REITs- Why are they priced so low?

[frommi]

 

Trying to look at KRG, KIM, BRX, RPT, REG, and STOR this weekend, with a view to tying to figure out who has best combination of shareholder/management alignment of interest, exposure to neighborhood centers and grocers, and lowest leverage. 

 

 

Read the latest CEO letter from STOR. (link: http://ir.storecapital.com/interactive/newlookandfeel/4553160/STOR_2017_CEO_Letter.pdf) While the others are surely more discounted, i think that STOR might be the best long term play. I choose BRX from the rest of the pack because they are the most discounted and it looks like they are doing the right thing with asset sales and share buybacks. (And their re-lease spreads are high, at least in the presentations.)

*EDIT* And BRX is selling their worst performing locations for a 7.8% caprate but the whole REIT trades at a 8.5% caprate, i think that shows how discounted it is right now.

[lessthaniv]

Any thoughts on WELL?

 

Seniors housing is sure to grow with aging boomers.

[CorpRaider]

I haven't looked at them, but I know there has been some financial distress among their tenants (I think some of them are owner-operators, right?).  I would be concerned about the reliance on the single payer (medicaid) and debt trends.  Also, I would expect the market to have fully discounted the fact that there are going to be lots of old boomers.  Let us know if you find anything interesting.

[Spekulatius]

Any thoughts on WELL?

 

Seniors housing is sure to grow with aging boomers.

 

This doesn’t matter if reimbursements for operators don’t grow. I also suspect there is a lot of wage pressure for operators as well. They don’t tend to pay nurses and skilled personal well, so if the labor market improves, those folks move on.

[StevieV]

I put WELL and KIM on my watchlist a month or two ago, near when this thread started.  I am not convinced that REITs are SO cheap.  At the end of the day, I think a simple yield + growth in yield formula gives you a reasonable idea of potential returns.

 

I think retail real estate is going to be challenged for obvious reasons.  Overbuild of retail, failing brick-and-mortar stores and, of course, interest rates.

 

WELL I see as in a good industry.  It still has to be sufficiently cheap to be attractive.  I am having trouble quickly pulling up dividend history and growth rates because of the ticker change.  However, they are yielding 6.7% now.  To be attractive, I think they need to be growing the yield at least 4%.  More than that to be "cheap."  They are cheaper than when I first put them on my watchlist.  Maybe they are getting into the attractive range, but I think not a screaming buy.

 

KIM is more in the teeth of potential problems.

 

[thepupil]

I think KIM and BRX are getting interesting down here @ 8-9% cap rates w/ lots of long term leases w/ groceries and very termed out debt / pref in the case of KIM (40% of debt/preffered is 2045 - perpetual). Continued dispositions inside of or in line w/ the overall implied cap rate confirm that stock is at discount to private market value as they are selling off the tail assets in the portfolio. KIM is at a 43% discount to JPM's NAV. The private market will continue to weaken based on what these stocks are doing and the outlook for retail is pretty shitty, but at a point these are worth a buy. Have a 3% position in KIM and will probably add a little BRX.

[CorpRaider]

I had an order in for BRX, but it didn't quite fill.  I'm probably going to start with BRX and KRG.  In addition to my VER, that is.

[EricSchleien]

Also been buying LAACO over the past few months (control 163 units as of now). Really interesting company, and I agree, it's quite cheap.

 

My family owns rental (commercial) property in Los Angeles and cap rates are been squeezed down to nothing (2-4%)

 

By contrast you can buy 5-7% out of state but in little podunk towns w/triple net leases.

 

Then the stock market multiple REITs selling at 10-11x AFFO and around 5-7% dividend.

 

I've been holding VER (ARCP formerly. All properties verified and 99% occupancy. It sells abt 10-11x AFFO and has a 7% dividend. This stock i understand why its low (Nick Schorsh legacy, lawsuit hanging over company etc)

 

Then you have KIM (kimco) selling at 11x AFFO, 7% dividend. 95%+ occupancy. Has positioned itself as Amazon resistant.

 

What is contributing to such a big pricing/yield gap between private transactions and public REIT transactions?

 

REITS historical undeperformance against sp500 index?

Hot money flying toward tech stocks?

REITs too boring?

Amazon?

 

Curious to see what the board thinks....

