve become increasingly bearish in the mall sector. Recently, we downgraded a number of companies due to the fear of continued department store closures.

Our primary angst about mall REITs has to do with capital management and the fact that many of them are becoming stretched to pay out their dividends and deploy capex dollars into vacated properties.

The reason we believe Simon is a long-term winner, however, is because of its incredible scale advantage. As it states in its Q3-19 fact sheet, it “owns or has an interest in 233 retail real estate properties, including malls, premium outlets, and The Mills, comprising 191 million square feet in North America, Europe, and Asia.”

In addition, Simon’s best-in-class tenant portfolio generates annual retail sales of more than $60 billion. So, while we believe there will be continued store closures in 2020 and beyond, Simon has adequate diversification that helps mitigate risks.

Also, its balance sheet is rock solid. That much is evidenced by its $7 billion of liquidity and more than $1.5 billion of free cash flow after dividends are paid.

The company has a $1.8 billion redevelopment backlog – on which it expects to earn 8% cash returns on investment and another $5 billion in shadow backlog projects that should generate returns of 7%-8%.

We believe that it’s “highly likely” that Simon will complete an M&A deal over the next decade. The most obvious name to take over would be Macerich (MAC).

With that said, we’ve also suggested that Washington Prime (WPG) could spin off another REIT to further consolidate players in the sector. For example, it could absorb CBL & Associates (CBL) and Pennsylvania Real Estate Investment Trust (PEI).

But, regardless, Simon is an absolute “best in breed” mall REIT and a worthy candidate for this Top 10 list.

Shares now trade at $144.79 with a P/FFO multiple of 12x. The dividend yield is 5.73%. And analysts forecast FFO per share growth of 5% in 2020 and 4% in 2021.

We maintain a Strong Buy.

Price: $144.79

P/FFO: 12x

Dividend Yield: 5.73%

Payout Ratio: 69% (based on FFO)

S&P: A

2019 total return: -6.4%

2020 FFO per share forecast: 5%

2021 FFO per share forecast: 4%

#9 – Digital Realty Trust Inc.

Digital Realty (DLR) is a data center REIT we’ve owed since October 2013. Shares have returned 20.6% per year during that period, and we expect more good things ahead.

Since going public in November 2004, they’ve returned 9.8% per year. And since the end of the recession, they’ve returned 11.8% per year.

As mentioned above, we like owning shares in DLR and CONE because we believe they’re “best in class” names. And we’re always looking to optimize the “trifecta” of cell towers, data centers, and industrial properties.

Year-to-date, DLR has returned a less impressive 16.4% total return, thanks in large part to the recent news that it’s merging with InterXion Holding (INXN), a Netherlands-based information technology services company.

Although we consider this to be a highly strategic and complementary transaction, there’s always integration risk to consider. The $8.4 billion transaction is being structured as a stock-for-stock combination. INXN will own approximately 20% of the combined company, and DLR shareholders will own the remaining 80%.

Even though earnings growth could be challenging over the next few quarters as the integration progresses, DLR should be in a stronger position to capitalize on favorable growth trends across Europe.

This deal should close this year, and it’s expected to have dilutive impacts. We’re modeling 2020 FFO at $6.92 per share.

Analysts forecast FFO per share growth of 2% in 2020, and normalized growth of 7% in 2021. DLR pays a quarterly dividend of $1.08 per share, or $4.32 annually. And it looks to continue a very consistent dividend growth record in which it has raised it every year since 2015.

Shares now trade at $120.37 with a P/FFO multiple of 18.1x. The dividend yield is 3.6%, which is higher than CONE’s, and we expect shares to return around 12%-14% per year.

We maintain a Buy.

Price: $120.37

P/FFO: 18.1x

Dividend yield: 3.60%

Payout ratio: 65%

S&P: BBB

2019 total return: 16.4%

2020 FFO per share forecast: 2%

2021 FFO per share forecast: 7%

#10 – Federal Realty Investment Trust

Federal Realty (FRT) boasts the best REIT dividend record in the world. The shopping center-focused company has paid and increased its dividend for a whopping 52 years in a row now.

While nobody has the crystal ball to know if it can continue that record, we believe it’s highly likely that the company will continue that trend.

First off, FRT has an impressive collection of assets: A portfolio that includes 105 well-situated shopping centers. They total 24 million square feet of leasable space leased to 3,000 tenants in some of the most densely populated, fastest-growing and most affluent cities in America.

It also owns nearly 2,700 apartment units as part of its increasingly mixed-use portfolio. This gives it a tremendous scale advantage.

Its top 25 tenants make up 27% of its rental income and include some of the strongest and fastest-growing retailers in America. Think TJX Companies and Home Depot.

Secondly, FRT has an impressive balance sheet that includes a leverage ratio of just 4.3x. That’s one of the lowest of any REIT in the world.

This allows it to borrow at an average interest rate of 3.8% for 11 years – locking in the profitability of its redevelopment projects. The company recently sold $100 million in 10-year bonds at an interest rate of just 2.7%.

That should show the power of its A-rated balance sheet to drive interest costs down even lower.

In 2020, analysts forecast FFO per share growth of 3% and normalized 5% growth in 2021. Given its current valuation with a P/FFO of 19.8x and a dividend yield of 3.34%, we believe FRT could generate returns of 10%-12% annually over the next few years.

We maintain a Buy.

Price: $125.92

P/FFO: 19.8x

Dividend yield: 3.34%

Payout ratio: 65%

S&P: A-

2019 total return: 12.6%

2020 FFO per share forecast: 3%

2021 FFO per share forecast: 5%

In Summary…

As I mentioned above, we picked these 10 REITs based on their quality ratings and valuations.

We could have easily included names like Realty Income (O), Store Capital (STOR), Crown Castle (CCI), and American Tower (AMT) due to their quality and predictability. However, the purpose of this article is to provide readers with an “actionable” Buy list.

Companies like those just mentioned (i.e., O, STOR, AMT, and CCI) should be included on your watchlist. They can help fill in the gaps when and if shares become safer to own.

My point is to always invest with a satisfactory margin of safety.

We purposely picked these 10 REITs so that you – being the savvy investor you are – can begin to build a REIT portfolio based on a firm foundation. As illustrated below, we forecast these 10 REITs to return an average of 13.5% per year:

I decided to also put together a quick chart comparing REIT performance. Based on total return, it shows how they did over the last decade.

I left Urban Edge off the list since it’s fairly new. Though I did include HTA, CONE, and DOC from when they first listed.

However, the average total annualized return for these nine REITs is 10.3%.

Finally, recognizing that there’s a highly likely chance of a recession in the next few years, we didn’t include lodging REITs.

We believe that 20 REITs is a reasonable number of companies to own in a diversified portfolio – allocating 5% for each REIT. And by adequately diversifying, the investor can reduce risk without sacrificing returns.

By diversifying, you provide yourself with insurance so that, if one or two REITs blow up, they won’t severely impact your total return. For example, we have 2.2% exposure in Tanger in the Durable Income Portfolio, and that basket of REITs has returned 20.25% annually since August 2013.

We intend to utilize the above-referenced 10 REITs as the core for our all-new K.I.S.S. portfolio. And we’ll be adding an additional 10 REITs to iREIT on Alpha.

By carefully screening for quality and value, investors should be able to generate solid returns without reaching for yield. After all, as Frank Williams said, “There is only one narrow trail leading to permanent success in the stock market.”

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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Author: Brad Thomas

Source: Seeking Alpha: 10 Must-Have REITs To Own During The Next Decade

Summary

  • FedEx is Monmouth’s largest tenant with 55.8% of rental revenue generated from the logistics giant.
  • Although FedEx has underperformed, the rent checks are backed up by an investment grade-rated balance sheet.
  • Monmouth is well positioned to generate impressive returns in 2020.
  • Looking for a portfolio of ideas like this one? Members of iREIT on Alpha get exclusive access to our model portfolio. Get started today »

A few days ago, I co-produced an article with Dividend Sensei titled “3 Reasons It’s The Best Time In 10 Years To Buy FedEx.” As many of my loyal readers know, I purposely focus on the REIT sector. But from time to time, I will veer over into another sector such as energy, utilities, or other dividend-paying categories.

As an investor myself, I don’t subscribe to putting all my eggs in one basket. And for that reason – and because it broadens my personal investment knowledge – I enjoy writing on non-REITs as well.

In addition, I typically look to increase my knowledge of the REIT sector by writing on companies that help me become a more knowledgeable REIT investor.

Let’s face it: There’s always something new to learn… and to benefit from.

