In my recently published book, The Intelligent REIT Investor Guide, I explain that “the most conservative investors – those seeking quality and safety above all else – are prone to buying blue-chip REITs.”
My book was actually dedicated to my friend and mentor Ralph Block and with his family’s permission I reused Mr. Block’s definition of a blue-chip REIT, as he explains certain qualities that set them apart, such as:
- Outstanding proven management that’s familiar with the demands of real estate ownership and operation, and the quirks of public markets
- A track record of effective deployment of available capital to create shareholder value
- Balance sheet strength and flexibility
- Sector focus and deep regional or local market expertise
- Conservative and intelligent dividend policy
- Good corporate governance
- Meaningful insider stock ownership.
Once again, citing my new book I explain that “the true test of quality comes when the going gets rough. That’s when excellent property management, superior asset location, admirable leasing skills, and strong access to capital make an obvious difference.”
Would you consider rising rates, record inflation, and a war in Ukraine to be choppy waters?
I went on to explain,
“When markets soften – meaning there’s more sellers than buyers – strong companies retain their tenants at much better rates, thus minimizing cash flow erosion.
They’re also in better positions to take advantage of opportunities to pick up sound, well-located properties at bargain prices – that can then be put back on track to produce excellent returns for shareholders.”
As seen above, REITs are down over 16% year-to-date, a long way from the double-digit returns we forecasted in early January.
Yet, Q1-22 earnings results for most REITs in our coverage spectrum were good to great, as many are on track to deliver double-digit earnings growth this year.
We’re not just fishing for all cheap REITs though, at iREIT on Alpha we’re most interested in owning shares in quality names, specifically blue-chip REITs.
As noted above, one of the defining attributes of a blue-chip REIT is its balance sheet, and it’s also highly correlated to other characteristics such as outstanding management, dividend policy, and a record of effective capital management.
Simply put, the balance sheet is what separates the best from the rest.
“Prudent financing strategy includes a firm commitment to maintain low leverage, mitigate refinancing risk by matching debt and asset maturity, rely on unsecured debt as a general rule, and manage interest rate risk using fixed-rate debt…A safe and growing dividend is mandatory to acquire a blue-chip label.” (quoted from my book).
As seen below, we screened the for all of the A-rated REITs using our iREIT Tracker:
As you can see below, all of the REITs, except for PS Business (PSB) has generate negative returns year-to-date. Remember PSB is being acquired by an affiliate of Blackstone (BX) in an all-cash transaction valued at approximately $7.6 billion.
As you can see below, many of the high growth names – Equity Residential (EQR), AvalonBay (AVB), and Camden Property Trust (CPT) – are still somewhat expensive to buy right now. Also, we’re watching Public Storage (PSA) as it is moving closer to fair value.
By process of elimination, this leads us to our listicle-style article today in which we will highlight three A-rated REITs that we’re buying hand-over-first.
Simon Property Group (SPG)
SPG is a mall REIT that owns an interest in 199 income-producing properties in the US, which consists of 95 malls, 69 Premium Outlets, 14 Mills, six lifestyle centers, and 15 other retail properties in 37 states and Puerto Rico.
SPG also owns a 80% noncontrolling interest in The Taubman Realty Group, LLC, which has an interest in 24 regional, super-regional, and outlet malls in the U.S. and Asia. Internationally the company has ownership interests in 33 Premium Outlets and Designer Outlet properties primarily located in Asia, Europe, and Canada.
SPG also owns a 22.4% equity stake in Klépierre SA, or Klépierre, a publicly traded, Paris-based real estate company, which owns, or has an interest in, shopping centers located in 14 countries in Europe. SPG’s top in-line tenants include (based on ABR):
- The Gap 3.0%
- Tapestry, Inc. 1.7%
- Victoria’s Secret 1.6%
- Signet Jewelers 1.5%
- PVH Corp. 1.5%
SPG’s top department tenants include (based on SF):
- Macy’s 11.0%
- JC Penney 5.1%
- Dillard’s 3.6%
- Nordstrom 2.3%
- Dick’s 2.3%
SPG’s quality score (92) is validated by the fortress A-rated balance sheet (A-/A3), with liquidity of approximately $8 billion, ~$1 billion of free cash flow, and a well-staggered debt maturity schedule.