 

I've written a bit about my experience in the last 10-15 years about figuring out "paying up for quality".  In short, the NYC and CA assets are higher on the quality spectrum and they rightfully deserve a lower cap rate.  Although, I disagree that you should pay 2% for anything. 4% is on the expensive side of reasonable for CA in my humble opinion.  Often time when you buy a high yield in the middle of lower, you're paying for the long term lease, you're not paying for the dirt and the replacement value.  If the existing tenant leaves upon lease maturity, you oftentimes can't get a similar tenant.  This is especially true in a smaller market where your building maybe 5% of the market. 

 

I personally think that interest rate risk is very real.  Assume you have a REIT that is 50% LTV, due to low interest rates, it trades at a 4% dividend yield.  Bc of higher rates, people demand a 5% yield. Two things will happen, first the cost of debt capital will go up when the debt matures.  Second, people now demand a higher dividend yield.  Third, the bank may want to maintain a 50% LTV but the value of the assets have moved against the REIT.  So, the REIT may have to put up more capital.  All of these factors makes levered REITs a really good investment when interest rates drop but terrible one when rates increase.  I am convince that this applies for companies trading at 20 P/FCF with substantial debt on them as well.  Unless you're a REIT that can grow out of these issues, you're going to have some tough going ahead.  We own FRPH and we know that FRPH will face some cap rate expansion headwind, but the FFO will be minimally impacted due to higher interest rate cost.  We own some LAACOs as well.  It is a severely under followed and under discussed name in Southern California and San Diego trading at 7.5-8.0% cap rate plus a free Downtown LA building.  The amount of debt is roughly $50mm versus a private market value that is in the 6-700mm range. 

 

Just to walk through that 50% LTV REIT excercise (this exercise applies to privately owned assets as well) - F

$1.0 bn asset with 50% LTV with 6% cap rate

$60mm in NOI less $10mm in G&A equates to $50mm in EBITDA

$500mm of debt at 4% equates to $20mm of interest expense

This equates to roughly $30mm of FFO and we assume 80% payout which equates to $24mm at 4% dividend yields a market cap of $600mm

 

Now that interest rate is 1% higher

Still $50mm of EBITDA because the assets still generate the same cashflow

$500mm of debt at 5% equates to $25mm of interest expenese

This equates to roughly $25mm of FFO and we still assume 80% payout which equates to $20mm at a 5% dividend yields a market cap of $400mm

 

This is how a 50% LTV REIT can logically lose 33% of its value in a 1% movement in interest rate.  This is also the reason why I've avoided RE companies with a lot of leverage.  FRPH and LAACO both have leverage below 10% of their private market value.  FRPH has non-recourse leverage at one of its multi-family building in DC, but that's a 10 year fixed mortgage.  So we view that a little differently. 

 

We've held a lot of cash because in a world where 3-4% interest rate is normal and cap rates in the 3-5% is normal for certain type of assets, a 100 bps movement is seismic.  This applies to both real estate and anything that trades at 20x FCF or higher.       

[Spekulatius]

The increasing cap rate issue become even more severe when there are secular headwinds like with retail properties. B malls trade at a much lower multiple than C malls and if a property drops from the B mall into hr C mall bucket, the cap rate could go from 7 to 10% easily.

 

That is why I am not sure, if stocks like KIM are really cheap. Yes, they do trade at a discount to NAV, but is the discount really 43% like the report above mentions suggest. We know that they dispose of properties for a 7.5-8% cap rate and KIm trades at an implied 8.5% cap rate. Well, at least optically, that is not much of a discount. Of course , KIm claims that they are selling their lesser properties, but what if the bucket of clunkers constantly gets refilled, due to the issues with retail?

 

It is not a gamble that I would be willing too take, given where I think retail is going and considering the fairly high leverage of even Reits considered to be well financed like KIM.

[DTEJD1997]

Hey all:

 

I suspect there are a LOT of things going on in the REIT space....

 

1). Some REITS are most definitely mis-priced.  There is opportunity here.

 

2). Some areas of REITS are having trouble AND are going to have trouble going forward.  Retail is one of these...especially lower grade malls.

 

3). Interest rates have gone up, and are going up for the foreseeable future.  Rising rates equals lower asset values.