What I Learned About FedEx

By researching FedEx (FDX), I gained insight into its business model, including these takeaways, as noted in the above-referenced article:

  • FedEx has been having a rough 2019, missing earnings expectations in three of the last four quarters. That’s due to the cyclical nature of its business as well as a $5.9 billion investment program that it’s undergoing to improve efficiency and global delivery capacity.
  • The company also is rapidly investing in automating its global distribution centers, allowing existing workers to be far more productive and reducing per-unit delivery costs (long-term boost to profitability).
  • FDX also has been steadily winning market share in U.S. trucking deliveries and is now the industry giant. We don’t care about short-term hiccups. (We care about) management’s long-term track record in delivering good execution and steady market share and fundamental growth.
  • FedEx’s growth runway remains strong, and analysts agree that management’s 10% to 15% (compound annual growth rate) CAGR long-term growth guidance is reasonable – courtesy of a decades-long growth runway in global e-commerce.

Now, as I said, I like writing on companies that help me gain more insight into my circle of competence in the REIT sector. In this case, it helps me better understand Monmouth Realty (MNR), an industrial REIT with significant tenant exposure to FedEx.

As viewed above, Monmouth has around 55.8% of its rent generated from FedEx, broken down as:

  • FedEx Ground (50.1%)
  • FedEx Express (4.7%)
  • FedEx Trade Networks (1%).

Notably, Monmouth also has 6.8% exposure to FedEx’s new arch enemy, Amazon (AMZN).

Here’s what else you’ll want to know about it.

A Company Overview

Monmouth commenced operations in 1968 and began investing in FedEx-leased properties in 1992. While 50% concentration to a single tenant provides enhanced risk, Monmouth’s portfolio is well laddered. That provides a sense of security, as illustrated below:

In fact, Monmouth’s minimal rent rolldown risk – as observed in the lease renewals above – is supported by an average lease maturity of 7.6 years and average historical retention of 90%. It saw 100% of those renewed in both fiscal 2015 and 2016, 92% renewed in 2017, and 69% in 2018.

As for fiscal 2019, that number bumped back upward to 76%.

As illustrated below, Monmouth has the lowest rent rollover risk in the industrial REIT sector.

Given what we’ve observed with FedEx, including its strong investment grade-rated balance sheet (BBB by S&P), we don’t believe there’s a defensive black swan argument to be made here that it might stop paying rent. Moody’s affirmed its Baa2 senior unsecured rating thanks to its “significant global scale, strong brand, growing e-commerce volumes and cost flexibility.”

Now, Moody’s did state that FedEx’s “credit profile has been weakened by rising funded debt balances driven by a historically aggressive financial policy characterized by share repurchases that have exceeded free cash flow generation.” It added how it:

“… expects that FedEx’s cash flows will continue to be constrained by macroeconomic pressure from slowing global trade, cost pressure from the ongoing integration of TNT Express, and continued high levels of capital investment to improve efficiency to lower operating costs as e-commerce grows.”

Yet, as illustrated below, it appears that FedEx has ample free cash flow to continue paying its dividend. And analysts are forecasting enhanced growth in 2021 and 2022.

Prices and Pricing

Now let’s examine the price movement related to FedEx and Monmouth over the last 20 years:

As you can see, there’s notable correlation in terms of price volatility, as you’d expect in such a highly connected business situation. But let’s still compare the two-year price point below, with the red arrows representing Buy dates we had on MNR:

Source: Yahoo Finance

Now, I think it’s also important to mention Monmouth in terms of its peer classification. While clearly, the company is an industrial REIT, we believe that it’s more of a hybrid industrial/net lease REIT. That’s because of its longer-duration lease profile (7.6-year average maturity) and high concentration with investment-grade rated tenants.

Approximately 80% of its rental revenue comes from investment-grade tenants or subsidiaries, with a roster that includes:

  • Amazon
  • Anheuser-Busch
  • Beam Suntory
  • Coca-Cola
  • Home Depot
  • Keurig
  • Dr. Pepper
  • Shaw Industries
  • Sherwin-Williams
  • Siemens
  • Toyota
  • ULTA
  • United Technologies

Other high-quality companies.

So let’s take a 20-year look at it against industrial REITs like Prologis (PLD) and Stag Industrial (STAG) and net lease REIT Realty Income (O).

As you can see, Monmouth has underperformed Realty Income substantially, based on price alone.

It’s interesting to see that Realty suddenly flips to the underperformer in this regard. So let’s now take a closer look at fundamentals to determine our course of action as it relates to Monmouth.

Focusing on Fundamentals

For starters, current economic indicators look attractive for the U.S. industrial real estate sector – and Monmouth’s portfolio – due to rising GDP, e-commerce growth, limited new construction over the past eight years, and manufacturing growth.

Also, there are continued benefits to consider from the recently-completed Panama Canal expansion. A few months ago, Panama canal authorities announced that the entrepot welcomed a record 403.8 million tons (of shipments). That’s the largest amount of annual volume ever transited in its 103-year history!

As a result, industry analysts say the impact on U.S. ocean cargo gateways will soon become evident.

The Panama Canal currently serves 29 major liner services. This includes 15 Neopanamax operators primarily located on the U.S. East Coast-to-Asia trade route.

Chris Rogers, an analyst with the global trade consultancy Panjiva, notes that the diversion of Asian-inbound traffic from America’s West to East coasts “took a step forward” with Panama Canal expansion. Data shows shipments to southeastern ports increased by 26.9% over fiscal year 2016. Meanwhile, those to California rose just 7.7%.

As viewed below, Monmouth has a diversified portfolio of 115 buildings in 30 states. Its highest concentrations are in Florida, Texas, Indiana, Georgia, and South Carolina. So it should benefit from these changes.

Moreover, Monmouth was early in anticipating consumer spending shift from traditional stores to Internet sales. This now very evident and growing trend has led to significant demand for large, modern industrial distribution centers.

U.S. e-commerce sales are expected to rise 14% between 2018 and 2019 to more than $587 billion, which represents 11% of total U.S. retail sales. And Monmouth’s vast FedEx holdings represent an integral part of that ecosystem.

The Balance Sheet

Monmouth ended the fiscal year with $20.2 million in cash and cash equivalents. It also recently revised its unsecured line of credit facility, increasing its revolver from $200 million to $225 million.

There also was an additional $100 million accordion feature involved.

The revolver currently bears 3.21% interest, with around $215 million available if needed. With the accordion feature Monmouth therefore has around $340 million of liquidity.

As Monmouth’s unencumbered asset pool continues to grow so nicely, its financial flexibility increases too, further strengthening its credit profile.

Here’s a snapshot of its capital structure from 2015:

Monmouth has completed more than $1 billion in acquisitions over the past five years. It’s also more than doubled its portfolio GLA.

In fiscal 2018, specifically, it bought up seven industrial properties. Of those, 85% are net leased to investment-grade tenants or their subsidiaries, amounting to about 2.7 million square feet and accounting for about $282.3 million.

Then, in fiscal 2019, it purchased three properties that added up to around 824,000 square feet for $138.6 million. Again, those are all net-leased to investment-grade tenants or their subsidiaries.

And so far in fiscal 2020, the company has acquired one property. This one fills up around 616,000 square feet and costs $81.5 million.

As for the future, its current acquisition pipeline is looking decent as well. There are four new build-to-suit properties it has its eyes on that total 997,000 square feet. All those are – you guessed it – net-leased to investment-grade tenants or their subsidiaries, with FedEx taking up the bulk of that at 85%.

Those assets are currently estimated at a cost of $150.5 million.

The REIT Securities Portfolio
As some of you may recall, I wasn’t enthusiastic with Monmouth’s securities portfolio, eventually downgrading shares to a Hold. I still maintain that stance with the family-related UMH Properties (UMH). But I decided to upgrade month to a Strong Buy in July 2019.

As I explained,

“The potential impact of Amazon’s venture into shipping is much less severe than the media depicts, and that’s precisely how I feel about Monmouth’s overhang… and the reason I consider shares grossly mispriced.

“There aren’t too many Strong Buys in REIT-dom today, and Monmouth is an outlier worth owning. We maintain our Strong Buy with expectations that shares could generate returns of 25% over the next 12 months.”

As you can see, there has been no huge move since the upgrade. But here’s what Monmouth’s CFO said on the latest earnings call all the same:

“Historically, we have aimed to limit the size of our REIT securities portfolio to no more than approximately 10% of our undepreciated assets. As we announced earlier this year, it’s now our goal to opportunistically reduce the size of our REIT securities portfolio to ultimately be no more than 5% of our undepreciated assets. There have been no open market purchases or sales of REIT securities since this announcement was made.”

That’s promising news. At fiscal year’s end, Monmouth had $185.3 million in marketable REIT securities representing 8.7% of undepreciated assets. And REIT securities investments reflected $49.4 million in unrealized losses as compared to $24.7 million a year ago.

The Finer Details…

In the latest quarter, Monmouth’s funds from operations (or FFO) – excluding unrealized securities gains or losses – was $81.2 million, or $0.87 per diluted share. For the same period the previous year, it was $69.8 million, or $0.89 per diluted share.

