A Tipping Point For REIT Investors

Malcolm Gladwell rose to success after penning a New Yorker article called “The Tipping Point,” which also served as the basis for his first book (in 2000). As the highly acclaimed author explained in the book,

“At various points in modern history, ideas, products, messages, and other behaviors have suddenly and unexpectedly become very popular. Certain clothes become fashionable, crime rates go down at an unprecedented rate, and religions find millions of new worshippers.”

The author calls the phenomenon a social epidemic and he describes three ways to understand social epidemics:

• In terms of the people who cause them.
• In terms of the content of the epidemic (i.e., the product, message, idea, or behavior being spread)
• In terms of the environment or context in which the epidemic takes place.

If you haven’t read Gladwell’s book, I suggest you do so.

Today I want to tell you about the tipping point in the real estate investment trust, or REIT, sector.

I Started Writing Here in 2010

As most of my readers know, I began writing on Seeking Alpha in 2010 and since that time I have penned just under 3,900 articles.

Back in the early days, there weren’t that many investors interested in REITs, as most companies (and their investors) were clawing out of the Great Recession.

Given the fact that most REITs either cut or suspended their dividends during the GFC, many investors were skeptical.

As you can see above, REITs – represented by (VNQ) – dropped 72% (from Jan 2007 to March 2009) and shares did not fully recover until 2015 (as seen below):

So, for much of my career writing on Seeking Alpha, REITs witnessed solid performance – shares were +107% from 2010 through 2019 (11.9% annually excluding dividends):

Then in 2013, the taper tantrum sparked panic after investors learned that the Federal Reserve was slowly putting the brakes on its quantitative easing (“QE”) program.

In the period since the GFC, the Fed had tripled the size of its balance sheet from around $1 trillion to around $3 trillion by purchasing almost $2 trillion in Treasury bonds and other financial assets to prop up the market.

Investors had come to depend on the ongoing massive Federal Reserve support for asset prices through its ongoing purchases and REITs were on top (outperforming SPY by a wide margin), generating 61% appreciation as shown below:

However, when Ben Bernanke, the former Fed chief, started to talk about the end of QE, REIT investors reacted accordingly. This is why REIT shares underperformed in 2013 after three subsequent years of outperformance – as shown below:

Then, in 2014 and 2015, REITs were on top once again.

Recapping REIT returns since I began writing on Seeking Alpha from 2010 to 2019:

• 2010: 28.0%
• 2011: 8.3%
• 2012: 19.7%
• 2013: 2.9%
• 2014: 28.0%
• 2015: 2.8%
• 2016: 8.6%
• 2017: 8.7%
• 2018: -4.0%
• 2019: 28.7%.

The average performance over these nine years was 14.6%.

To be honest, it was like shooting fish in a barrel, and that’s a primary reason that many investors began to invest more heavily in REITs.

Our Durable Income Portfolio returned roughly 13% per year, and our Small Cap REIT portfolio returned around 35%.

Life was good!

Then, there was a tipping point…

The Global Pandemic

I’ve lived through eight recessions, which includes four recessions (as an investor)

The first one was the early 1990s recession that was triggered by the same inflationary pressures we’re seeing today. The Fed raised rates from 1986 to 1989, and this recession only lasted eight months and peak unemployment hit 7.8%.

The next recession was the early 2000s recession that was triggered by a combination of the dot-com bubble and the September 11 attacks. It also lasted 8 months, and peak unemployment was 6.3%.

Then there was the Great Recession, which was the most memorable for me, which was caused by the subprime mortgage crisis that led to the housing bubble.

This recession lasted 18 months, and peak unemployment was 10%.

Finally, there was Covid-19, which led to the fourth recession of my investing career in which 24 million people lost their jobs in just three weeks (in April 2020).

This was the shortest recession on record, helped by Internet activity, zero interest rates, and the loosening of fiscal policies by the Federal Reserve.

As seen below, REITs – represented by VNQ – have fallen by 18% since January 2020, compared with SPDR® S&P 500 ETF Trust (SPY), which has grown by 35%.