 

4). Some REITs have to rollover debt on a pretty much constant basis.  Credit is becoming more expensive.  What happens if underwriting criteria tightens?  What happens if credit markets constrict or even close?  Trouble for REIT's.

 

5). I am sure there is some form of herd mentality going on.  Fund managers in NYC suddenly think that AMZN is going to take over the grocery industry.  They (and those they associate with) shop at WFM...so they think everybody else in the country does this.  Reality is that WFM has maybe 1% market share?  So they double and go to 2%?  Hardly a wipe out of the grocery industry.

 

6). Some REITs were probably mis-priced in the past in that they were "too expensive". 3- 4% cap rate?  I don't care how high quality that property is, that is simply too low a rate of return.  Now that share price has gone down, things that were too expensive to begin with have come to a more reasonable rate.

 

Interesting things are going to take place in this area, that is for sure!

[thepupil]

The increasing cap rate issue become even more severe when there are secular headwinds like with retail properties. B malls trade at a much lower multiple than C malls and if a property drops from the B mall into hr C mall bucket, the cap rate could go from 7 to 10% easily.

 

That is why I am not sure, if stocks like KIM are really cheap. Yes, they do trade at a discount to NAV, but is the discount really 43% like the report above mentions suggest. We know that they dispose of properties for a 7.5-8% cap rate and KIm trades at an implied 8.5% cap rate. Well, at least optically, that is not much of a discount. Of course , KIm claims that they are selling their lesser properties, but what if the bucket of clunkers constantly gets refilled, due to the issues with retail?

 

It is not a gamble that I would be willing too take, given where I think retail is going and considering the fairly high leverage of even Reits considered to be well financed like KIM.

 

Stifel provides a NAV range of 6-7% cap rate ($~18.25 - $23.50 / share) versus stock @ $13.33 (~8%) w/ an additional $1.00+/share or so in RAD/Albertsons stake. So that's a 25-45% discount at 6-7% OR a like a 0% discount at 8%.

 

February 20, w/ stock @$15.25 Valuation:

Shares currently trade at a 7.7% implied cap rate. Our $20.75 NAV estimate is based on a 6.5% cap rate. Our NAV range of $23.50-$18.25 reflects a cap rate range of 6.0%-7.0%. Our current NAV values KIM’s Albertsons investment at book or $140 million($0.33/share). If we were to incorporate the value of KIM's ownership stake using valuation estimates of $448 million and $574 million,our NAV at a 6.5% cap rate would increase to $21.50 and $21.75, respectively, all else being equal

 

https://www.reuters.com/article/us-usa-property-kimco-realty/kimcos-u-s-asset-sales-show-gap-in-public-private-market-prices-idUSKBN1HO2X6

 

the way i see it is "don't be a hero but start to buy" time in REIT land broadly. KIM sold 5% of its buildings (but like 2% of its EV) in the first quarter. and has another 3.8% of EV under contract. If you are buying the whole thing at 8% and they're selling the crap at what i regard to be a very decent clip at 7- 8%, that's great, in my view.

 

I broadly agree with you that the bottom probably keeps falling out of the bottom x% of assets a quarter. But the (so far) very liquid private market is allowing them to exit at a decent clip (~7% of EV in sales planned for this year). the recycling / will cause NOI / FFO to decrease, but will also increase the remainder in quality over time. the company sees overall NOI over the next few years increasing as developments/re-developments come online.

 

KIM has ~25% of ABR in the top 5 metro areas in the US (85% in top 50). I see no properties on loopnet w/ decent anchors in these markets at anything close to an 8% cap rate and some what look to be reasonable comps at a 4-5% cap. REG (higher quality) trades at about a 6%.

 

I mean here's an Old Time Pottery Petsmart Dollar Tree in far-out Orlando for 8%. When I go through a loopnet search with >$10mm, shopping center/retail, and sort by cap rate, high to low, there's simply not that many in a state for above 8%. There are some, but they all feel lower quality than what the public REITs own. I encourage those more knowledgable than I wrt commercial real estate to provide some counterexamples.

http://www.loopnet.com/for-sale/fl/multiple-property-types/?sk=5beec26afc6872519f91cf90ad800554

 

the description of the properties as well as the trends in all measures of portfolio quality indicate to me that they are indeed selling their worst assets and have been culling the portfolio for a number of years. they went in to the crisis extended and complicated and have been simplifier/upgraders for years.