Adjusted funds from operations (or AFFO) – which also excludes securities gains or losses – was $0.85 per diluted share for fiscal 2019 as compared to $0.87 per diluted share a year ago.

Monmouth’s rental and reimbursement revenues were $158.5 million, increasing 13.9% from the previous year. And net operating income rose 14.3% to $131.2 million.

Now let’s take a closer look at Monmouth’s performance by comparing FFO per share with the previously referenced peers:

As you can see, Monmouth is the only one to generate negative FFO growth. (Note: The comparison isn’t apples to apples though since we use MNR’s fiscal year vs. the other REIT’s calendar-year data.)

Also worth noting is Monmouth’s dividend performance, as shown above. That’s grown only three times since 1999, with the last increase happening in 2018. Compare that with its referenced peers, which are mostly generating steady dividend increases:

Admittedly, we would like to see Monmouth deliver annual dividend growth. As viewed below, it has a well-covered dividend that supports potential future increases.

Right now, analysts are forecasting modest growth of 3% for Monmouth in 2020:

And improved growth of 6% in 2021:

Can Monmouth Deliver Superior Growth in 2020?

Finally, let’s look more closely at Monmouth’s valuation.

As shown below, its dividend wasn’t fully covered in fiscal 2013, 2014, or 2015. It did begin rapidly growing AFFO per share then, up:

23% in 2016
9% in 2017
14% in 2018.
And while it did generate negative earnings in 2019 – remember that analysts have much more positive forecasts for the next two years. Also keep in mind that it has the highest overall occupancy rate among industrial REITs:

As illustrated below, it also has the lowest P/FFO multiple:

That’s why we’re maintaining a Buy. Monmouth is taking the necessary steps to divest its REIT securities, therefore eliminating overhang related to risky REITs such as CBL (CBL) and Washington Prime (WPG).

It also continues to source and acquire high-quality properties leased to investment-grade tenants.

Plus, Monmouth has never cut its dividend in more than 40 years. And while we’d like to see more consistent increases, management does seem to adhere to its “shareholders first” principles.

That’s why we’ve moved it back to a Buy, with a targeted 22% annualized return. The 4.7% dividend yield is well covered, and we anticipate a modest increase in 2020.

Clarification (12/31/2019 at 5:30): I decided to include an apple to apples total return comparison (dividends + price appreciation). As you can see below, Monmouth underperformed in the 9-year and 2-year examples (not 19-year and 5-year examples):

Glossary of Terms:

FFO: Stands for Funds from Operations = Net Income + Depreciation + Amortization – Gains on Sales of Property. This is the yardstick for measuring earnings for REITs.

AFFO: Stands for Adjusted Funds from Operations (non GAAP): FFO – Straight-Lined Rents – Recurring Capital Expenditure (or CAPEX) + Equity-Based Compensation + Lease Intangibles + Deferred Financing Cost

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.

Managing Risk Is What We Do Best

iREIT on Alpha is one of the fastest-growing marketplace services with a team of five of the most experienced REIT analysts. We offer unparalleled services including five customized portfolios that are doing extremely well in the moment – but are built to stand the test of time too.

Author: Brad Thomas

Source: Seeking Alpha: Monmouth Realty: 20% Total Return Potential In 2020

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

Many income investors today bemoan the fact that stocks have rallied so strongly since their December 2018 bottom (the worst correction in a decade). Back then the forward PE on the S&P 500 bottomed at 13.7, 15% historically undervalued, and a level not usually seen except during bear markets.

It’s Been A Great Year For Stocks, REITs and Brookfield Property:

Since then almost all asset classes, including REITs have stormed higher and many now fear that there are no high-yield bargains to be found. Brookfield Property (BPR)(BPY) has slightly outperformed REITs over this time period, yet still remains attractively valued today.

In fact, at a 23% discount to 2020’s fair value, it’s a strong buy, and one of my top REIT picks for 2020.

There are three reasons for that, including its safe 7.1% yield, its strong long-term growth prospects (5% to 8% dividend growth guidance), and the potential to enjoy 9% to 21% CAGR long-term total returns from today’s $18.5 price.

Reason 1: World-Class Assets Managed By The Berkshire Of Global Real Estate

Brookfield Property is available in two forms, BPY and BPR. BPY is a limited partnership run by Brookfield Asset Management and BPR is technically a subsidiary that owns all its core retail real estate assets.

However, in reality, these two stocks are economically identical, and the only difference is in how they are taxed.

Dividends are identical, and grow at the same rate. Most REIT investors will want to own BPR, which uses a 1099 tax form and pays unqualified dividends just like any US REIT.

BPY uses a K1 tax form, which brings with it deferred tax benefits, but more complex tax preparation. BPY is structured to avoid UBTI and be safe for retirement accounts like IRAs and 401Ks.

In this article, I’ll be referring to BPR but all analysis pertains equally to BPY which is essentially the same stock (their prices move in lockstep and are nearly identical).

BPR And BPY Are Economically The Same Stock

BPR/BPY pay BAM a hedge fund-like fee structure:

a 0.5% (of market cap) management fee, with a $50 million minimum

BPY also pays 25% incentive distribution rights (it’s structured similar to an MLP), meaning 25% of marginal distributions also go to BAM

There is a 1.25% performance incentive fee, for market cap growth over a hurdle rate of $11.5 billion

Brookfield’s total management fees are currently running at $130.4 million per year or 1.4% of total return. Management is waiving the incentive distribution rights it’s entitled to. If it were to stop doing so annual management fees would rise to $185 million or 2% of revenue.

Is Brookfield Management worth those fees? They’re worth every penny. And here’s why.

Brookfield Asset Management (BAM) is the world’s premier hard asset manager, with $511 billion under management in real estate, infrastructure, utility and renewable power funds and LPs. Brookfield has 120 years of experience with hard assets, making it one of the most trusted names in a rapidly growing industry.

Brookfield’s real estate track record stretches back 90 years, and in 2018 it bought Forest City (another REIT) for $11.4 billion, which also has been in commercial real estate (specializing in retail properties) for 90 years. That same year it bought OliverMcMillan’s assets, a leading national mixed-use developer specializing in apartments that will be added to many of its trophy assets.

Brookfield operates globally out of 30 offices on five continents.

It’s able to put together deals that BPR participates in, including its highly lucrative LP investments.

Brookfield Property owns 88% of BAM’s real estate assets, 85% of which are in its core office/retail property portfolio. These are what generate stable rent (operating cash flow) over time.

Management is striving for 95% long-term occupancy and 2.5% SS NOI growth, driven by strong lease spreads sustained by its $7 billion total development backlog.

It also wants to opportunistically sell $2 billion worth of GGP assets at a profit to pay down 20% of the $10 billion in debt taken on to buy GGP for $15 billion in 2018. That acquisition is how BPR ended up owning 8% of America’s Class A malls.

Its core properties are expected to generate 10% to 12% CAGR total returns over time. LP investments (15% of assets) are where Brookfield can consistently generate up to 20% or more returns.

The 259 office buildings BPR owns that generate 95% of office NOI comes from some of the largest metro centers in the world, such as NYC, Washington DC, Toronto, Houston, LA, Syndey, and London.

Q3 SS NOI growth: 2.5%

YTD SS NOI growth: 3.2%

average remaining lease: 8.1 years

average rent/market price: 95% (built-in catalyst for future growth)

Core Retail Statistics

Brookfield considers its GGP class-A malls to be its core retail properties, and those continue to do well. Occupancy in Q3 was 95% and management expects to close the year at 96% courtesy of 10 million square feet of new leases in YTD 2019.

The quality of its mall can be seen by its high sales per square foot ($787) which is rising steadily over time, as well as the $62.14 average base rent which is on par with Taubman’s (TCO) industry-leading figures and higher than Macerich’s (MAC) and Simon Property’s (SPG).

lease spreads (same property basis): 5.4%

total lease spreads: 2.4%

sales per square foot: $787 (vs $325 US mall average) + 5.4% YOY

Lease spreads have come down significantly in 2019 due to a larger than normal amount of retailers closing stores in 2019. Management is confident that lease spreads will improve significantly in 2020, citing little trouble replacing failed tenants with omnichannel savvy ones.

Results this quarter continue to be impacted by bankruptcies that took place since the beginning of 2018. These bankruptcies which should aggregate three million square feet have put pressure on our same-property NOI results, which were flat on a period-over-period basis. But significant progress has been made in re-leasing 75% of that space at higher rental rates. We expect this impact to only be temporary.

– Bryan Davis, CFO Q3 conference call (emphasis added)

The elevated number of bankruptcies has resulted in about 2% of its square footage going dark. But the quality of its assets plus a skilled leasing team has been able to release 75% of those vacant stores already and at higher rental rates.

