Written By: Brad Thomas
Yes, good things come in small packages – REIT investing is no exception – so here are 5 “Small-Cap” Real Estate Investment Trusts worth considering for your portfolio.
But first, a (small) handful of reasons that I like Small-Cap REITs:
1. With Small-Caps, I can fish for bargains, and try to identify soon-to-be “big players” in an otherwise small-cap pond. It’s worth going where many analysts, “the Street,” and other investors often fail to look. I like looking for trends and finding them: the small-fry company on an upswing, the underdog racing past in victory, the seemingly newly-hatched “overnight” sensation whose business plan has been underway for a decade.
2. As a long-time REIT aficionado and analyst, I’m quite comfortable researching REITs for hours – and then collecting my dividends, especially as they grow over time, all while I simply hold the shares.
3. There are important guidelines and rules for successful Small-Cap REIT investing. With less volume of shares traded for a given ticker symbol, the price spread will typically be wider. Placing limit orders instead of market orders can help prevent your final price from getting attached to the higher (“ask”) side of the spread.
4. With lower volume, a more thinly-traded stock may not have enough supply when you want to buy – so again, patience is required.
5. With smaller company balance sheets, fewer and less diverse holdings, and oftentimes limited or narrower future prospects, it’s good to restrict your small-cap holdings to a smaller portion of your portfolio – often as “speculative” buys, and not to exceed a 1% holding for any one stock.
Look for my entire 21-stock Small-Cap Portfolio – and all of my REIT recommendations in the August Forbes Real Estate Investor newsletter, publishing Wednesday. To whet your appetite – here are 5 Small-Cap REITs that can enhance your investments:
SMALL-CAP BREAK OUT CANDIDATE #1:
The Big WHY: CareTrust completed its spinoff from The Ensign Group Inc. (ENSG[NGS] – $35.74 1.37 (3.69%) in June 2014 when the Mission Viejo-based company became a separate publicly traded REIT. Ensign Group split into two publicly traded companies through a tax-free spin-off transaction (in June 2014) and the resulting real estate company, CTRE, is one of the smallest REITs in the healthcare sector.
Feathers in Their Cap: CTRE’s performance has been differentiated through its partnerships with well-capitalized regional operators and operationally-focused underwriting. CTRE has focused investments on skilled nursing (72% of ABR), multi-service campuses (13%), and senior housing (14.6%).
Downsides: One of CTRE’s top 5 tenants, Pristine, has been forced to transition assets. As a result, CTRE has reduced exposure (to Pristine) from then over 15% of revenue to less than 7% at year-end run-rate revenue. Also, CTRE is rated BB- by S&P.
Performance YTD: 2.4% (but shares have returned 27% since May 1st).
Alpha Insider Management Update: CTRE is yielding 4.9%, one of the lowest in the peer group, but the company also has the lowest payout ratio in the healthcare REIT sector (~60%).
Bottom Line: CTRE shares are trading at $16.70 with a P/FFO multiple of 13.5x (4-year average is 14.5x). We believe this small cap ($1.2 B market cap) has more room to run.
SMALL-CAP BREAK OUT CANDIDATE #2:
The Big WHY: DEA is the only internally-managed REIT with a focus on investing in U.S. government-leased buildings. The other direct peer is Government Properties Income Trust (GOV), an externally advised REIT. Since 2010, DEA has acquired 48 properties encompassing 3.8 million square feet, including 44 properties leased primarily to U.S. government tenant agencies, and two properties entirely leased to private tenants.
Feathers in Their Cap: DEA sticks to critical missions of the Federal government that don’t go out of favor – agencies such as the Federal Bureau of Investigation and Immigration and Customs Enforcement.
Downsides: DEA’s common stock offering in June prompted a pullback, in which the company said it was acquiring 14 new buildings for $430.0 million (at a 6.5% cap rate). Given DEA’s cost of capital today (of around 5.5%), the portfolio appears to be accretive, but there is integration risk to consider.
Performance YTD: -7.0%
Alpha Insider Management Update: DEA has a high-quality earnings stream that provides the company with stable dividend growth. The combination of these two (5.4% yield + 5% growth) suggests that the company is a SWAN-a-be (“SWAN Wannabe”) – and see all the SWAN-a-bes in the upcoming edition of Forbes Real Estate Investor).
Bottom Line: DEA shares trade at $19.25 with a P/FFO multiple of 15.3x (2-year average is 17.1x). The dividend yield is 5.4%, and we like this small cap ($1.162 B market cap) for its durable pure-play focused platform.