 

2008:  As of December 31, 2008, the Company had interests in 1,950 properties, totaling approximately 182.2 million square feet of gross leasable area (“GLA”) located in 45 states, Puerto Rico, Canada, Mexico, Chile, Brazil and Peru.

 

2017: As of December 31, 2017, the Company had interests in 493 shopping center properties (the “Combined Shopping Center Portfolio”), aggregating 83.2 million square feet of gross leasable area (“GLA”), located in 29 states, Puerto Rico and Canada. In addition, the Company had 372 other property interests, primarily through the Company’s preferred equity investments and other real estate investments, totaling 5.8 million square feet of GLA.

 

KIM has about $4B of debt due over the next 10 years, $0.5B of which is well above market rates (luckily this is the stuff due in 2018-2020). So $3.5B has risk from rising rates starting in 2021 (3 years out). Seems very manageable. In fact, discounted purchases the $2.2B of very high duration 2045+ unsec's and pref's could be a significant offset to rising rates.

 

An immediate 200 bp increase on that $3.5B would increase interest cost by $70mm over a course of 10 years (~11% of 2017 FFO), but it'd also cause $2.2B of liabilities to trade at about $63 (assuming constant credit spreads on the unsec's / pref's).

 

[no_free_lunch]

Anyone follow OHI?  I am new to them myself and no position.  The basic thesis is a health care REIT which has ran into problems with some of it's hospital operators.  There was a small pullback in ffo, I think around 10%.  As a result the stock has pulled way back and it is now yielding over 10%.  They do have a history of raising their dividends,  think they quadrupled the dividend over the past 15 years.  However, they are not without issues as in the late 90's they ran into some type of stress and the stock and dividend got hit.  Overall I still have a lot to learn about management and the history.

 

The payout ratio to ffo is around 83% so the dividend is reasonably safe.  Some of the complaints are around it being dead money but then you are getting paid 10%.  I think it's fair compensation.

 

The industry seems like a mixed bag with positive demographics but then the government trying to lower costs.

 

Still just something I am thinking about.

[CorpRaider]

Did a little update since it was ~ 90 days since I first looked at the retail REITs. 

 

Damn Brohams...

 

I hope you all loaded UP on BRX and KIM (and KRG and CBL!!!)!

[thepupil]

Did a little update since it was ~ 90 days since I first looked at the retail REITs. 

 

Damn Brohams...

 

I hope you all loaded UP on BRX and KIM (and KRG and CBL!!!)!

 

My highest cost lot (Feb 2018) is up ~17% and lowest cost lot (April 2018) is up 30% in Kimco, overall +24%; it is a low conviction small position that is part of my basket of similar NAV stories.

 

Kimco has outperformed Berkshire by ~30% (+25%, -5%) over the past 3 months and is trading at close to the sell side's lower end of NAV estimates. There's still upside (trading to NAV, market recognizing some level of platform value in terms of financing advantage, etc). I think the fattest part of the trade is over and am kind of disappointed with the move up in REITs in general (they've gone from ~15% discount to PMV to ~5% overall) in that it looked like we had a very interesting opportunity forming, but I don't see any screaming bargains right now. I bought a fair bit of Forest City following the disappointment / no sale announcement (which confirmed PMV in the mid $20's) and now Brookfield is rumoured to be interested again and it's at $23 and it's not that interesting. Sold my FRPH @ $62, deferring to superior knowledge of the security and blindly following the Mr. Chen's advice on VIC.

 

The problem with small discounts to NAV / intrinsic value (small being defined as 20-40%) is that when things go up 15-25% they don't have a ton of upside beyond the compounding of intrinsic value, which for most of these things isn't at that high a rate. I personally don't find many a 50 cent dollar or multi-year compounder and am somewhat content to slum it in 70 cent dollar / low rate of compounding land, but it definitely has its annoyances. Probably selling some KIM soon to add to my already huge hedged Berkshire position.