Here are some examples of how the failure of big-box department stores like Sears (OTCPK:SHLDQ) and Macy’s (NYSE:M) is actually helping BPR’s malls become more stable sources of recurring cash flow

• Paramus Park, Paramus, NJ: Sears box replaced with grocer Stew Leonard’s

• Tyson’s Galleria, McLean, VA: Macy’s box replaced with Bowlero and Lifetime Fitness

• The Maine Mall, South Portland, ME: Bon-Ton box replaced with Jordan’s Furniture

• Market Place Shopping Center, Champaign, IL: Bon-Ton box replaced with Costco

• Oxmoor Center, Louisville KY: Sears box replaced with TopGolf

In 2020, BPR’s lease spreads on its core retail properties should rebound back to their historical double-digit rates, based on the fact that management has already completed 50% of next year’s re-leasing plan but over a year ahead of schedule. Those new leases have yet to start contributing to cash flow.

We continue to see a backlog of digitally native retailers who wish to open stores within our malls. Our biggest issue today is to decide which retailers to lease space to in the limited vacancy that we have available for them. We believe this will increasingly be a focus for our business as online and store-based retail converge.

Looking forward to 2020, we’ve established a leasing goal of over 8 million square feet in our retail business of which almost half is already completed.

Brian Kingston CEO

When asked about long-term SS NOI growth in the retail business, CEO Brian Kingston provided the following”

Our expectations overall, we should be — the NOI should be growing in the neighborhood of 2% on an annual basis.

2% SS NOI growth in retail is basically what analysts expect from Class A malls over the long term, and what Simon expects as well, including in 2019.

The bottom line is that BPR is a hybrid REIT and not a pure-play mall REIT. The malls it does own are among the best in the country, as seen by its fundamentals, which are set to get stronger in 2020 and far beyond thanks to management’s $7 billion redevelopment plan.

Brookfield’s track record on achieving its return targets is legendary, with the world-class management team achieving almost 23% CAGR returns thus far with its six private equity funds.

Brookfield’s ability to deliver 19% CAGR returns (across its entire empire) over the past 20 years is on par with the best investors in history.

Over the past five years, BPY has invested $5 billion into LP investments with BAM. Over the next five years alone it expects to average $900 million in annual cash inflows from rent and realized capital gains (from $1 to $2 billion in annual asset sales). YTD BPR’s share of dispositions is $1.45 billion and management thinks it will finish the year at the upper end of its guidance.

For context today BPR’s operating cash flow is $1.4 billion, meaning realized gains would boost its distributable cash flow by 62% over the coming years.

Today BPR’s FFO payout ratio is 91%, though that falls to 70% when you include realized gains from its portfolio. Management guidance is for the FFO payout ratio to decline to about 80% by 2022. Asset sale profits are expected to provide an extra safety cushion with a combined payout ratio of about 65%, on par with Simon’s current FFO payout ratio.

BPR’s asset sales have averaged 4% above estimated book value showing the management is being conservative and trustworthy with its financial accounting.

BPR’s long-term goal is to deliver 5% to 8% dividend growth for investors, and it’s achieved that courtesy of 5% FFO/share growth over the past five years, driving 6% dividend growth.

In the future management’s $7 billion growth backlog is expected to drive 7% to 9% FFO/share growth, supporting its 5% to 8% long-term dividend growth plans.

And should long-term rates fall even lower causing cap rates on commercial real estate to decline as well then BPR estimates its NAV/share would rise significantly.

Over the last 12 months, we have seen interest rates decline dramatically in the U.S. and Europe but are yet to see this reflected in the valuation of our assets. To put this into perspective, a 100-basis-point reduction in cap rates adds almost $20 per share to our NAV.

-Brian Kingston, Q3 shareholder letter

For context, Brookfield, which is very conservative with its book value, estimates its intrinsic value at $28.61. A $20 increase in NAV/share would represent a 70% increase in book value which would give Brookfield Property an incredible ability to repurchase its stock at a 62% discount rather than the 35% discount that’s currently available.

Why does NAV matter to REIT investors? Because it’s one of the principal ways REIT investors value stocks and any REIT that buys back shares at a discount to NAV automatically boosts book value per share (intrinsic value).

BPR/BPY has repurchased $500 million in shares so far, funded with asset sale proceeds. $30 million more is authorized and management says it plans to continue repurchasing stock at highly accretive prices.

Despite a strong asset performance, BPY shares currently trade at a discount. We therefore continued on the path of repurchasing shares this quarter, since we believe it represents an attractive investment opportunity for us. As a result, total purchases for this year now total over $500 million…

We’ve been fairly active in the market over the past quarter and continue to be into the fourth quarter and I’d expect, we will be over the course of the year as we have been in the past.

The only other thing to think over and above that is whether we do another substantial issuer bid as we did in January and I think that really is a function of where the share price trades versus other investment opportunities that we’ve got. But we’ll certainly continue to be very active on the normal course issuer bid.

Brian Kingston Q3 conference call

Basically, Brookfield Property represents ownership in some of the world’s premier commercial real estate, managed by some of the most talented value-focused investors in the industry.

The core properties alone are worth owning this REIT, whose 7.1% yield is among the most generous available among high-yield blue chips today. The LP portfolio’s $800 million in annual capital gains proceeds represents a cherry on top that should allow Brookfield to self-fund its growth plans while steadily repurchasing its stock at highly favorable valuations.

While buybacks and opportunistic investments represent two ways BPR can grow in the future, the biggest growth catalyst, and second reason I am so bullish on this REIT, is the long-term growth runway.

Reason 2: Strong Growth Runway Means Generous And Steadily Rising Dividends For Years To Come
In the first three quarters of 2019, Brookfield developed over 5 million square feet of office/retail space, realized $2 billion in asset sale profits, and invested $1.3 billion into new developments and acquisitions.

Brookfield Property has $5.1 billion in growth projects under construction right now that it expects to increase its book value by $1.75 billion. For context, its book value is currently $28.86, meaning the $3.5 per share increase in NAV from projects under construction would increase the intrinsic value of the stock by about 13%.

What is Brookfield planning to spend that $5.1 billion on? 67 million square feet worth of upgrades to its 150 class-A malls, or 45% of its total retail square footage.

Brookfield plans to add thousands of apartment units, hotel rooms, and millions of feet worth of office space to improve its already world-class facilities.

This redevelopment plan is designed to take advantage of the major secular trend of increased urbanization, both in the US and abroad.

Growing cities around the globe should be conducive to steady rental growth in both office and retail properties in the years and decades to come.

In the three examples above, management expects these mixed-use improvements to potentially result in $870 million in potential realized profits should it sell those malls later. Remember, that’s three malls out of the 150 that Brookfield currently owns.

According to a study by George Washington University, mixed-use properties, on average boost the amount of rent generated by malls by 75%, relative to traditional properties.

Including the potential projects Brookfield is considering, the total growth backlog stands at $7 billion, matched only by industry juggernaut Simon Property Group (SPG), another of my top conviction REITs for 2020.

Brookfield expects to earn 6.9% average cash yields on investment with its current backlog which would represent $352 million per year in additional operating cash flow.

Over the long term, Brookfield is guiding for FFO/share growth of 7% to 9%, with the current $5.1 billion backlog representing 25% FFO growth (about 5% CAGR) all on its own. 2% to 3% SS NOI growth, plus buyback accretion, is how BPR can realistically get to that 7% to 9% growth target.

To finance this ambitious growth plan BPR has $7 billion in liquidity available, matching Simon Property for both the largest access to low-cost capital and the largest growth backlog.

Brookfield has been using non-recourse, asset-level debt for over 30 years, including during the Financial Crisis, when credit markets slammed shut for almost everyone (though not BAM).

$46 billion worth of total debt gives it a leverage ratio of 7.1 on a consolidated basis but investors are only responsible for $2.5 billion or 5% of that (effective leverage of 0.4).

Similarly, the interest coverage ratio of 1.1 is actually 22 at the corporate level, 11 times greater than the 2.0 or higher that are considered safe for REITs.

That’s why Brookfield has a BBB rated balance sheet according to S&P and is able to borrow at an average cost of 4.4%.

Over the next five years, Brookfield plans to use retained cash flow and asset sale proceeds to repay $3 billion worth of non-recourse debt and reduce its debt/equity ratio from 55% to 45%. 50% is considered very safe for REITs, and 60% is safe.

OK, so now you know why I like BPR, but there is one final reason why I consider this 7.1%-yielding REIT to be a very strong buy for 2020.

Reason 3: One Of The Best Values In REITdom Creates Double-Digit Long-Term Growth Potential
There are many ways to value a company, and one popular method is to look at NAV/share or book value.

Brookfield is conservative with its NAV estimates, as seen by the fact that it consistently sells assets at a premium (4% in Q3 same as the five-year average). BPR’s book value is currently $28.61 and management thinks that continued low-interest rates could significantly increase that in the future (as will opportunistic buybacks that automatically increase NAV/share).

