Written by: Brad Thomas
10 NOTES FROM MY REITs FIELD JOURNAL:
1. As a real estate investor for over three decades, I’ve seen a number of economic cycles – and the power of financial discipline.
2. Thousands of empirical studies show that companies usually don’t make good use of their cash – when it’s lying around, they usually spend it on projects that don’t benefit shareholders.
3. Not just with REITs, but in general, shareholders are better off when companies pay out earnings as dividends. When a company wants to make an investment, shareholders benefit if capital is raised by “going outside” – floating a secondary equity offering or corporate bond, or seeking private debt from a bank or other source, etc.
4. Companies get timely feedback: if “what they want to do” is good, then funding will be available on favorable terms. If it’s a bad idea, it will be harder to find funding.
5. And funding comes with a cost, and a high equity multiple provides the company with a better cost of capital, that’s also “capital market discipline.”
6. So, if company managers are making good use of cash, they don’t need to withhold dividends because the company will consistently have favorable access to capital.
7. The most common reason a company has, to avoid paying dividends, is to avoid subjecting itself to capital market discipline – which means company managers retain the ability to make bad use of their cash.
8. Empirical evidence shows dividend policy affects company management decisions, and companies that pay out most or all of their free cash flow as dividends, do better (all things being equal) than companies that hold onto their free cash flow.
9. To help prove the point, I had to conduct my own experiment, comparing 5 of my top SWAN (Sleep Well At Night) picks… with 5 randomly-picked non-REIT blue chips… over 5, 10, 15, and 20 years. (The non-REITs were: BAC, KO, PG, JNJ, and WFC.)
10. My hand-picked blue-chip REITs performed well over the years (despite lackluster performance in the first quarter 2018). In fact, in the two-decade history, comparing my REITs with the non-REIT blue-chips, four of the five REIT companies… out-performed. The average annualized price increase for all 5 REITs over 20 years was 24.3% vs. 7.3% for the non-REITs.
Here are the five REITs that out-performed… due to their powerful capital management discipline – with an extraordinary record of dividend growth.
Realty Income O[NYE] – $58.37 : Triple Net Lease REIT with high-quality tenants (over 51% investment grade-rated). Conservative capital structure. Prepared for rising rate environment by maintaining highly disciplined balance sheet. Uses low leverage to mirror long-term lease liabilities, generates healthy investment spreads. High retail exposure, mostly necessity-based. Traditional retail generates 81% rental revenue, industrial 13%. Increased 2018 acquisitions guidance to about $1.75 billion (prior $1 billion to $1.5). Credit rating just increased by Standard & Poor’s from BBB+ to A-. Annual dividend yield 4.52%, paid monthly.
Simon Property Group SPG[NYE] – $180.07: Mall owner well-diversified by geography, tenants, and real estate sector revenue perspectives. Properties in Florida, Texas, and California deliver over a third of Net Operating Income. Tenant pricing power, given its high-quality properties. Impressive moat using its scale and cost of capital advantages. Sears and J.C. Penney weakening, but Simon has highest quality malls (sales per sf). Owns 21.1% of Klépierre (shopping centers in 16 European countries). Reasonable debt levels and balanced debt maturity schedule. Strong balance sheet. Only Mall REIT with A & A2 rating. Superior operating financial flexibility to continue to create long-term value for shareholders. Well-covered dividend yield 4.30%.
Federal Realty Investment Trust FRT[NYE] – $129.38 : Highly diversified portfolio, no single tenant over 3% ABR, no single category greater than 9%. Owns flexible real estate purposefully positioned to be real estate of choice for widest selection of tenants. Holds power centers (12%), super-regional centers (25%), mixed use (31%), grocery-anchored (26%). Tactical exposure in retail portfolio, focusing on underlying demographics and high-quality tenants. Relatively low 3.14% dividend, but paid out and increased every year for 50-years (average increase 5.4% annually the last 10 years). Well-positioned with capital strength.
National Retail Properties, Inc. NNN[NYE] – $45.95: Unlike larger net lease REITs, focuses exclusively on “small-box retail” of around $2-4 million investments. Primarily customer services & experiences, e-commerce resistant necessities, little exposure to apparel or mall-based concepts. Modest rollover of about 1% leases coming up for renewal. Good tenant health, including restaurants, many with same-store sales growth (helps to pay rents). Guidance: AFFO/share +4.5 to 5% per year. Declining AFFO payout ratio means dividend is much safer. 4.36% yield. One of the few REITs that have successfully grown their dividend over 25 consecutive years.
Essex Property Trust Inc. ESS[NYE] – $244.38: Only public multifamily REIT dedicated exclusively to coastal markets of California and Washington with high barriers to entry, favorable demographics, and diverse demand drivers. Highest total return of all public REITs since the IPO in 1994. Ownership interests in 247 apartment communities comprising more than 60,000 apartment homes with an additional 6 properties in various stages of active development. Investment-grade rated balance sheet (BBB+, Baa1, and BBB+) with favorable leverage. Dividend yields 3.07%, with 24 consecutive years of dividend growth.
Note: We will provide a detailed SWAN (Sleep Well At Night) research report in the September edition of subscriber-based Forbes Real Estate Investor.
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