[frommi]

The problem with small discounts to NAV / intrinsic value (small being defined as 20-40%) is that when things go up 15-25% they don't have a ton of upside beyond the compounding of intrinsic value, which for most of these things isn't at that high a rate. I personally don't find many a 50 cent dollar or multi-year compounder and am somewhat content to slum it in 70 cent dollar / low rate of compounding land, but it definitely has its annoyances. Probably selling some KIM soon to add to my already huge hedged Berkshire position.

 

Why do you think that something like KIM doesn`t compound as fast as BRK? BRK bookvalue growth was around 10% (without tax reform) over the last decade, with a 6.4% dividend yield KIM just has to grow NOI/dividends by 3.6% to match that. Don`t you think that is a pretty low hurdle?

[thepupil]

The problem with small discounts to NAV / intrinsic value (small being defined as 20-40%) is that when things go up 15-25% they don't have a ton of upside beyond the compounding of intrinsic value, which for most of these things isn't at that high a rate. I personally don't find many a 50 cent dollar or multi-year compounder and am somewhat content to slum it in 70 cent dollar / low rate of compounding land, but it definitely has its annoyances. Probably selling some KIM soon to add to my already huge hedged Berkshire position.

 

Why do you think that something like KIM doesn`t compound as fast as BRK? BRK bookvalue growth was around 10% (without tax reform) over the last decade, with a 6.4% dividend yield KIM just has to grow NOI/dividends by 3.6% to match that. Don`t you think that is a pretty low hurdle?

 

well, management is guiding to 1.5-2% NOI growth and I don't really see the overall environment for strip/power centers getting much better, so I'm not sure if 3.5% growth is a "pretty low hurdle"; there are real issues in retail RE. At low teens I thought KIM was starting to price in some deterioration in economics of owning this type of stuff. I'm not convinced that deterioration is not happening (everyone seems to be developing/upgrading their way to quality, which illustrates that over time assets deteriorate and that some of these centers face obsolescence risk).

 

In general, all else equal, I'd consider a portfolio of businesses assembled by Warren Buffett to have better re-investment opportunities, intrinsic rate of compounding, etc particularly on a risk adjusted basis; I think NAV for Berkshire is in the $220-$250 range so it's not like you're paying a premium or even full value (I think most of Tilson's assumptions are reasonable). And all else equal I'd own much more Berkshire at the same discount to NAV; Berkshire gives me a warm and fuzzy feeling and I'll own some forever. Berkshire is a wife. Kimco is a one night stand, for me at least. I will probably err on the side of underestimating the ultimate upside. I mean one can dream and point out that KIM traded at 3.5% dividend yield not long ago.

 

EDIT: also, REITs do have a fair bit of drag from management overhead over time, whereas Berkshire's "expense ratio" would be measured in basis points

[gokou3]

Who is making money from struggling U.S. malls?

https://www.reuters.com/article/us-usa-malls-investment/who-is-making-money-from-struggling-u-s-malls-idUSKBN1JM17V

[LR1400]

I don’t agree with no middle at all. That’s bs.

 

That may be the case for development but not investing.

 

Middle area and middle income allows value add and most consistent and largest renter base.

 

 

[thepupil]

I like FCE;  it will be sold. News a few months ago that EQC would buy. NEws out today that brookfield will buy, but not for a big premium. I think it gets taken out in the high 20's. Small position w/ costs of $19.40 / share though, not sure if I'd buy it post B-field bump (ya ya I know everyday you aren't selling you're buying).

 

Not quite high $20's, but I'll take it.

https://www.bloomberg.com/news/articles/2018-07-31/brookfield-is-said-to-near-6-8-billion-deal-for-forest-city

 

Overall, REITs have done quite well lately and the private market bid has come in a few times (Brookfield, Blackstone, etc.).

 

I'm more or less fresh out of interesting ideas, clinging to a large position in EQC (an exercise in watching paint dry) and a small, low conviction position in Vornado.

 

Recently took a look @ British Land in the m60's as % of NAV w/ an LTV of 26%, but the cap rate used to value NAV is 4-5% which is tough given the heavy retail exposure and Brexit/macro risks. 

[CorpRaider]

Did you listen to the EQC call yet?

[thepupil]

Did you listen to the EQC call yet?

 

Seems like more of the same, did I miss something significant that you heard/read?

[CorpRaider]

No, I was just being lazy/hadn't read transcript yet.  I read it now.  Agree.