However, due to its complex corporate structure (including external management fees), and high use of non-recourse debt, the market has never paid book value of BPY/BPR.

Thus, to estimate fair value for this REIT I apply the historical metrics investors have actually paid for its fundamentals, including dividends, EBITDA and EV/EBITDA.

Yield

Current Price

2019 Fair Value

Approximate 2020 Fair Value

Discount To Fair Value

5-Year CAGR Total Return Potential

7.1%

$18.5

$23

$24

19% for 2019, 23% for 2020

9% to 21%

That’s how I estimate its fair value at $23 in 2019 and about $24 in 2020, based on 4% consensus EBITDA/share growth in 2020 per FactSet.

Classification

Margin Of Safety For 9/11 Blue Chip Stocks

2019 Price

2020 Price

5-Year CAGR Total Return Potential

Reasonable Buy

0%

$23

$24

4% to 16%

Good Buy

10%

$21

$22

6% to 18%

Strong Buy

20%

$18

$19

9% to 21%

Very Strong Buy

30%

$16

$17

11% to 23%

Current Price

$18.5

Based on 2020’s expected results BPR is currently a strong buy and offers the potential for strong double-digit long-term returns.

To model future returns I use the Gordon Dividend Growth model, which says total returns are a function of starting yield + long-term growth + valuation changes (mean reversion for individual companies).

This model has been relatively effective over 5+ year time periods since 1956 and is what numerous asset managers, including Vanguard founder Jack Bogle, have used for decades (the Dividend Kings as well).

BPR already sports one of the most generous safe yields on Wall Street so let’s look at its growth profile.

Management growth guidance: 7% to 9% CAGR

Historical growth rate (operating cash flow): 5% CAGR

Realistic growth range: 5% to 9% CAGR

Fair Value (for return modeling purposes): 2 to 3 times EBITDA/share (2.8 average since IPO)

For total return forecasting, I use a range that applies a company’s realistic growth range to its historical fair value range, based on the most appropriate metrics.

BPY has historically traded near 3 times EBITDA/unit but its historical EBITDA multiple range is two to three. For the conservative end of my total return potential range, I assume management will miss its guidance and deliver 5% growth, the same as its historical operating cash flow growth rate.

Then applying the very conservative 2 times EBITDA multiple we can see that BPR/BPY is still capable of 9% CAGR total returns, even if it grows significantly slower than management expects.

In case you think 9% return potential is weak, consider that most asset managers expect just 2% to 7% CAGR total returns from the S&P 500 over the next seven to 15 years.

The Gordon Dividend Growth model expects 4% to 6% CAGR returns from the broader market over the next five years.

BPR’s current yield, which is likely to grow at 5% to 8% over time per management guidance, is sufficient to likely outperform much weaker future returns from the S&P 500.

If management delivers the upper range of growth guidance, and the stock returns to the upper end of its fair value range, it could achieve 21% CAGR total returns.

My base case, for what I consider most likely, is 7% long-term growth (mid-range of management guidance), and a return to its historical 2.8 EBITDA multiple, generating 17% CAGR long-term returns.

But while Brookfield Property is one of the best REITs you can buy for 2020, that doesn’t mean it doesn’t have a unique risk profile to consider before entrusting it with your hard-earned money.

Risks To Consider

The biggest fundamental risks to Brookfield Property involve its heavy use of non-recourse debt. Right now, BBB-rated bonds are trading near their lowest levels in history, which means BPR should be able to lower its borrowing costs in the future.

However, as you can see BBB rated bond yields are highly volatile, rising and falling with economic and inflation expectations.

Currently, the bond market is forecasting low 1.75% long-term inflation, relatively in-line with the Fed’s 2.0% long-term target.

This means that low-interest rates are likely to persist for longer. How low? Well, since 1955, the average inflation-adjusted 10-year yield has been 2.33%.

If the bond market is correct and inflation runs at 1.75% over the next decade then a return to historical real treasury yields would mean 10-year yields max out at 4.1%.

However, there are also short-term rates to consider, because 30% of Brookfield’s debt is floating rate, and tied to LIBOR or the upcoming replacement for LIBOR. Floating rate loans are closely correlated to the fed funds rate.

Now, the good news is that Brookfield knows what it’s doing and has a good reason for using so much floating rate debt.

In part our decision around fixed or floating and this is true for malls or industrial or malls or office buildings, et cetera we try and match up the financings with our business plan.

So it just so happened, in this case, all of the malls that we refinanced this quarter either are transitional in nature where we’re spending some capital and we think there will be an opportunity to refinance again in a couple of years or assets where we’re looking to sell or bring in partners.

And so for that reason, we keep the debt terms a little more flexible.

In the fourth quarter, we were in the process of completing a couple of others. And they’re all going to be at fixed rates because they’re sort of longer-term hold. So, it’s more driven by the business plan of the assets than an interest rate call.

BPY CEO Brian Kingston

Brookfield uses short-term debt for assets it plans to sell quickly, but locks in low rates for assets it plans to retain and improve. However, the fact is that no management team is infallible and Brookfield is still taking a rather large bet about where short-term interest rates will be going.

The Fed is backing up Brookfield with the FOMC currently forecasting no rate hikes in 2020, and just one each in 2021 and 2022, respectively. The Fed’s long-term forecast calls for three rate hikes over the long-term meaning 2023 or beyond.

But there is always the risk that interest rate forecasts will change, such as if the economy continues to outperform long-term growth expectations. For example, the Fed’s forecast for three long-term rate hikes assumes 4.1% long-term unemployment.

According to the Atlanta Fed job calculator, just 105,000 net average new jobs need to be created to keep unemployment at 3.5%, the lowest level since 1969.

For context, we’ve averaged 180,000 average net jobs in 2018 and 205,000 over the past three months. And that was before the phase one trade deal was struck, which is expected to be signed in the first week of January.

What effect will the phase one trade deal have?

15% tariffs on $120 billion worth of apparel will fall to 7.5%

25% tariffs on $250 billion worth of intermediate goods stay the same

December 15% tariffs on $160 billion worth of apparel/consumer electronics are canceled

China agrees to buy more US imports (White House claims $50 billion per year, the actual amount to be determined by January 2020)

Phase two negotiations (surrounding IP protection and non-tariff trade barriers) to begin in early January 2020

Goldman Sachs estimates that phase one will boost US 2020 GDP growth by 0.2%, Jeff Miller 0.3%.

Goldman is forecasting 2.5% GDP growth next year (up from 2.3% pre-phase one), 3.3% unemployment and 3.5% wage growth (up from 3.1% today). Goldman’s unemployment and wage growth estimates might prove conservative now that corporate/small business/consumer confidence is likely to get a boost from phase one.

Unemployment Rate End Of 2022

Average Monthly Net Jobs Needed (Assuming Constant Labor Participation Rate)

1.0%

218K

1.1%

214K

1.2% (1944 record low)

209K

1.3%

205K (3-month average)

1.4%

200K

1.5%

196K

1.6%

191K

1.7%

187K

1.8%

182K

1.9%

178K (2019 average)

2.0%

173K

2.1%

169K

2.2%

164K

2.3%

160K

2.4%

155K

2.5% (1952, non-WWII record low)

151K

2.6%

146K

2.7%

142K

2.8%

137K

2.9%

133K

3.0%

128K

3.1%

124K

3.2%

119K

3.3%

115K

3.4%

110K

3.5%

106K

If the Fed is right that we won’t get a recession through 2022 (bond market puts 2021 recession risk at 25%) then very modest job growth could send unemployment much lower than expected. Those figures assume a constant labor participation rate (63.2% today) which has been trending higher since 2015.

In reality, unemployment isn’t likely to approach 1% or 2%, but it could very well challenge 1952’s 2.5% non-WWII record low over the Fed’s current forecast time frame. Non-supervisory wage growth (80% of workers) is running 3.7% YOY near the 50-year wage growth average of 4.0%.

If the economy does in fact grow around 2% over the next few years, then the Fed may end up having to raise rates a lot more than twice by 2022, possibly three or four times.

Would that threaten BPR’s dividend safety? Not likely, since a thriving economy would benefit its tenants and drive stronger SS NOI and cash flow growth. But depending on how rapidly inflation expectations rise, Brookfield’s short-term borrowing costs might increase faster than expected, generating a growth headwind that might cause its growth rate to come in at the lower end of its expected range.

In terms of valuation risk, BPR has little of that, given the significant margin of safety shares currently trade at. However, investors need to be aware that even though BPY/BPR has historically never been overvalued, it still experiences periods of intense volatility, far more than most REITs (a low beta sector).

Brookfield Property Peak Declines Since 2014:

Brookfield Property is actually still in a bear market right now that’s lasted 17 months, and it has experienced two corrections besides that over the last five years.