2023 has been an especially difficult year for REITs, as evidenced by the screenshot below (VNQ -8.4% YTD).

It’s important here to stop here and remind you that you should not paint all REITs with the same brush.

Do you own any of these REITs? (I do, as you can see in bold.)

Or maybe you own these REITs?

I was not writing on Seeking Alpha in 2008 and 2009, so I can only imagine what it would be like for other writers or investors.

I know what it feels like to lose 60% (in value) in one or two stocks (like MPW and SAFE), but I cannot relate to seeing my entire REIT portfolio go down in value by over 70%, as in 2008 and 2009.

Get Ready for 2024

One of the things I learned about REITs over the last 13 years is that most of them are in much better shape now than they were in 2009.

To be clear, I said “most” and not “all.”

To a large extent, many of the REITs in 2008 were highly leveraged, and it took a black swan event like the Great Recession to get management teams to become more responsible. As Nareit explains,

“Although recent bank failures are turning the screws further on the availability of capital for commercial real estate, most publicly listed REITs are well positioned to navigate in a more capital constrained marketplace.”

Today, REITs are sitting on stronger balance sheets as compared to where they were in 2008, and the financing landscape is by no means as dire as what existed when capital dried up during the GFC.

REIT management teams have laddered out maturities and reduced their leverage with less exposure to floating rate debt. A lot of REITs have not only addressed their 2023 maturities but also their 2024 maturities.

Debt maturities for rated REITs that issued bonds that expire in 2023 and 2024 were at $20 billion and $40 billion, respectively. Maturities climb to $50 billion in 2025 and $70 billion in 2026.

Also, the majority of bank lines of credit held by REITs are undrawn, which means that there’s plenty of capacity for most REITs to wait out this environment.

Although rates are likely to remain higher for longer, our team is laser-focused on researching the highest quality REITs that can continue to grow earnings and dividends during the current environment.

Following the GFC, a common strategy among REITs was to de-lever balance sheets so they would be in a better position to take advantage of growth opportunities that emerge in market downturns. Now, those strategies are paying off.

Mergers and Acquisitions

There are plenty of REITs today that are in great shape to go out and play offense, and make accretive investments and find opportunistic deals, including M&A.

Looking back at M&A since the global pandemic you can see a number of deals:

2020

Simon Properties Group (SPG) acquired 80% ownership in Taubman Centers for $3.4 billion.

2021

Realty Income (O) merged with VEREIT in an $11 billion all-stock transaction.

Kimco Realty (KIM) merged in a $3.8 billion deal with Weingarten Realty

Kite Realty (KRG) merged with Retail Properties of America

Blackstone (BX) acquired QTS Realty for $10 billion.

American Tower (AMT) acquired CoreSitre for $10.1 billion.

VICI Properties (VICI) buys MGM Growth Properties for $17.2 billion.

2022

Industrial Logistics Properties (ILPT) acquired Monmouth Real Estate for $4 billion.

KKR (KKR) and Global Infrastructure acquired CyrusOne for $15 billion.

Blackstone (BX) buys Preferred Apartment for $5.8 billion.

Healthcare Realty (HR) acquired Healthcare Trust of America for $17.6 billion.

Blackstone (BX) acquired American Campus for $12.8 billion.

Prologis (PLD) acquired Duke Realty for $23 billion.

2023

Ready Capital (RC) merges with Broadmark Realty to become the fourth-largest commercial mortgage REIT

Extra Space (EXR) merges with Life Storage in an all-stock transaction valued at $12.7 billion.

Regency Centers (REG) acquires Urstadt Biddle in an all-stock transaction, valued at approximately $1.4 billion.

Kimco Realty (KIM) has agreed to acquire RPT Realty (RPT) in an all-stock deal for $2 billion.

Healthpeak Properties (PEAK) to acquire Physicians Realty (DOC) for $2.64 billion.

Realty Income to acquire Spirit Realty (SRC) for an all-stock price of $9.3 billion.

That’s 19 deals in around 3 years, or an average of one M&A deal every other month.