This means that SPG should be sufficiently well-positioned to capitalize on the “opportunity” to buy back its stock (announced a new buyback given the discount and signaled it is ready to enter the market to commence buybacks as soon as permissible) and increase its dividend (to $1.70 per share, a 3% increase). The payout ratio is 58% (based on FFO).
SPG is now trading at $116.78 per share with a P/FFO multiple of 9.9x (compared with the normal valuation of 16.7x). The dividend yield is now 5.8% and analysts are now forecasting FFO (per share) to decline modestly (-2%) in 2022 and increase (+4%) in 2023.
Demand is strong and occupancy is rising, as per management most of this leasing will not impact cash flow until 2023-24, given tenant occupancy timelines and free rent burn-off, and is a catalyst we are actively monitoring. Although management dismissed the Westfield US opportunity, we would not rule out M&A for this mall monster REIT. iREIT forecasts SPG to return 20% over the next 12 months.
Prologis Inc. (PLD)
PLD is the global leader in logistics real estate with a focus on high-barrier, high-growth markets. The company owns investments in properties and development projects expected to total approximately 1.0 billion square feet in 19 countries.
PPD leases modern logistics facilities to a diverse base of approximately 5,800 customers principally across two major categories: business-to-business and retail/online fulfillment. It is the undisputed king of the warehouse industry and the top customers include:
- Amazon 4.8% of Net Effective Rent
- Geodis 1.4%
- FedEx 1.3%
- DHL 1.2%
- Home Depot 1.2%
- GXO 1.1%
Around a month ago we explained that “Prologis is a stock that we’ll always be looking to buy when shares trade at or below fair value. However, we’d need to see an extreme sell-off for that to occur and therefore, right now.”
Mr. Market delivered…
PLD shares have dropped over 21% since our last article, primarily because of the news that Amazon was seeing slower growth. AMZN is racing to meet demand even though shoppers are venturing more outside the home and returning to a pre-lockdown sales trajectory.
Once again, PLD collects rent checks and this 20% decline in price provides us with an opportunity to scoop up shares.
PLD has 97.6% occupied in the U.S., 98.4% occupied in other Americas, 97.8% occupied in Europe and 94.6% occupied in Asia.
Last year (Y21), Prologis recorded $4.76 billion in revenue even with the supply chain issues and a worldwide pandemic. They persisted through an increase in demand and continue to increase their square footage across the world.
Chairman and CEO Hamid R. Moghadam includes in his “Chairman Video” that Prologis has an abundant “land bank” that could provide another $28 billion in projects if built out today showing a safe long-term opportunity for investors.
A few days ago, PLD sent a letter to James B. Connor, Chairman and Chief Executive Officer of Duke Realty (DRE) proposing to acquire Duke Realty in an all-stock transaction and based on PLD’s closing price (on May 9th) represents a premium of 29% to DRE’s closing price on the same date.
A few days later DRE said that the latest $24 billion offer from PLD was “virtually unchanged” from prior proposals and is “insufficient”, though the company still remains open to exploring ideas.
This news shows the strength and attractiveness of the market for warehouses as well as the strength of PLD’s fortress balance sheet. The company flexed its financial muscle during the Q1-22 raising cash at an extremely low rate.
“During the first quarter, Prologis and its co-investment ventures issued $2.6 billion of debt at a weighted average interest rate of 1.5%. This activity includes $1.6 billion in green bond raises. The company has maintained its leading liquidity position with approximately $6.8 billion in cash and availability on its credit facilities.”