Over that time BPY has had a 25% higher beta than REITs and 31% higher standard deviation (i.e., annual volatility).

I don’t point out this historical volatility to scare you out of owning Brookfield Property. It is merely to highlight the fact that all stocks are volatile at times and thus prudent risk management is essential to sleeping well at night and avoiding costly portfolio mistakes (like selling during corrections or bear markets).

These are the risk management guidelines we use in managing all my portfolios.

Since 1945 we’ve experienced a 5+% pullback/correction/bear market, on average, every six months.

Pullbacks/corrections are a healthy and normal part of the market cycle and help keep bear markets rare (once per decade, usually during recessions) by keeping valuations from becoming dangerously inflated.

Today the S&P 500 is trading at a forward PE of 18.6, about 15% historically overvalued, according to JPMorgan Asset Management.

That level of overvaluation means that pullback/correction risk is now elevated, though we can’t know when the next one will start.

That’s because valuation explains just 10% of 12-month returns, rising to 46% over five years, and 90% over 10+, according to Bank of America and Princeton studies.

The point is that we’re very likely to get a pullback/correction sometime in 2020 and BPR/BPY can be expected to decline just like most stocks. Anyone considering this REIT needs to size their position according to their risk tolerance. MY recommendation is 5% to 10% of your portfolio, leaving sufficient room under that cap for opportunistic future buying.

Bottom Line: Brookfield Property Is One Of The Best REITs You Can Buy For 2020 And Far Beyond
Despite the strongest year for stocks and REITs since 2013, something great is always on sale. In this case, I consider Brookfield Property, in both its forms, to be one of the best high-yield blue chip REITs you can buy for next year, and far beyond. That’s due to:

A world-class management team, with 90 years of experience in opportunistically buying, improving and selling commercial real estate at impressive profits

a collection of premier trophy properties that will be improved via a $7 billion growth backlog

access to a mountain of low cost capital ($7 billion in liquidity, sufficient to finance 100% of its growth backlog)

a safe 7.1% yield that’s likely to grow 5% to 8% over time

23% discount to 2020’s fair value

9% to 21% CAGR long-term return potential (17% CAGR base case)

While no stock is without its risks, I consider Brookfield’s margin of safety high enough to make it a strong buy for 2020, and thus one of the best REITs you can buy for next year.

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.

We’re Raising Prices in 2020…Act Now!
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Source: Seeking Alpha: 3 Reasons Brookfield Property Is One Of The Best REITs You Can Buy For 2020

It has been just under 12 weeks since I first wrote about Broadmark Realty Capital (BRMK).

Hailing it as “a new commercial mortgage REIT with a targeted 12% dividend yield” – and one that’s paid monthly, at that (something my regular readers recognize I’m very interested in) – I made it clear how intriguing I found this brand-new entity.

My introductory paragraphs on the subject went like this:

“As my readers know, I rarely recommend REITs that offer a double-digit dividend yield. It’s these high-yielding stocks that too often fall flat… though only after turning otherwise intelligent investors into speculators, hypnotizing them by the glare of fool’s gold.

“In fact, I’ve become increasingly more bearish about these opportunities over the years. And although I didn’t coin the term “sucker yield,” I frequently use it to warn readers away from higher-risk securities.

“Today, however, I’m going to provide you with a new name that could become well known in the REIT arena. This particular stock does have a high dividend yield, it’s true. But from what I can tell so far, it’s truly differentiated by design.”

Today, I have some updates to share on the company. But first, for those who didn’t read the article above, let me explain exactly what I meant with that opening.

An Impressive Company Overview

Meet Broadmark Realty Capital, a real estate-minded financier that’s finishing up its first decade of being in business. On its website homepage, it bills itself as a group of “experienced lenders of commercial loans, construction loans, and land loans.”

Just a scroll or two down, it also describes itself as being a hard-money lender specializing in “construction loans designed for real estate investors and developers who require quick closings, outside-the-box thinking, a high loan-to-value, and the utmost professional service.”

Moreover, it has “originated over 1,000 loans with an aggregate face amount of approximately $2.0 billion.”

In other words, Broadmark is pretty well established by now. It has a successful track record of raising capital privately for real estate lending. And that in turn provides it with impressive financial growth opportunity for itself.

Plus, it’s a very big deal that it does all that with zero debt.

As in zip. Zilch. Nada.

Are you starting to see why I’m impressed with it?

Now, when I first covered it back on Sept. 11, Broadmark was not trading under the ticker BRMK. It was only in the process of combining with Trinity Merger Corporation – a special purpose acquisition company, or SPAC – with that end goal as a determined result.

As I explained in my initial article, “Their combined aim is to form a publicly-traded, internally-managed mortgage REIT with an expected equity value of $1.5 billion.”

I also quoted Trinity on its Aug. 13 joint investor call with Broadmark as saying:

“The Broadmark Group maintains a competitive advantage in the marketplace through its proven lending process and its proprietary network of borrowers and capital providers. It is a highly profitable lender that enjoys multiple avenues for sustained growth across existing and new markets.”

We can’t help but agree.

A Company That Knows Where It’s At

Both before and since the merger, Broadmark has had a good grasp of the U.S. market. That much is evidenced by its four main office locations in Rockville, Maryland, Denver, Colorado, Seattle, Washington, and Atlanta, Georgia.

Yet it doesn’t go just anywhere the wind blows it. Broadmark makes sure to target areas with strong migration rates over high-cost states like New York and California. It knows where its most savvy clients will be, and so that’s where it goes as well.

One of the many reasons it stands out is how it doesn’t just believe in getting business. It believes in cultivating and keeping it. As a result, it’s developed a network of more than 500 borrowers, with many of them proving to be loyal repeat customers.

At last check, about 65% of the loans it issued as recorded in its Pyatt Broadmark Real Estate Lending Fund II have been to repeat borrowers.

Its differentiated approach also is worth highlighting. In fact, it’s worth re-highlighting as well, considering how I shared this same information in the September article.

Broadmark conducts its business with “an alternative, unlevered, credit-focused strategy that generates a double-digit yield with limited correlation to broader equity capital markets.” That results in:

  • A successful track record of raising capital privately for real estate lending, providing significant growth opportunity to generate additional fee income
  • A high-quality, unlevered, double digit-yielding portfolio that supports book value
  • An attractive 16% average unlevered fixed-rate yield that provides earnings stability
  • Targeted loans with short-term maturities that provide multiple benefits

For that reason, and so many more, I promised to keep you updated on Broadmark’s progress. Consider this the beginning of that promise.

Broadmark’s Management Sounds Just as Good as Its Business Looks

I always like to touch base with management whenever possible. It’s true that reading reports and looking over financials is an important part of what I do. However, there’s nothing quite like hearing it from the corporate horse’s mouth.

With that philosophy in mind, I made sure to reach out to management earlier this month.

It was shortly after the company announced its successfully completed merger and official debut on the New York Stock Exchange. And while I didn’t want to overwhelm anyone right after such an epic change, I figured that the company’s executives were big boys and girls who could more than manage their schedules.

Sure enough, they were ready to talk, providing me with a great exclusive interview, which I then shared with my own exclusive audience over at iREIT on Alpha, my Marketplace subscription service.

To get the full set of questions and answers, you’ll still have to subscribe there. But I did want to share certain parts of the interview here on my free page as well.

It was an extremely good talk, starting with the explanation I got of its management structure.

According to my new inside source, the new REIT is internally managed, which is precisely what I like to hear. That way, it can provide the best quality consideration to everyone involved: Company, customer, and shareholder alike.

It’s an automatically positive indication of where it’s headed in the near future. Since I also asked about that though, here’s what it had to say:

“We have not yet provided guidance for 2020 but believe we have capacity to leverage our lending platform to grow by raising additional private real estate lending companies where it would receive management fee income.”

So far, so good. And here’s more of where that came from…

Broadmark Knows Its Bread and Butter

When I asked for Broadmark’s take on today’s business climate and demand for new construction, here’s what it said:

“Real estate investment is a capital-intensive business that relies heavily on debt capital to acquire, develop, improve, construct, renovate, and maintain properties.

“Due to structural changes in banking, regulation, and monetary policies over the last decade, there has been a reduction in the number of lenders servicing this segment. Broadmark believes there is a significant market opportunity for a well-capitalized real estate finance company to originate attractively priced real estate loans secured by the underlying real estate as collateral.

“Broadmark also believes that the demand for relatively small real estate loans to construct, develop, or invest in residential or commercial real estate held for investment located in states with favorable demographic trends presents a compelling opportunity to generate attractive risk-adjusted returns for an established, well-financed, non-bank lender.

“Historically, regional and community banks were the primary providers of construction financing to smaller, private builders. Over the past several decades, there has been significant consolidation within the commercial banking industry – with the number of commercial and savings institutions having decreased by 59% and 71%, respectively, since 1992, as reported by the FDIC.