Last week I interviewed Joey Agree, CEO at Agree Realty (ADC), and he explained,

“We’re going to see 20 to 30 REITs go away. We have too many REITs. Too many banks and too many sell-side analysts…we’re going to so inefficient companies go away. I don’t see a place for REITs sub $3 billion dollars.”

I happen to fully agree with Mr. Agree.

I see more M&A opportunities ahead, especially in the net lease, shopping center, and apartment sectors.

This is part of the so-called “tipping point” that I’m referring to here which validates the fact that REITs like Agree Realty, Realty Income, VICI, and Kimco are well-positioned to grow even in this current rate environment.

The REIT Maven

Back to Malcomb Gladwell’s book, The Tipping Point, in which he points out that a market maven is a person who researches prices in order to find the best deal. They play a crucial role in the economy: they keep businesses honest.

As I pointed out, I’ve been a voice on Seeking Alpha for over 13 years and I hope you consider me a REIT maven. I’ve earned my stripes (most followed on Seeking Alpha with over 113,000 followers) and battles-tested (4 recessions and a global pandemic).

So, folks, I suppose you could say that I have a certain degree of street cred.

While there’s certainly fear in the market with regard to commercial real estate right now, REIT valuations are back to levels last seen a decade ago, and the sector is screening very attractive.

When I began writing on Seeking Alpha in 2010, I was not prepared to scoop up bargains because I was still licking my wounds from being a developer in 2007.

However, after witnessing the evolution of REITs over the last 13 years I can say that now is one of the best times in my life to take advantage of the bargains.

But you MUST be selective!

The key to success is to focus on both quality and value.

Three such examples include…

Realty Income now trades around $50.00 per share with a P/AFFO of 12.6x (the normal multiple is 17.7x). The dividend yield is 6.1% and well-covered with a payout ratio of 76%.

Keep in mind, the rental stream is stronger than ever, especially when the company integrates the SRC portfolio which will boost the total portfolio size to over 15,000 rent checks. Analysts are forecasting growth of 4% in 2024 and 2025.

Our base case total return estimate is 25% annualized:

Agree Realty is now trading at $56.65 with a P/AFFO of 14.4x (the normal multiple is 20.3x). The dividend yield is 5.2% and is well covered by AFFO with a payout ratio of 74%.

In my interview with Joey Agree last week, he told me that the company could grow by 3% annually if it did nothing at all, although he did point out that was not likely. I’m sure that, due to lessons Joey learned from 2008 and 2009, he’s much more defensive (like me), and that helps me sleep well at night.

Our base case total return estimate is 20% annualized:

VICI Properties is now trading at $28.46 with a P/AFFO multiple of 13.4x (normal is 16.5x). The dividend yield is 5.8% and well covered (75% based on AFFO per share).

I interviewed VICI’s CEO, Ed Pitoniak, last week, and he said,

“We’re a pure play experiential REIT. As I look across the REIT landscape, we don’t see any pure play experiential REITs that we would acquire. If we do REIT M&A deals, we would be drifting strategically.”

Analysts are forecasting growth of 4% in 2024 and 2025.

Our base case total return estimate is 20% annualized:

Constant Change

The book (The Tipping Point) concludes that the world is not immovable and is constantly “tipping” in different directions, because of the laws of social epidemics.

As I see it right now, REITs are cheap, and some (of them) should be.

Whereas others are cheap and deserve to be trading at higher multiples, and some much higher multiples.

This high interest rate environment has created the perfect storm for higher-quality REITs to continue to grow, consolidate, and scale.

M&A is just one such tool as we suspect sale-leasebacks and acquisitions will serve as other growth mechanisms.

I like how Gladwell uses the phenomenon of snow as an example of a Tipping Point that everybody knows: water gets colder and colder without changing visibly – but then when it cools to below 32 degrees, it suddenly changes in very obvious ways.

Events in life happen suddenly and unexpectedly, and while we’ve all witnessed the volatility of REITs over the last few quarters, I suspect the tipping point for REITs is near…

But again, stay focused on quality balance sheets, quality properties, quality earnings, quality dividends, and quality management.

This is why I’m continuing to grow my portfolio strategically, methodically, and defensively.

Happy REIT Investing!