PLD’s low cost of capital certainly plays a role in its consistent growth. The balance sheet remains strong with 4.7x Debt/Adj. EBITDA excluding development gains (-40bps q/q). During Q1-22, PLD and its JVs issued $2.6B of debt at a weighted average interest rate of 1.5%, including $1.6B of green bonds. PLD has $6.8B in cash and availability. Regarding the overall debt load on its balance sheet, the company said,
“As of March 31, 2022, debt as a percentage of total market capitalization was 13.5%, and the company’s weighted average interest rate on its share of total debt was 1.7% with a weighted average term of 10.0 years.”
Because of the strong Q1 results and a positive outlook in the logistics space moving forward, PLD management increased its 2022 guidance during the Q1 report.
Previously, the company was calling for net earnings to come in a range of $4.40-$4.55 during 2022. The company’s prior core FFO guidance called for a range of $5.00-$5.10. Now, PLD is expecting to see net earnings of $4.85-$5.00 and core FFO of $5.10-$5.16.
PLD is now trading at $128.35 per share with a P/FFO multiple of 30.9x (compared with the normal valuation of 27.6x). The dividend yield is only 2.5% but it’s also easily covered by the 60% payout ratio (based on FFO).
Analysts are forecasting PLD’s FFO to grow by 24% in 2022 and 10% in 2023 and we forecast shares to return 24 % over the next 12 months. Stay tuned with regard to DRE…
Realty Income (O)
I save the best for last, O, O, O, it’s magic you know…
O is a net lease REIT that was established in 1960 and listed shares in 1994. The company owns a portfolio of over 11,000 properties in 50 states and Europe and it has paid an increased dividends for 28 years in a row and is considered a Dividend Aristocrat.
O has one of the most diversified platforms in the REIT sector, with over 1,000 customers in 60 different industries. Around 94% of total rent is resilient to economic downturns and/or isolated from e-commerce pressures.
Although the company has exposure to gyms (4.7%) and theaters (3.4%), it managed to grow earnings (or AFFO per share) during the worst of Covid-19. O is one of just three net lease REITs that was able to grow AFFO (per share) during that time.
O has generated 5.1% historical (median) growth since 1996, stronger that the historical growth rate vs. REITs (3.9%) and the company has generated positive earnings growth in 25 of 26 years, with modest annual downside volatility of 2.8%.
Moreso, O has a proven track record of maintaining 5%+ earnings CAGR since listing regardless of size, and earnings growth has accelerated as portfolio real estate value crossed $10 billion: 6.4% AFFO/share CAGR since 2012.
Recently O announced a new deal, that will also become a new category: the company is purchasing the Encore Boston Harbor (Encore) Resort and Casino for $1.7 billion at a 5.9% cash cap rate. The transaction is consummated under a 30-year triple net lease with favorable annual escalators.
O’s exposure to the gaming sector is expected to be < 3.5%, preserving prudent diversification and also demonstrates the growth profile of the business model. O’s entry into the gaming industry demonstrates that its growth opportunities are unconstrained by industry, property type or geography.
O also has a fortress balance sheet, rated A3 by Moody’s and A- by S&P, and the company entered 2022 from a position of strength with a net debt to annualized pro forma adjusted EBITDAR of 5.3x, with ample liquidity to capitalize on acquisition opportunities, with around $1.5 on the revolver and $259 million in cash.
Recently the company announced it had declared its 622nd consecutive common stock monthly dividend ($0.247 per share, representing an annualized amount of $2.964 per share payable on May 13th).
There are 19 analysts in the pool with an average growth forecast of 8.6%. The dividend yield is 4.5% and the payout ratio is in great shape at 76%. We maintain a BUY for O with a 12-month total return target of 20%
We believe that most all investors should own blue-chip REITs, especially during times like these.
We continue to recommend an overweight allocation to cheaper blue-chip names, recognizing that they are best positioned to navigate risks that include rising rates, inflation and global instability.
Also, all three of these REITs are diversified geographically (outside of the US), which is also an important risk mitigator.
In short, these 3 blue-chip REITs are hard to beat!