“In addition, many traditional commercial real estate lenders that have competed for loans within Broadmark’s target markets are facing tighter capital constraints due to changing banking regulations following the 2008 financial crisis.”

That’s quite the long, detail-driven answer, I know. But it’s understanding those kinds of details that matter to a company’s ultimate success, which this one definitely does.

Then again, I suppose that’s to be expected of a team with this one’s past successes and future promises.

We’re Initiating a Buy on Broadmark Realty
During the interview, I also asked:

  • How the company was capitalized
  • Whether it offered a dividend reinvestment plan, or DRIP (it doesn’t at this time)
  • What its exact target markets were
  • Whether former Trinity shareholders had to take any action in order to maintain their positions in the newly formed company.

After everything was said and done, I felt more than confident to initiate a Buy. This is a solid stock with a lot of opportunity in front of it.

As such, Broadmark expects to see core earnings per share (or EPS) growth – specifically from new investments in-balance sheet loans and assets under management (or AUM).

“… we estimate 2020 dividends totaling $1.14 per share,” I concluded in the exclusive article. “We are establishing a price target of $12 per share, which is based on shares trading at 130% of book value. We will add BMK to our commercial mortgage REIT coverage.”

(Based on annualized dividend income of $1.14/sh BRK yields ~ 10.5%.)

In other words, stay tuned. I look forward to giving you some very positive updates in the near and longer-term future!

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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Author: Brad Thomas

Source: Seeking Alpha: Broadmark Realty: A High-Yielding, Monthly-Paying REIT We’re Buying

Let’s talk about millennials. And let’s hold off on any instant opinions you might have on the subject for these first few paragraphs.

We want to start off with facts first, not feelings. Or at least as close to the facts as we can possibly get. Admittedly, finding out certain figures isn’t always easy.

For example, when you search for “how many millennials are there in the U.S.,” don’t expect a universal answer.

The first hit, at least on Google, is from Wikipedia. Of course.

You don’t even have to click on the link to see that (allegedly):

“In a 2012 Time magazine article, it was estimated that there were approximately 80 million U.S. millennials. The United States Census Bureau, using birth dates ranging from 1982 to 2000, stated the estimated number of U.S. millennials in 2015 was 83.1 million people.”

Scroll down past that, and you’ll find a second result, this one from the much more reliable Pew Research. Last year, it said that, “Millennials, whom we define as ages 20 to 35 in 2016, numbered 71 million…”

And just two months ago, CNN wrote that this particular generation was born between 1981 and 1996 – though it’s “sometimes listed as 1980-2000.”

Clearly then, the number of millennials all depends on how you define the cut-off ages involved. For better or for worse.

Breaking Bad Stereotypes
No doubt on the “worse” side of what it’s like to be a millennial is plentiful – and not at all flattering – stereotypes older generations (and even some Gen Zers) want to label them with.

For instance, millennials are called “snowflakes” who can’t handle reality. And “everyone” knows they all live in their parents’ basements and spend their days online, trolling people on Twitter.

Unfortunately, there does seem to be at least a little something to that unflattering depiction. For the record, don’t blame me for saying that. My millennial editor is the one who provided me with the following Business Insider headline from July 2019:

“Meet the average American millennial, who has an $8,000 net worth, is delaying life milestones because of student loan debt, and still relies on their parents for money.”

Ouch!

The article does go on to declare that most millennials are “actually financially savvy.” But it also actively admits that:

“There’s no way around it: The average American millennial is financially behind.

Faced with a high cost of living, staggering student loan debt, and the fallout of the Great Recession, American millennials are trying to make ends meet in the midst of The Great American Affordability Crisis.”

Apparently, “the generation overall is plagued by financial problems that baby boomers didn’t have to face at their age.” It’s hardly the most pleasant picture of 71-83 million people. But I guess that’s just how the cookie crumbles.

Sometimes…

Then again, sometimes it doesn’t crumble that way. Sometimes it doesn’t crumble at all. That’s why I’m going to draw your attention to a key adjective in that Business Insider headline: Average.

Because there are definite exceptions to that rule. And they’re more than worth noting.

Millennials Who Are More Than Making It
Actively fighting the stereotype described above are the 619,000 American millionaires who are apparently out there. That figure comes courtesy of yet another Business Insider article, this one published this month.

Here’s how the article begins:

“There are 618,000 millennial millionaires in America, and they’re sitting on a nice pile of assets. Think a net worth ranging from $1 to $2.49 million, three properties, and a BMW. That’s according to a new report by Coldwell Banker.

“The Coldwell Banker Global Luxury program worked with wealth intelligence data and research firm WealthEngine to analyze the lifestyles of millennial millionaires, from wealth creation and property investments to spending trends. It defined millennial millionaires as those ages 23 to 37 with a net worth of more than $1 million.

“The report found that the average millennial millionaire is married, lives in California, and is on the hunt for real estate that is affordable and within walking distance of the center of action.”

In which case, I like how these young-ish 40 millionaires think. Though, based on the description above – and throughout the rest of the article – I think they can do better with what they’ve got.

I’m more than happy to point out how.

Now, naturally, as pointed out in the last article segment, this generational subcategory largely owns their own homes. As well they should.

That’s a very important investment to make, to be sure. Moreover, many of them own more than one. And those might be great investments as well.

But personally owning physical property should be the mere start of a beautiful, lasting, productive love affair with real estate.

There’s so much more to go from there – particularly through a portfolio bolstered by real estate investment trusts, or REITs.

The REITs to Make the Most of Your Millennial Million

Crown Castle (CCI) is a cell tower REIT that should benefit from the growth in 5G. In our view, wireless connectivity has become more of a utility status and deserves to be covered as more of a critical mission infrastructure classification. With this sector, we see little impact with regard to political headwinds as we consider the asset class highly defensive with a firm “go-go grow” representation.

The main reason to own cell tower REITs (and data center REITs) is because we see no slowdown in demand, regardless who the next president is.

Over the years Crown Castle has delivered outsized growth – averaging 9.5% since 2016 – and steady dividend increases (of around 8%-9% per year). Shares are now trading at $131.11 with a dividend yield of 3.66% and given the more recent pullback, we have moved the company from a Hold to a Buy Watch. The dividend is well covered (76% payout ratio) and the BBB- rating is adequate for the company to optimize its cost of capital to scale the business model.

American Campus (ACC) is a campus housing REIT that millennials can appreciate. While it’s true than the parents are generally on the hook for the rent, college students recognize that room and board is an essential part of the college experience, and somewhat recession proof.

As Hoya Real Estate Capital explains: “over the past decade, student housing REITs have built a stellar reputation as the leaders in student housing development and the stalwarts of the public-private-partnership model.” American Campus recently updated FFO per share by raising the midpoint by $.02 per share. The company said that the raise was “driven primarily by better core performance, including better than anticipated operating performance year-to-date, improved seasonal occupancy performance in the spring and summer months facilitated by the advancement of our next-gen systems and business intelligence initiatives, and our performance from our 2018 and 2019 developments.”

We believe this sub-sector of residential housing is often overlooked by mainstream investors, and given the steady dividend growth profile, we expect to see more growth ahead. Analysts estimate that FFO per share will grow by around 5% per year and that the company can grow its dividend by the same rate. Shares now trade at $46.96 with a dividend yield of 4.0%. Given the more recent pullback, we have moved the company from a Hold to a Buy watch.

Digital Realty (DLR) is a data center REIT that in our view has one of the widest moats in the category. The company has been able to utilize its impressive balance sheet to deliver powerful economies of scale. The company enjoys a BBB rating with weighted average debt maturities of over six years and a weighted average coupon of 3.2%. Around 99% of debt is unsecured, providing the greatest flexibility for capital recycling.

The company recently announced it was combining with Interxion “in a highly strategic and complementary transaction that 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.” Digital expects to refinance Interxion debt assumed in the transaction with a combination of investment-grade corporate bonds and proceeds from other financings.

In the near term the transaction is said to be dilutive, but the company pointed out that it should provide “significant financial benefits” as the “combined company will have a global presence in 44 metros across 20 countries on six continents with an enterprise value of approximately $50 billion, nearly five times the size of the next largest competitor.”

The market was less receptive. Shares have pulled back around 6%, moving us from a Buy Watch to a Buy. Digital also has an impressive growth model, and that includes FFO per share of around 7% to 8% annually, with a well-covered dividend 65%. Shares now trade at $116.66 with a dividend yield of 3.70%.

Vici Properties (VICI) is a gaming REIT that has become the consolidator in the sector. The company was formed in 2017 as a result of the spin off of Caesars Entertainment (CZR) and today the company has 32 assets in 18 markets. Year-to-date the company has announced and closed the ~$558 million of acquisition of JACK Cincinnati, the $278 million pending acquisition of the Century Portfolio.