SMALL-CAP BREAK OUT CANDIDATE #3:
The Big WHY: City Office was formed on November 26, 2013, to acquire, own, and operate high-quality office properties located within its specified markets in the U.S. The company listed on the NYSE on April 11, 2014 (over three years ago) by raising ~$82 million at a price of $12.50 per share. It is one of the smallest office REITs in our research lab, with a market cap of around $461 million.
Feathers in Their Cap: CIO invests in high-quality office properties in mid-sized metropolitan areas with strong economic fundamentals, primarily in the southern and western U.S. The company focuses on assets valued at $25-100 million with targeted cap rates of 7-8% (not as much competition for these assets, and this is a competitive advantage).
Downsides: CIO’s continued focus has been to push out-lease terms, with high credit tenants, reinvest in buildings to elevate its market position and find creative ways to unlock value at the properties. Retention risk is a primary concern.
Performance YTD: 2.3%
Alpha Insider Management Update: CIO’s dividend is $.235 per share, and the company generated $.18 per share in Q1-18; however, the company expects it will cover the dividend (by AFFO) in Q4-18. Maintaining STRONG BUY recommendation and we believe as CIO’s dividend becomes safer (payout ratio under 100%), the valuation gap should tighten.
Bottom Line: CIO shares trade at $12.78 with a P/FFO multiple of 12.2x. The dividend yield is 7.4% and CIO is expected to generate 18% FFO/share growth in 2018 and double digits in 2019.
SMALL-CAP BREAK OUT CANDIDATE #4:
The Big WHY: In December 2014, CTT completed its public offering of 10.526M shares of Class A stock at $13.50 per share and raised gross proceeds of around $142M. The company has opted to focus on high-demand southeastern U.S. markets – “the fiber markets” – where it owns around 508,000 acres of timberlands. CTT operates in four distinct markets – Mid-Atlantic, Coastal, South Central, and Southwest – with diverse mills, well-capitalized customers, and strong productivity.
Feathers in Their Cap: CTT’s business model focuses on harvest operations of owned and leased timberlands to secure durable earnings and does not include more volatile land development and manufacturing. CTT strategically manages harvest plans, operating in prime mill markets for sawtimber and pulpwood, to serve customers and optimize yields within sustainable parameters.
Downsides: CTT is seeing acquisition opportunities from a pricing and return perspective in the company’s very robust pipeline. These opportunities extend throughout the U.S. South as well as in the Pacific Northwest.
Performance YTD: -1.9%.
Alpha Insider Management Update: CTT announced a joint venture that will buy 1.1M acres of east Texas timberland for $1.39B. For an investment of up to $227.5M, CTT will more than triple the number of acres under its control and management to about 1.6M acres. The JV will assume existing long-term sawtimber and pulpwood supply agreements with Georgia-Pacific and International Paper (IP[NYE] – $53.18 1.16 (2.23%).
Bottom Line: CTT’s shares trade at $12.58 with a P/EBITDA of 13.2x. The dividend yield is 4.3% and analysts forecast CTT to grow substantially in 2018 and 2019. This is a small cap ($617 million), but we find this pick worthy of consideration.
SMALL-CAP BREAK OUT CANDIDATE #5:
The Big WHY: CORR can provide a source of funds from something that already exists on its balance sheet. It can sell relatively low-returning critical assets and then redeploy those dollars into higher-return opportunities, thereby enhancing the value of its enterprise.
Feathers in Their Cap: CORR owns assets that are critical to upstream counter-parties that are located in desirable fields that are integral to their overall operations. This REIT has proven that the revenue stream is reliable, even in periods of distress, as long as the assets are critical to the upstream operators. Having come out of the energy crisis with its strategy validated, CORR has become a battle-tested REIT that is now better prepared to scale into a safer investment platform.
Downsides: CORR is exposed to considerable tenant risk within the portfolio, and although the assets appear to be mission critical, investors must be satisfied with the risk and proceed accordingly.
Performance YTD: 2.7%.
Alpha Insider Management Update: Although CORR does not have the diversification of the peers, we like the company’s conservative capitalization strategy and modest payout ratio (also CORR continues to receive participating rents, which contribute to increase the dividend coverage). While CORR has capacity to grow the dividend, the company recognizes the dividend is already attractive.
Bottom Line: CORR shares trade at $37.52 with a P/AFFO multiple of 9.5x. The dividend yield is 8.0% and the company is well-positioned to capitalize on corporate sale/leasebacks to drive earnings.
In closing: My Small-Cap REIT portfolio in 2017 generated returns in excess of 22%. The key is to focus on fundamentals and always maintain adequate diversification. As Sir John Templeton explained, “The only investors who shouldn’t diversify are those who are right 100% of the time.”
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