In 2030 VICI is forecasted to generate around $1.2 billion of net operating income, and by utilizing a 6% cap rate (Bellagio sale to Blackstone is 5.75%), we believe shares could be valued at $20 billion. After debt of roughly $6 billion – that translates into an equity valuation of $14 billion. And divide that by 500 million shares, and VICI could fetch $28 per share.

The stock is trading at $24.58 per share with a dividend yield of 4.8%. The P/FFO multiple is 15.1x, and given the price appreciation year-to-date (of ~25%) we have moved the company back from a Strong Buy to a Buy. We still like the growth prospects of the company that includes steady dividend growth. The company paid a dividend of $0.2975 recently (based on an annualized dividend of $1.19 per share), representing a 3.5% increase from the prior annualized dividend.

Simon Property (SPG) is a mall REIT that’s our top “Millennial Millionaire” pick. The company is a leader in the sector defined by best-in-class malls that generate sales per square foot of around $852. As CEO David Simon pointed out on the Q2 conference call those basic stats fail to take into account just how strong its property portfolio really is.

“We have over 77 properties; that’s right 77 properties that if you average their total sales will be over $900 a foot. So 77 over $900 a foot, and you can see that clearly as our report retail sales on an NOI weighted basis of $852.” – David Simon”

The average US malls generate about $325 sales per square foot and Simon’s malls are more than double that and, on a weighted NOI basis, nearly triple the industry norm.

Simon also has a quality balance sheet with around $6.8 billion in liquidity (second highest of any REIT in America behind Brookfield Property) and $1.5 billion in annual retained cash flow. The company recently announced a dividend of $2.10 per share, a 5% increase year-over-year.

Simon has grown the dividend more than 8% over the last few years and the dividend yield is now 5.4%, more than 325 basis points higher than the 10-year Treasury. The dividend also is well covered (more than 1.5x) and the company has paid out roughly $30 billion in dividends since going public.

We maintain a Strong Buy, recognizing that the company has ample cash flow to manage through the current retail cycle. While we anticipate more store closures in 2020 and beyond, we believe Simon is capable of growing its cash flows and dividend. Shares trade at $165.42 with a P/FFO multiple of 12.9x.

“I know multi-millionaires that do whatever they want, whenever they want because their business model is mobile and has nothing to do with an elevator or swiveling chair.” Richie Norton.

Author: Brad Thomas

Source: Seeking Alpha: The Millennial Millionaire’s REIT Portfolio

A common mistake investors and analysts can make is to assume that companies in a peer group are highly similar. This can be especially true in the net lease area.

After all, net lease companies aren’t real estate companies in the purest sense. They don’t entitle or develop properties. They’re not focused solely on limited geographic footprints. And they are more leanly staffed, with no need for on-site property management personnel.

The thought is that these corporate entities are often in the business of buying properties and going from deal to deal.

Enter Store Capital

In May 2011, after leading two successful prior net lease companies, CEO Chris Volk – together with Mary Fedewa, Cathy Long, Michael Bennett and Michael Zieg – opened the doors of a new REIT called Store Capital (STOR). One of their primary goals in this was to establish five strategies. And, sure enough, they’ve adhered to those ever since. Starting with this one…

First and foremost, Store’s investment strategy is restricted to profit center assets or “single tenant operational real estate.” That’s the inspiration for its name: STORE. The essentiality of profit center assets is simpler to gauge because of the availability of unit-level profit and loss statements that support net lease contract seniority over most other corporate obligations.

Second, Store originates its own investments. Essentially, it’s a developer of net lease contracts. Approximately 80% of its quarterly investments result from direct client relationships. And virtually all its investment activity is though net lease contracts created by the company.

The third strategy is to focus its investment origination efforts on middle-market and larger companies that are bank-dependent. For those types of businesses, real estate net lease contracts are debt and equity substitutes, making net lease decisions more optional.

Store’s fourth pillar is to try to restrict investments to assets that meet one or more of the following qualifications:

It’s purchasable at or below the cost to rebuild.
It delivers property-level financial statements.
It has strong contractual alignments of interest such as master leases.
It has initial yields and gross rates of return in excess of those available in the broader auction broker market.

And fifth, Store compiles a highly granular investment portfolio. It looks to have as little investment correlation as possible in order to target aggregate investment-grade performance.

It’s been almost five years since Store went public in November 2014. Since that time, it’s increased its dividend per share by a sector-leading 40%. And it’s delivered a total average annual rate of return of nearly 20%.

At the same time, the company has raised its dividend protection by lowering its payout ratio. That combination is no doubt part of why it now counts luminary names like Berkshire Hathaway, Fidelity and Wellington among its shareholders.

Yet somehow, despite its strong share performance… Store’s price/AFFO (adjusted funds from operations) ranks number six of its public peer group.

A Store of Consistency

Store Capital’s adherence to its investment approach has resulted in impressive origination consistency.

With average originated property lease terms ranging from 15 to 20 years, over the past eight quarters, it’s generally maintained new investment primary lease terms between 16 and 20 years.

Consistent newly originated lease terms are one byproduct of a direct origination strategy. So are longer lease terms, which has helped Store maintain its peer group primary lease length leadership position. Given concerns of a potential recession, longer lease terms will be more defensive.

One way to look at companies’ ability to grow this way is through the amount of lease intangibles capitalized on their balance sheets. Lease intangibles result from investments in property that are acquired – subject to an existing lease and amortized over the primary term of that lease.

And Store’s lease intangibles are among the lowest of net lease market participants.

Over the past eight quarters, its direct origination platform has delivered… with an investment average of more than $130 million a month and average transaction sizes of just under $10 million – together with an impressive number of transactions, averaging more than 40. This consistency lets it maintain the highest level of portfolio diversity within our universe of net lease participants.

Improving Financial Metrics

When Store went public, it stated a leverage target of 6X-7X funded debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization). That and a single BBB- investment-grade rating.

Early in its history, it relied on its A+ rated secured borrowing conduit for term borrowings. That involved the creation of a highly flexible, 70% leveraged real estate master trust – a structure pioneered by Chris Volk in 2005 and copied by a number of its competitors since then.

Store Capital continues to use this asset-backed financing tool, believing in the importance of borrowing source diversity.

In October 2018, it issued its first AAA-rated master funding notes to a leverage of 45%… with 25% additional notes to an A+ rating to equal the 70% overall conduit leverage. By the summer of 2017, it had earned BBB corporate credit ratings from all three credit rating agencies. That allowed it to start lowering its leverage target to 5.5X to 6X, where it’s been ever since.

That level of borrowing amounts to a debt-to-investment cost of approximately 40%. This means that unencumbered assets – which are now about two thirds of all the company’s assets – have the lowest leverage among the net lease peer group at around 25%.

Store continues to blend borrowing sources, currently offering the lowest cost of debt, followed by its unsecured corporate BBB-rated debt. Not only has it been consistent in its stated borrowing strategy since its public listing… but it’s among the best-laddered corporate borrowing maturities in its peer group set.

Its master trust helps maintain those relatively even maturities, permitting a wider borrowing variety. They’re also pre-payable at par for between two to three years in advance of their maturities. This offers Store added flexibility.

Currently, average maturities fall below annual expected corporate free cash flow in every year. (I’m including retained corporate cash flow and proceeds from regular asset sales in that calculation.) That’s unusual for any REIT, lessening corporate interest rate sensitivity.

Stalking the Goal

Earlier this year, Chris Volk authored an article in Seeking Alpha entitled “Real Estate Moneyball.” In it, he described Store’s shareholder return goal, writing this:

“My goal became to realize equity rates of return that exceeded our long-term cost of equity estimate and thereby to also be a leader in realizing compound MVA (market value added) growth. Billy Beane wanted to buy wins. I wanted to buy market-leading compound MVA growth. More than that, I wanted to be a leader in realizing risk-adjusted outperformance.”

For the past two years, Store has done something unusual for a REIT. It’s included pages in its corporate quarterly presentation devoted to current comparative investment equity returns and compound annual market value added growth. Recently, Institutional Shareholder Services has placed increasing emphasis in realizing rate of return in excess of corporate costs of capital that contribute to MVA growth, with Store rating in the upper quartile.

Store Capital’s MVA creation has been driven foremost by the consistently high spreads achieved by its gross cap rate – defined as the cash investment yield for new investments made during the quarter, plus the accompanying annual equivalent lease escalations – over its cost of borrowings.

Notably, the company has staked out a sector-leading compound annual MVA creation. And it’s done that while not ranking near the top of the sector in terms of traded price/AFFO multiples. This illustrates that Store’s potent business model has important margins of safety that permit sector-leading shareholder value creation over a variety of traded multiples.

Ben Graham would have approved of this discipline, which may be why his protégée, Warren Buffet, has made Store Capital his singular REIT investment.

I own shares in STOR.

Author: Brad Thomas

Source: Forbes: An Intelligent REIT By Design

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